Coronavirus Pandemic Could Pose ‘Major Resilience Test’ for Global Financial System, IMF Says

WASHINGTON—Huge government spending and other steps to boost coronavirus-stricken economies have limited immediate risks to global financial stability while fueling a debt buildup that could spell trouble later, the International Monetary Fund said Tuesday.

“The COVID-19 pandemic could be a major resilience test for the global financial system,” the IMF economists wrote in the Global Financial Stability Report. “Triggers such as new virus outbreaks, policy missteps, or other shocks could interact with pre existing vulnerabilities and tip the economy into a more adverse scenario.”

Companies that borrowed heavily at low interest rates to cope with the crisis may have trouble paying their debts, the report said, increasing the risk of bankruptcies. The danger is particularly acute among smaller companies that don’t have easy access to capital markets, it said.

Under such a scenario, bankruptcies could prompt an increase in borrowing and a tightening of bank lending standards, creating headwinds to a recovery, the IMF said.

The impact could be especially severe in Europe, where small and medium-size firms account for more than half of total output and two-thirds of employments, the report said.

Thanks to the regulatory overhaul that followed the 2008 financial crisis, banks entered the downturn with strong capital and liquidity buffers, IMF economists said. Even so, they warned, the banking system in some nations may suffer “significant capital shortfalls” due to increases in defaults among businesses and households.

The IMF also addressed risks among so-called nonbank financial institutions, like asset managers and insurance companies, which have assumed an increasingly important role in credit markets.

“They have managed to cope with the pandemic-induced market turmoil thanks to policy support, but fragilities, such as liquidity mismatches and exposure to credit risks, remain high,” Tobias Adrian, director of the IMF’s Monetary and Capital Markets Department, wrote in a blog post. “At some point, fragilities could spread through the entire financial system.”

The IMF urged countries to maintain easy policies to ensure a sustainable recovery, while at the same time strengthening the regulatory framework for the nonbank financial sector and containing excessive risk-taking as interest rates remain low.

The IMF also highlighted the disconnect between rising stock market valuations and the state of the economy, as central banks’ policy rate cuts and other measures have boosted investor sentiment.

The S&P 500 index is up 9.4% this year and up 58% since March 23, while China’s Shanghai Composite Index has gained 10% this year.

In its semiannual World Economic Outlook released earlier Tuesday, the IMF projected a global economic contraction of 4.4% in 2020, followed by growth of 5.2% in 2021. The forecast for 2020 is stronger than the 5.2% contraction the fund predicted in June.

Stocks are booming while companies shed millions of workers from payrolls. WSJ explains why the stock market seems disconnected from economic reality in the U.S. Photo Illustration by Carlos Waters/WSJ

Write to Yuka Hayashi at [email protected]

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