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Home Finance

COVID-19 Crisis Threatens Financial Stability

by Jacob Warrior
April 21, 2021
in Finance
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COVID-19 Crisis Threatens Financial Stability
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The COVID-19 pandemic has caused unprecedented human resources and health crisis. The measures required to contain the spread of the virus triggered an economic downturn. At the moment, there is huge uncertainty about its depth and duration. The latest edition of the Global Financial Stability Report shows that the financial system has already been hit hard, and further exacerbation of the crisis could affect global financial stability.

Since the outbreak of the pandemic, there has been a sharp drop in the prices of risky assets: at the low point of the recent active sell-off, the prices of at-risk assets have declined by half or more of their declines in 2008 and 2009. For example, many stock markets — large and small countries alike — experienced price declines of 30 percent or more at the bottom. Credit spreads have jumped, especially for lower-rated companies. There were also signs of stress in major short-term finance markets, including the global US dollar market.

Market tensions

Amid uncertainty about the economic impact of the pandemic, volatility has spiked, in some cases to levels last seen during the global financial crisis. With the surge in volatility, there has been a significant decrease in liquidity in markets, including in markets that are traditionally viewed as capacious, such as the US Treasury market, which has contributed to sharp surges in asset prices.

Central banks around the world have become the first line of defense, taking steps to maintain the stability of the global financial system and support the global economy. First, they have substantially liberalized monetary policy by cutting policy rates – in the case of advanced economies to record lows in history. And half of central banks in emerging market and low-income countries have also cut policy rates. The impact of lower interest rates will be reinforced by guidance from central banks on the future trajectory of monetary policy and expansion of asset purchase programs.

Second, central banks have provided additional liquidity to the financial system, including through open market operations.

Third, a number of central banks have agreed to provide USD liquidity through credit line swap arrangements.

Finally, central banks have resumed programs used during the global financial crisis and launched a number of new large-scale programs, including to buy riskier assets such as corporate bonds. By entering these markets essentially as “buyers of last resort” and helping to contain upward pressure on the cost of credit, central banks are ensuring that households and companies can maintain access to credit at an affordable cost.

So far, central banks have announced plans to expand liquidity provision – including through loans and asset purchases – by at least $ 6 trillion and have announced their readiness to take more ambitious measures if the circumstances warrant.

As a result of these actions, aimed at containing the recession caused by the pandemic, there has been a stabilization in investor sentiment in recent weeks. Tensions in some markets eased somewhat, and risky asset prices recovered part of the recent downturn. However, sentiment remains volatile and global financial conditions remain much tighter than at the start of the year.

Overall, the sharp tightening of global financial conditions since the start of the COVID-19 outbreak – coupled with a fundamental deterioration economic prospects – led to a large-scale leftward shift in the statistical distribution of forecasts of world growth for the year ahead. This indicates significant risks of deterioration in economic growth and financial stability. Currently, there is a 5 percent chance (a situation that occurs once every twenty years) that global growth will decline to below -7.4 percent. By comparison, in October 2019, this threshold was at over 2.6 percent.

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