Mr. Fabian Valencia, Richard Varghese, Weijia Yao, and Juan Yepez
The policy response to the COVID-19 shock included regulatory easing across many jurisdictions to facilitate the flow of credit to the economy and mitigate a further ampli-fication of the shock through tighter financial conditions. Using an intraday event study,this paper examines how stock prices—a key driver in financial conditions—reacted to regulatory easing announcements in a sample of 18 advanced economies and 8 emerging markets. The paper finds that overall, regulatory easing announcements contributed to looser financial conditions, but effects varied across sectors and tools. Financial regulatory easing led to lower valuations for financial sector stocks, and higher valuations for non-financial sector stocks, particularly for industries that are more dependent on bank financing. Furthermore, valuations declined and financial conditions tightened following announcements related to easier bank capital regulation while equity valuation rose and financial conditions loosened after those about liquidity regulation. Effects from non-regulatory financial measures appear to be generally more muted.
Outside of financial crises, investors have little incentive to produce private information on banks’ short-term liabilities held as information-insensitive safe assets. The same does not hold true during crises. We measure daily information production using data from credit default swap spreads during the global financial crisis and the subsequent European debt crisis. We study abnormal information production around major events and interventions during these crises and find that, on average, capital injections reduced abnormal information production while early European stress tests increased it. We also link information production to outcomes: high levels of information production predict bank balance sheet contraction and higher government expenditures to support financial institutions. In an addendum, we show information production on nonfinancials dramatically increased relative to financials at the height of the COVID-19 crisis, reflecting the nonfinancial nature of the initial shock.
Brandon Tan, Ms. Deniz O Igan, Mr. Maria Soledad Martinez Peria, Mr. Nicola Pierri, and Mr. Andrea F Presbitero
The COVID-19 pandemic could result in large government interventions in the banking industry. To shed light on the possible consequences on market power, we rely on the experience of the global financial crisis and exploit granular data on government interventions in more than 800 banks across 27 countries between 2007 and 2017. For identification, we use a multivariate matching method. We find that intervened banks experience a significant decline in market power with respect to matched non-intervened banks. This effect is more pronounced for larger and longer interventions and is driven by a rise in costs—mostly because of higher loan impairment charges—which is not followed by a similar increase in prices.
Carlos Caceres, Diego A. Cerdeiro, Dan Pan, and Suchanan Tambunlertchai
This paper analyzes a group of 755 firms, with aggregate indebtedness of US$6.2 trillion, to assess the solvency risks and liquidity needs facing the U.S. corporate sector based on projections of net income, availability and cost of funding, and debt servicing flows under different stress test scenarios. The paper finds that leveraged corporates account for most of the potential losses arising from the macroeconomic stresses associated with the COVID-19 crisis, with a concentration of these losses in the oil and gas, auto, and capital and durable goods manufacturing sectors. However, potential losses from corporate debt write-downs appear to be a fraction of banks’ capital buffers and, given the size of the leveraged segment and the relatively long duration of that sector’s debt, the near-term liquidity needs of these corporates appear modest. Corporate stresses could, however, amplify the current economic downturn—as firms cut investment spending and reduce employment—potentially giving rise to significant indirect losses for the financial system.
Mr. Marco Gross, Dimitrios Laliotis, Mindaugas Leika, and Pavel Lukyantsau
The objective of this paper is to present an integrated tool suite for IFRS 9- and CECL-compatible estimation in top-down solvency stress tests. The tool suite serves as an illustration for institutions wishing to include accounting-based approaches for credit risk modeling in top-down stress tests.
International Monetary Fund. Middle East and Central Asia Dept.
This paper presents an assessment of Somalia’s eligibility for assistance under the enhanced Heavily Indebted Poor Countries (HIPC) Initiative. The macroeconomic framework reflects the policy framework underlying the proposed three-year Fund-supported program. The debt relief analysis (DRA) remains largely unchanged, but some of the underlying debt data has been updated to reflect new information from creditors. In addition, this paper presents an assessment of debt management capacity in Somalia and a full Debt Sustainability Analysis under the Debt Sustainability Framework for Low-Income Countries. The DRA reveals that, after traditional debt relief mechanisms are applied, Somalia’s debt burden expressed as the net present value of debt-to-exports ratio is 344.2 percent at the end of December 2018—significantly above the HIPC Initiative threshold. Despite the challenging environment, progress on reform and policy implementation has been good and sustained reforms have translated into economic results. In addition to the coordinated support from the World Bank and the IMF, reforms have been supported by other development partners.