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    FSB Reports Assess Impact of Pandemic on Financial Stability

    November 17, 2020

    FSB published a letter from its Chair Randal K. Quarles, along with two reports exploring various aspects of the market turmoil resulting from the COVID-19 event. In the letter to G20 leaders, Mr. Quarles notes that FSB will continue to act to address vulnerabilities in the financial system exposed by COVID-19 and the new and emerging risks. One of the reports provides a holistic review of the March market turmoil while the other report considers the financial stability impact and policy responses to the COVID-19 event. Both these reports have been delivered to G20 leaders ahead of their November Summit.

    The report on holistic review of the March market turmoil finds that the breadth and dynamics of the economic shock and related liquidity stress in March were unprecedented. While stronger bank capital and liquidity positions, built over the past decade as a result of the post-crisis reforms, helped to prevent a sharp rise in counterparty risks, banks may have been unwilling or unable to deploy substantial balance sheet capacity in an uncertain and volatile environment. Dealers also faced difficulties absorbing large sales of assets, amplifying turmoil in short-term funding markets. Market dysfunction was exacerbated by the substantial sales of US Treasuries by some leveraged non-bank investors and foreign holders. Absent central bank intervention, it is highly likely that the stress in the financial system would have worsened significantly. The March turmoil underscores the need to strengthen the resilience of non-bank financial intermediation (NBFI). The review sets out an NBFI work program, which focuses on three main work areas: examining and addressing specific risk factors and markets that contributed to amplification of the shock; enhancing understanding of systemic risks in NBFI and the financial system, including interactions between banks and non-banks and cross-border spillovers; and assessing policies to address systemic risks in NBFI.

    The report on financial stability impact and policy responses to COVID-19 event finds that global financial conditions have overall continued to ease since the G20 meeting in July on the back of the decisive policy action taken earlier this year. However, risks to global financial stability remain elevated. Deteriorating credit quality of non-financial borrowers poses risks to the financial sector. The intensification of the pandemic, together with the resulting necessary government containment measures as well as greater uncertainty about its duration, is increasing vulnerabilities in the non-financial sector. These vulnerabilities may increasingly affect banks and the supply of financing to the real economy. If banks face rising loan losses and a worsening in asset quality, they may be tempted to tighten credit conditions. In addition, further credit ratings downgrades could put bond markets under pressure. The report highlights that it is critical to address potential obstacles to the use of bank capital and liquidity buffers to absorb losses and support lending, while avoiding harmful deleveraging. The use of analytical tools such as stress testing is important to inform the assessment of potential solvency risks on financial stability and adjustments in policy responses. Authorities’ communication of their expectations of future policy, at a time when conditions are changing fast and the outlook is uncertain, is important to support confidence.

     

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    Keywords: International, Banking, Insurance, Securities, COVID-19, NBFI, Systemic Risk, G20, Liquidity Risk, Stress Testing, Credit Risk, Financial Stability, FSB

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