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24 août 2022

Getting the World’s Financial System Beyond COVID - Financial Stability Board Interim Report

Thomas Krantz
Advisor to the Managing Director
This opinion comes in two sections. The first is a summary of preliminary findings of the Financial Stability Board, published in July 2022, on how to shake off the lingering effects of the Covid-19 pandemic. The second was a Joint Declaration made by WAIFC members in May 2020 on how they viewed the work to be done in those first months of the pandemic. The texts are strikingly similar in their calls to action, as well as in their internal tension: coordinated, simultaneous global policy to get the world’s financial system beyond the harms created by Covid is effectively limited by the greatly varying circumstances in each jurisdiction. That leaves the authorities with the imperative of being exceptionally clear in their public communications to limit harm to others as each advances on its bespoke path.

Key Points from the Financial Stability Board’s Interim Report

Recovery from the varied economic impacts of the COVID-19 pandemic has been different from one jurisdiction to another. In part, this has been due to different cyclical and structural factors, including health measures, and also to the different duration of health policy-related restrictions. Emerging markets and developing countries have had far more limited ability to provide additional policy support, in particular in the form of fiscal stimulus, and that explains the weaker recovery of many of those countries as opposed to wealthier nations. This increases the risks of significant long-term scarring in those poorer societies. Disruptions to global supply chains alongside global demand recovery, and in some countries greater demand stimulus, created upward pressure on inflation.  In response, global financial conditions began to tighten.

Russia’s invasion of Ukraine has added substantially to these pre-existing challenges, by causing a setback to global growth, triggering yet higher inflation, and adding to economic uncertainty. Elevated commodity prices increase industry costs, and high food and energy prices weigh on household incomes, particularly in poorer countries.

The varied causes of COVID-19's lingering effects exacerbate the challenges for policymakers in supporting a strong, equitable, and inclusive recovery. Vulnerabilities from the COVID-19 crisis may now materialize at a time when policy space is limited, and firms and households have reduced financial buffers. A more uneven global recovery increases the risk of negative spillovers from one jurisdiction or industrial sector to another.  Taken together, these setbacks are likely to add to hinder future growth.

A resilient global financial system is necessary for addressing these challenges.  It:

  • supports the financing of the economy through a steady supply of credit and low-risk premia;
  • ensures effective transmission of monetary and fiscal policy, and so allows for greater efficiencies;
  • helps to cushion possible external spillovers, ensures that financial markets can continue to price assets; and
  • enables risks to be hedged, and price transparency also reduces uncertainty.

The policy remedy requires effective domestic policies, containing cross-border spillovers, and addressing debt overhang issues. Close cooperation and information exchange amongst authorities becomes even more critical for ensuring appropriate bespoke policy responses.  Policy mixes must evolve with economic circumstances, providing the right tools and incentives as required, while remaining financially durable. These last few years have resulted in a rapidly evolving economic and financial environment, and so the authorities must continuously assess impacts, interactions, and trade-offs of policies affecting the financial sector - including stress tests to gauge the effect of tightening financial conditions on credit quality. Further, a better understanding of the build-up of hidden leverage in markets should also inform decision-making. The authorities must be vigilant as to whether, and how, support measures should be readjusted in terms of their targeting. Communication of policy can build on lessons learned during the pandemic.

The prospect of an uneven global economic recovery may increase the risk of negative spillovers. Exit strategies from extraordinary support need to reflect specific domestic economic conditions and avoid excessive financial market reactions, which may well limit the scope of authorities to engineer a synchronized exit across jurisdictions. For instance, clear and consistent messaging on central bank actions may help market participants to appreciate the motivation for, and drivers of, differences in policy normalization across jurisdictions. Cross-border spillovers can also be reduced by addressing excessive procyclicality in capital flows.

Targeted approaches and phasing-out of COVID-19 measures may help to mitigate the adverse effects of high debt. To this end, the authorities in each jurisdiction must pay attention to the coordination of the narrowing down and phasing out of these support measures while simultaneously providing for effective mechanisms to deal with the debt overhang caused by COVID-19 support measures, a task grown yet more complicated by heightened geopolitical tensions.

When commissioned in late 2021, the report commissioned by G20 governments was intended to discuss policies in the aftermath of a very great COVID-19 shock. Since then, the economic and financial market situation has evolved considerably. The final report will be presented to G20 heads of state and government in Jakarta and will outline how the FSB will address these issues going forward.

The WAIFC Joint Declaration of May 2020

“The world’s leading financial centers stand together and will do their part to mitigate the current crisis and to prepare for an economic recovery. International financial centers will play a vital role in getting the world’s economy back on its feet as well as in serving the real economy and society as a whole in the post-crisis period.

The global economic shutdowns necessitated by the pandemic have required unprecedented interventions, and our industry has been vital in supporting these actions. As soon as the Coronavirus is defeated, we will need to restart the global economy as part of the recovery process.

  • In the short term, resilience is critical. We need to protect and serve the most vulnerable parts of our economies.
  • Entrepreneurs and start-ups are key sources of innovation. We need to support them in challenging times with emergency funds.
  • SMEs are the backbone of our economies. They represent a large part of global employment, and we need to support them. They need access to both public and private funding.

The working population in general. Many people have lost their jobs due to the current crisis, and others are employed only part-time with lower wages. The financial industry needs to support them for keeping our societies together.

In the medium term, countries need to scale up investments and continue to develop digital infrastructures. During the phases of lockdowns, we have experienced the importance of digital services in finance and beyond.

To contribute to these different priorities, we have set up joint international working groups to issue new recommendations.

Our authorities have started to address these issues nationally, but we firmly believe that international cooperation for a global economic response is critical. We need to support various initiatives, including fiscal and monetary stimulus. In this way, mitigation action will be much more effective.

Governments and regulators need to continue to coordinate their response to the pandemic. Firms will need the space and regulatory assistance to focus on meeting the challenges ahead. Countries must avoid the self-defeating lure of protectionism and work together to open trade and investment constructively and sustainably for our economies.

And in the long run, it is essential that we reconsider our economic models and give a new priority to long-term perspectives, innovative business models, sustainable economies, and environmental and social considerations.”