BIS has published a brief note or Bulletin on the economic effect of COVID-19 outbreak on corporate sector liquidity. Based on a sample of 40,000 listed and large unlisted non-financial firms across 26 advanced and emerging economies, this Bulletin estimates that if 2020 revenues fall by 25%, then, in the absence of any rollover, debt service and operating expenses will exceed cash buffers and revenues in more than half of the firms sampled. Given this challenge, the Bulletin makes a strong case for policy interventions to avoid the negative consequences for the economy and financial markets.
In the short run, the COVID-19 shock challenges corporate liquidity by impairing corporate cash flows, which will likely go deeply negative for many firms as they are unable to cut their costs in line with plunging revenues. In addition, a number of factors compound this problem. Existing credit lines could provide firms with additional resources to help them meet short-term liquidity needs. However, credit lines often have a short-maturity and under the current stressed conditions banks may be reluctant to renew them. Taken together, these factors are placing enormous strains on corporate cash buffers. Both the ability of firms to roll over debts and the size of their cash buffers will have strong influence on their ability to cover operating losses and debt-service obligations.
Many governments have already taken bold action to avoid negative consequences for the real economy and financial markets. Bridging loans would help ensure that the sudden stop to corporate cash flows does not lead firms to a near term default on operating expenses, wages and salaries, or short-term obligations. However, such credit will increase corporate leverage, potentially creating solvency challenges further down the road. Given the size of existing credit lines, authorities may need to develop policies to monitor draw-downs and availability. One risk is that banks do not roll over expiring facilities. In this regard, governments can ease the rollover of credit lines by providing guarantees or credit enhancements. This would reduce bank capital needs when corporates use them.
The Bulletin emphasizes that mechanisms to prevent the seizing of trade credit would also be important. For example, schemes that help firms sell their receivables or receive credit against them, at least partly, may be needed. One possibility would be for central banks to offer a facility where certain short-term claims collateralized with specific types of assets can be re-discounted. Another would be for governments or a single government-related entity to take advantage of centralization to net out trade credit assets and liabilities. To be sure, such schemes would face limitations, not least in terms of moral hazard (manipulation of trade credit accounts) and adverse selection (assets on most risky borrowers would be submitted first). However, limiting such a facility to firms that did pay taxes over previous years and, hence, have been profitable and to assets and liabilities contracted prior to the virus outbreak could mitigate these limitations.
Keywords: International, Banking, COVID-19, Liquidity Buffer, Liquidity Risk, Credit Risk, Loan Guarantee, Regulatory Capital, BIS
The European Banking Authority (EBA) published four draft principles to support supervisory efforts in assessing the representativeness of COVID-19-impacted data for banks using the internal ratings based (IRB) credit risk models.
The European Council and the European Parliament (EP) reached a provisional political agreement on the Corporate Sustainability Reporting Directive (CSRD).
The Prudential Regulation Authority (PRA) launched a consultation (CP6/22) that sets out proposal for a new Supervisory Statement on expectations for management of model risk by banks.
The European Commission (EC) published the Delegated Regulation 2022/954, which amends regulatory technical standards on specification of the calculation of specific and general credit risk adjustments.
The Bank for International Settlements (BIS) Innovation Hub updated its work program, announcing a set of projects across various centers.
The European Insurance and Occupational Pensions Authority (EIOPA) published two consultation papers—one on the supervisory statement on exclusions related to systemic events and the other on the supervisory statement on the management of non-affirmative cyber exposures.
Certain members of the U.S. Senate Committee on Banking, Housing, and Urban Affairs issued a letter to the Securities and Exchange Commission (SEC)
The European Insurance and Occupational Pensions Authority (EIOPA) published a consultation paper on the advice on the review of the securitization prudential framework in Solvency II.
The Prudential Regulation Authority (PRA) issued a statement on PRA buffer adjustment while the Bank of England (BoE) published a notice on the statistical reporting requirements for banks.
The Basel Committee on Banking Supervision (BCBS) issued principles for the effective management and supervision of climate-related financial risks.