Don’t be fooled by banks’ reserve releases
As Covid cases surge, the widespread hope that economic growth will contain defaults and banks will emerge unscathed looks optimistic.
On Tuesday, the Financial Stability Board released its preliminary report into lessons learned from the Covid pandemic, while acknowledging that it is not over and that its financial impact has only been mitigated by extraordinary monetary and fiscal policy.
The FSB sees a need to strengthen resilience in non-bank financial intermediation. It highlights the procyclicality inherent in margin calls, while looking back to the dash for cash at the start of the pandemic that revealed vulnerabilities stemming from liquidity mismatches, leverage and interconnectedness.
Central banks, in effect, replaced the markets.
Banks’ asset quality will deteriorate when the bulk of the public emergency support is withdrawn
That allowed some companies to increase leverage when they perhaps should have been put out of their misery.
High corporate and sovereign indebtedness was already a concern before the outbreak of Covid-19, the FSB points out. Rapid and large credit support has since increased debt levels, especially in the hardest-hit sectors.
As banks now start to report second-quarter earnings boosted by reserve releases, the FSB worries that the current low level of corporate insolvencies is predicated on continued policy support.