Covid-19 Liquidity Issues to Morph into Solvency Threat: BIS

Once the acute illiquidity phase of the crisis passes and insolvency problems emerge, the onus of crisis management will shift from central banks to fiscal authorities.

Central banks played a key role in the response during the acute phase of the Covid-19 pandemic, working with fiscal and prudential authorities to cushion the blow and support companies and workers, the BIS (Bank for International Settlements) says in its Annual Economic Report 2020.

“Nimbleness, boldness and decisiveness were called for. And central banks delivered,” said BIS General Manager Agustín Carstens. “However, it has been quite challenging, given the limited policy space available before the pandemic and the build-up of underlying vulnerabilities.”

Analysing central banks’ response to the “global sudden stop”, the BIS highlights the evolution of their role as lenders of last resort, marked by a shift towards providing funds to the non-bank private sector and, in emerging market economies, towards interventions in domestic currency asset markets.

The report also highlighted the use of prudential tools to preserve the flow of bank credit to firms and households, by temporarily easing capital and liquidity requirements and encouraging banks to make free use of capital buffers.

According to the BIS, the next phase of the crisis the focus will move from liquidity to solvency, where the long-term viability of many companies will be tested and corporate defaults will likely surge. Banks will also incur losses, impacting their ability to support the recovery.

To address the impending insolvency problems, governments will have take the lead to promote a strong and sustainable recovery through prudent fiscal policy, the report said.

“Only the fiscal authorities can transfer real resources outright, as opposed to just providing funding. And only they can, ultimately, support or implement efficient debt restructuring programmes… Balance sheet clean-ups are critical in re-establishing the conditions for a sustainable recovery.”

The report urges central banks to plan for how they will reign in Covid-19 support measures, amid concerns of complacency in financial markets, looming inflation and ongoing economic uncertainty.

The full report is available here.

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