Reflections on Financial Regulators’ Initial Responses to COVID-19

5――International coordination

I served as the chair of the FSB’s Standing Committee on Supervisory and Regulatory Cooperation (SRC) from August 2019 to September 2021.

Within the FSB, the Standing Committee on Assessment of Vulnerabilities (SCAV) analyzed the impact COVID‑19 had on the financial system and market. Based on the SCAV’s analysis, the SRC proposed policy responses, and the Standing Committee on Standards Implementation (SCSI) monitored the implementation of the agreed responses. The SRC had 24 virtual meetings and published 23 reports and recommendations during the 19 months between the outbreak of the pandemic and September 2021, when I handed over the chair to Governor Bailey of the Bank of England.¹²

The SRC convened an online workshop in May 2020 to discuss what could occur and what should be done, inviting financial institutions, exchanges, and credit rating companies. The following introductory remarks I made at the workshop may convey how the regulators were feeling their way at the very early stage of the pandemic.¹³

Thank you everyone for joining this conversation.

Facing the COVID‑19 pandemic, the financial sector needs to meet three challenges: supporting the economy, sustaining itself, and preparing for the recovery. The official sector has strived to assist the private sector’s efforts to meet these challenges.

National authorities have taken agile actions: there are already 1,600 policy actions registered in the FSB database. Standard-setting bodies issued a series of guidance to extend the implementation timelines and to encourage the use of flexibility.

Individual jurisdictions tailored their responses to their own conditions but have coordinated with each other with the following five principles in mind:
First, we monitor and share information to address risks;
Second, we use the flexibility built into existing financial standards;
Third, we seek opportunities to temporarily reduce operational burdens on firms and authorities;
Fourth, we act consistently with international standards, and will not roll back
reforms; and
Fifth, we will coordinate on the future timely unwinding of the temporary measures taken.

And these principles were endorsed by the G20 Finance Ministers and Central Bank Governors in April.

The global financial system has entered the crisis with much enhanced resilience, as a result of your efforts and the G20 regulatory reforms. We have to admit that the shock in March was beyond the self-healing ability of the market: massive central bank actions were required to end the heightened volatility. But the banking sector has continued to finance the real economy and, in late March, capital markets started to resume their normal functions. Financial market infrastructures, including CCPs, have functioned well, despite the challenging external conditions, both financial and operational.

But we cannot be complacent. The world still faces an unprecedented level of uncertainty. We need to be prepared for a wide range of scenarios. What I would like to discuss today is how we should act at different phases of the crisis under a range of scenarios.

Looking back, what lessons can we draw from the policy measures already taken? What measures seem to be working well and what are not? Have we observed operational frictions or obstacles, trade-offs and potential unintended effects? How can we enhance the effectiveness of the measures taken?

And looking forward, what kind of possible developments should we be attentive to? Which risks are you particularly worried about? Liquidity, solvency or operational risks? Under a range of scenarios, how can the official sector ensure financing to the economy, financial stability, and eventually, a strong recovery? How should we take into account intertemporal trade-offs and macroprudential effects arising from the feedback loop between the various segments of the financial system and the real economy? What roles should stress tests play?

The official sector side is represented today by central banks, regulatory authorities, finance ministries, the Basel Committee on Banking Supervision, the Committee on Payments and Market Infrastructures, the International Association of Insurance Supervisors and the International Organization of Securities Commissions. We are keen to hear your inputs to better discharge our policy work so that the efforts by the private and official sectors will work together well to help overcome the pandemic and ensure strong recovery.

Countries face different pandemic conditions, and the regulatory responses need to be tailored. The ultimate responsibility to protect the lives of the nation lies in the national governments, and I thought that international organizations should refrain from excessively constraining national governments’ crisis management responses. At the same time, the past achievements in global regulatory reforms and convergence should not be surrendered.

The SRC started a soft coordination mechanism to support national authorities to take into consideration other authorities’ responses in designing their own by gathering response information from members on a real-time basis and weekly sharing compiled information.

The five principles mentioned in the introductory remarks above accommodate temporary deviations from international standards unless they compromise core regulatory objectives while referring to the timely elimination of deviations.

To provide useful input to the formulation of national responses, the SRC attempted to make its agenda as forward-looking as possible. The introductory remarks, which were given right after the stabilization of the March liquidity crisis, already refer to a potential solvency crisis and a post-pandemic economic recovery. Specifically, the SRC agenda included: (1) compilation and analysis of national stress testing practices, (2) consideration of when and how to unwind emergency measures, (3) coordination between supervisory and resolution authorities, and (4) ways to mitigate debt overhang and to deal with zombie corporations.

As a result of the discussion on the item (2) above, the FSB published a report titled “COVID‑19 Support Measures: Extending, Amending and Ending” in April 2021. The G20 ministers and governors welcomed the report in their communique.

At the time of the report, the second wave of the COVID 19 infection was growing and the report discussed extending and amending of support measures as well as ending. Particularly, on the choice of the timing of ending support measures, the report argues:

[W]ithdrawal of support measures before the macroeconomic outlook has stabilised could be associated with significant immediate risks to financial stability. At the same time, financial stability risks may gradually build if support measures remain in place for too long. On balance, most authorities believe that premature withdrawal of support could inflict more damage to the economy than maintaining support for too long.

The report also points out that authorities have a number of options for managing these trade-offs and may follow a flexible, state-contingent approach. Authorities may choose to adjust and withdraw support measures gradually by (1) ensuring that measures are targeted to those most affected, (2) requiring beneficiaries to opt in to receive support rather than automatically, (3) making the terms on which support is provided progressively less generous, and (4) sequencing the withdrawal of support measures rather than withdrawing all at once.

The report maintains that clear, consistent, and timely communication about policy intentions can help reduce risk of surprises and abrupt adjustments in financial markets and the costs associated with withdrawal of support.

The discussion of the agenda item (4) above resulted in the FSB’s publication of a discussion paper titled “Approaches to Debt Overhang Issues of Non-Financial Corporates” in February 2022. The paper was produced by a team of interested SRC members chaired by Toshiyuki Miyoshi and participated by Hiroaki Otsuki, both members of JFSA.

The discussion paper maintains that the debt overhang of nonfinancial companies could result in underinvestment by viable companies, misallocation of resources to unviable companies, and lower productivity due to loss of entrepreneurial capacity. These could result in a drag on the economic recovery and pose risks to the financial stability.

To address these risks, the discussion paper discusses (1) how to assess companies’ viability in the context of COVID‑19, (2) how to facilitate timely restructuring of viable companies and the exit of unviable companies; and (3) how to manage the debt restructuring of a large number of small- and medium-sized enterprises and micro-companies.

As noted, the solvency crisis or the issue of excessive debt has not materialized in the manner initially feared. Responses to debt overhang issues, however, will significantly affect the post-pandemic medium-term economic growth paths. The discussion paper, with rich examples of national practices, will help national authorities design their own responses.

¹² The member of the FSB secretariat in charge of SRC was Yasushi Shiina, who before joining the secretariat was a staff member of the JFSA. He repeated several times a month a cycle of setting agenda, coordinating the drafting of meeting documents, coordination with member authorities, briefing to the chair, drafting of the meeting summary, reporting to the FSB plenary, and publication of the agreed reports.
¹³ Himino Ryozo, Introductory Remarks at the FSB Virtual Meeting on Policy Responses to COVID‑19, 26 May 2020

6――In retrospect

The COVID‑19 pandemic has seen many waves and lasted much longer than many had initially anticipated. Neither a second liquidity crisis nor a solvency crisis, however, has occurred.

The firefighting toolbox the central banks developed to fight the GFC proved effective in containing the liquidity crisis and preventing its recurrence.

A solvency crisis has not occurred partly because the manufacturing sector recovered in late 2020 and early 2021. In addition, government grants, subsidies, and guarantees mitigated borrowers’ worsening financial condition. The post-GFC regulatory reforms enhanced the resilience of financial institutions and made it possible for them to continue to support the economy. Regulatory responses with unprecedented speed, scale, and scope should also have contributed to the continued functioning of the financial system. The COVID‑19 shock, however, has revealed the inadequacy of past regulatory reforms on nonbank financial intermediation.

In the past, regulators tend to focus on policies required to ensure financial stability against endogenous credit and business cycles. The pandemic caused regulators to focus on an exogenous shock. The risk of exogenous shocks, including climate changes, earthquakes, further pandemics, cyberattacks, and geopolitical incidents, would persist. The global policymakers’ responses to the COVID‑19 shock will be referred to as a precedent in future cases of exogenous shocks.

Please note: The data contained in this report has been obtained and processed from various sources, and its accuracy or safety cannot be guaranteed. The purpose of this publication is to provide information, and the opinions and forecasts contained herein do not solicit the conclusion or termination of any contract.