Systemic Risk Council’s Advice for Central Banks, Banks, and Governments
The Systemic Risk Council, sponsored by CFA Institute, says the Covid-19 crisis does not need to lead to an economic meltdown. It calls on the authorities of the major economies to work together closely, and on international financial institutions to step in to support and guide smaller emerging-market and developing economies. Their goal, collectively and individually, must be to avoid a devastating depression that could harm families, businesses, and economies for a generation or more.
The SRC outlines specific suggestions on what banks and their supervisors, central banks, and government should and must do. Here’s a short recap of their recently published open letter to G20 ministers and central bankers.
Advice for banks
- Banks should immediately cease all equity buybacks and dividends and should be ready to suspend bonuses to a thick layer of senior and other highly remunerated staff in order to maximize their capacity to lend. If the health crisis lasts into next year, credit supply and the economy will be held back by distributions allowed during the current year,
- If banks seek to conserve capital, supervisors should permit them to use capital buffers to increase lending, and exercise prudent forbearance toward fundamentally sound borrowers, even if that reduces regulatory capital ratios in the short run.
- Supervisors should oversee a careful and appropriately gradual deleveraging of trading books by banks, dealers, and funds, including derivative books and repo and securities-lending books that are not supporting, including through market making, participants in the real economy or long-term investment institutions. This will entail difficult judgments, in the interests of ensuring that scarce financial system capital is deployed to the best possible purposes given the crisis.
A big role for central banks too
- Encourage the use of discount-window facilities by banks and other eligible borrowers, as some already are doing.
- Get ready to open the Window to other financial intermediaries whose distress would materially damage the real economy.
- Widen the collateral used in their longer-term market operations, with legislatures (for example in the US) permitting them to conduct repo operations against suitable privately issued securities.
- Prepare to act as market makers of last resort in capital markets that are fundamentally sound but in which malfunctions will be socially costly.
- Prepare for and conduct wider outright purchases of private securities and for these purchases to be guaranteed by governments);
Governments, as necessary with legislative backing, need to make a few things clear
- They will guarantee new loans by banks to businesses or households in distress, which should be eligible as collateral in central bank facilities;
- Provide direct aid to business sectors that are vital to addressing the health crisis.
- Provide direct aid to households who lose work or, for other reasons, cannot cope financially even though they remain healthy;
- Prepare plans, even if not published, for providing Capital-of-Last-Resort support to distressed but essential businesses for which funding support is not enough, but whose failure would unnecessarily impair economic prosperity once the health crisis has passed. A good tool here would be the use of convertible securities (which proved effective during 2008/09) with incentives to redeem quickly once crisis passes.);
None of this will be easy. If things deteriorate a lot more, whether quickly or slowly, governments may find themselves facing the question, not seen outside major wars, of whether to steer the economy’s production priorities, whether to support household spending with subsidies and welfare payments much higher than in normal circumstances. For all their interventions, governments and central banks should incorporate into their design incentives for a smooth exit when conditions permit. This is as important for forbearance in banking supervision as it is for central banks’ market support measures, and government subsidies and guarantees.
Systemic failure is not inevitable, even in times like these. But, avoiding it requires action.
Image Credit: © Getty Images /Sarote Pruksachat