Rebuilding better - banks, central banks and governments in a Covid economy

Panel remarks by Mr Agustín Carstens, General Manager of the BIS, at the Santander International Banking Conference 2020, 7 October 2020.

Let me first say a few words about the role of central banks during the Covid-crisis. I think they did a superb job during this episode in two ways: First they helped in stabilising the economy through monetary policy stimulus. In concert with fiscal authorities, they were at the forefront of the response. Second, and not emphasised as much, was their important role as a "market maker of last resort". With forceful actions, they stabilised markets and arrested adverse feedback loops that may otherwise have led to funding and possibly solvency crises. These interventions to address market functioning issues were important to ensure that the monetary policy stimulus could eventually reach the economy as a whole.

The response was not only large-scale and swift, but also innovative. That was necessary since the Covid-crisis is unique and unexpected, while the financial system has evolved. The pandemic was a tremendous shock that rocked financial markets. The good news is that the banking sector was not at the epicentre - banks proved to be resilient enough to be part of the solution this time around, rather than being part of the problem. Instead, the turmoil exposed new vulnerabilities among non-bank financial intermediaries (or NBFIs) - which include money market funds, hedge funds, principal trading firms and the like. It demonstrated some of the fragilities in the demand and supply of liquidity in a more market-based financial system, including triggering the widespread "dash for cash" in March. This called for large-scale and new forms of central bank interventions, crossing some red lines.

Overall, I believe the interventions have worked well to preserve financial and economic stability. But, the episode will require us to think more deeply about what we can do to make the financial system more resilient, accounting for the reality of a greater role played by NBFIs.

One area where we now need "build better" is the NBFI sector. The footprint of NBFIs has grown significantly post-GFC, but the regulatory architecture for the NBFI sector has not kept up with its growing importance. The recent episode showed us (again) that collectively some of the building structures are not very stable. Some of these fragilities are not new: we have talked about liquidity mismatches and investor runs in money market or corporate bond funds often before. And, that use of leverage can destabilise through forced selling and adverse feedback loops has also been observed before.

We should create a more resilient system to avoid repeats of what happened earlier in the year. We need to ensure that some of the private players are resilient to tremors and do reasonable amounts of self-insurance themselves, which could reduce the likelihood and severity of liquidity crises. Addressing these and other issues through carefully designed and calibrated regulatory measures will be on the top of our mind at the BIS and in the official sector in the months ahead.