The Financial Stability Implications of support measures to protect the real economy from the COVID-19 pandemic

The report shows that the fiscal response designed to support the real economy has stabilised lending and that the financial system has continued to function. However, as risks still lie ahead, the report also identifies policy priorities in terms of the design and duration of the fiscal measures, enhanced transparency and reporting, and preparedness for further adverse scenarios. The ESRB report provides the first assessment of the financial stability implications of crisis-related fiscal measures across 31 ESRB member countries. Macroprudential authorities reported fiscal support packages related to the COVID-19 pandemic of around 14% of member countries’ combined GDP (more than €2,400 billion) to the ESRB. The packages include public guarantees on loans, public loans, direct grants and tax measures. By September 2020, the reported uptake of these programmes was roughly 4% of member countries’ combined GDP. In addition, around 5% of banks’ total loans were subject to moratoria. Differences in fiscal measures reflect, to a large extent, different exposures to the pandemic. Countries hit harder by the pandemic tend to have larger programmes with greater uptake, while countries with a higher share of employment in vulnerable sectors rely more on direct grants. The uptake of moratoria is positively correlated with the pre-crisis debt levels of non-financial corporations and households. During the first phase of the pandemic a liquidity crisis was avoided and the financial system continued to function. Up to one-third of new bank lending to companies has been subject to crisis-related fiscal measures, and the prompt action taken by governments has been essential to mitigate the impact of the crisis on households and firms. The financial system has benefited from fiscal support programmes as well as from monetary policy. Moreover, a flexible approach within the existing regulatory frameworks has supported these measures, also by temporarily relaxing some bank balance sheets constraints. To date, increases in non-performing and forborne loans have been smaller than might have been expected, given the magnitude of the shock. Overall, spillovers from the real economy to the financial system have so far been contained. The longer the crisis lasts and the weaker the economic recovery, the greater the risk that losses in the non-financial sector could spill over into the financial sector. During this phase of the pandemic, authorities should focus on (i) targeting fiscal measures to the most affected sectors, (ii) monitoring private debt sustainability, given that some of the measures increase the indebtedness of borrowers, (iii) preparing for a scenario of increased distress in the corporate sector by promptly addressing potential administrative constraints with regard to dealing with non-performing loans and the insolvency process, (iv) enhancing financial institutions’ balance sheet transparency and upgrading reporting, and (v) coordinating policies across policy areas and countries. Authorities need to carefully manage the trade-offs related to the duration of the measures. The scale of potential future solvency problems depends on the evolution of the pandemic, the performance of the different sectors and the appropriateness of policy responses. Withdrawing fiscal support too soon could exacerbate the effects of the economic crisis and put financial stability at risk. Maintaining fiscal support for too long would increase budgetary pressures and could delay structural change. Managing this trade-off effectively requires access to timely and reliable information on the state of the economy and the effects of policy measures. The ESRB will continue to monitor the financial stability implications of fiscal measures. It has a broad mandate, which includes the monitoring and prevention of all risks affecting all types of financial intermediaries, markets and infrastructure. It is in this context that the ESRB considers the overall implications – and in particular the cross-border and cross-sectoral implications – of the COVID-19 crisis and the reactions to it for the financial sector as a whole. The ESRB is monitoring the measures that are implemented directly through the financial system, such as moratoria, public guarantees on loans and credit insurance, as well as measures of a fiscal nature that could have an impact on the creditworthiness of borrowers, issuers and investors. These include loans by public entities, direct grants, tax measures and public equity participation.