Simon Ray, economist at BSI Economics, answers three questions about the financial crisis linked to the COVID-19 pandemic.
BSI Economics – Is the financial crisis linked to COVID-19 comparable to that of 2008?
Simon Ray – The triggering event is undoubtedly different. The 2008 crisis is commonly analyzed as a crisis of confidence among financial market participants that threatened to bring down the global financial system and led to a sudden halt in financing for the real economy. The current economic crisis stems from an unexpected shock to the income of commercial activities resulting from social distancing measures and the shutdown of entire sectors of the economy. The duration of this shock is still very uncertain. The scale of the more structural effects of this crisis will largely depend on its duration, particularly in terms of sectoral redeployment and the restructuring of value chains, even if some changes already seem to be a foregone conclusion. While the financial sector appears to be holding up for the time being thanks to monetary policy support—to the point that some are surprised by the relative good health of certain asset classes— the S&P 500 is now at the same level as it was a year ago! – it is not certain that the shockwave will not shake it further in the coming months. We could then see the developments of the 2008 crisis superimposed on the current crisis. This prospect is particularly grim given the limited room for maneuver in fiscal and monetary policy.
Could the current crisis lead to a credit crunch?
The latest credit statistics from the European Central Bank show that corporate lending was buoyant in March (+5.2% year-on-year across the eurozone). Several factors explain this increase. Firstly, demand from businesses. Companies are seeking cash loans to avoid running out of cash in the face of drying up revenues or to strengthen their cash buffers in response to the shock of uncertainty. Second, measures to support credit supply. All major economies are supporting credit supply through government guarantee programs. In addition, supervisors have significantly relaxed capital requirements for banks, notably through countercyclical buffers and Pillar 2 requirements, thereby freeing up capital that can be used to increase credit supply (up to $5 trillion globally, according to a recent BIS analysis). Monetary policy is also supporting credit supply by allowing banks to access improved conditions for central bank liquidity and thus reduce their financing costs when lending to businesses. As a result of these economic policy measures, a credit crunch, i.e., a massive contraction in credit supply, has so far been avoided, but the risk remains in the medium term. Banks’ room for maneuver in terms of capital could be eroded by rising risk costs and declining profitability in the banking sector, particularly in Europe. Furthermore, the inevitable phasing out of government guarantee programs will inevitably raise the question of access to financing, outside of (tacitly) subsidized mechanisms, for companies weakened by the crisis.
Is the level of non-financial corporate debt a cause for concern?
During this crisis, many companies are converting their shortfall into future commitments, mainly through bank debt. This mechanism, supported by the public authorities, is an emergency response to prevent a massive and indiscriminate wave of defaults. This episode will result in a substantial increase in corporate debt, in absolute terms and even more so in relation to their production or profits. For example, in France, the aggregate amount of guaranteed loans announced by the government, which, given the pace at which they are being granted, is likely to be distributed in large part or even in full, could increase corporate bank loans by nearly 30% by the end of the year, assuming that these guaranteed loans are not used to roll over pre-existing debt. The question of whether this is cause for concern relates, for creditors, to the solvency of indebted companies and, for the economy more generally, to the impact of these debt levels on investment and employment. It is inevitable that the rise in debt in the current climate of ongoing uncertainty about the pace and conditions of the recovery in production and the state of demand will lead to an increase in defaults and a decline in investment. In this context, two structural challenges for medium-term growth are predominant. First, a significant number of companies will need equity financing in the future, either to make their liability structure sustainable again or to invest despite their accumulated debt. Capital financing ecosystems will need to be in place and adapt their offerings to possible new types of companies. Second, there is a risk of exacerbated divergence between companies that entered the crisis with significant room for maneuver—due to their debt levels, liquidity, equity, and ex-ante profitability—and others, which is likely to increase the market power of the strongest players. This means ensuring the effectiveness of competition policies and not exacerbating these difficulties with support policies that vary greatly between EU27 member states.
