Question

As a result of the global Covid-19 pandemic and lockdown, central banks around the world have stepped in to provide massive liquidity to the capital markets. Among the key policies are to keep interest rates low or sub-zero (zero interest rate policy or ZIRP). Discuss the implication of such policies to credit risk management from the perspective of adverse selection and moral hazard.

（400 words）

Answer 1

Greetings for the day,

In a period of uncertainty, it’s time for authorities and regulators who are regulating the economy as a whole to step up, Central bank is the plays a major role in managing the liquidity in the market. COVID-19 has certainly developed into an unprecedented situation on a global scale I think every country is being highly affected with this COVID-19 — with potentially bigger impacts even than the global financial crisis (GFC) that began in 2008/09.

So, how have central banks responded? We saw during the GFC (Global financial crisis) just how crucial their interventions are to supporting economies — even if there were criticisms from some that they were slow to react. The government think everything at a bigger perspective and we individual thinks as a smaller or even with own perspective so that’s why it is always critical in the society.

This time, it seems, they have certainly learned from the past, because, if we compared with our past crisis, this time actions have been taken very rapidly, and on an enormous scale. Commentators like to talk about ‘bazookas’ — they have been used in full force to date.

I am going to cover some policies that are being changed or newly implemented during COVID in various countries by their central government:

1.  China: The central bank of China i.e. the People’s Bank of China (PBC) gave an RMB3 trillion injection into the banking system in the first half of February or we can say at the very initial phase of COVID-19, with a further RMB20 billion at the end of March 2020, along with other financing support measures to help the business and individuals.

2.  US: The central bank of US i.e. the Federal Reserve (Fed) slashed interest rates by a full percentage point to effectively zero and launched a US$700 billion package of quantitative easing (QE). This was accompanied by a huge fiscal intervention — the US$2.3 trillion Coronavirus Aid, Relief and Economy Security Act (CARES).

3.  Europe: the central bank of Europe i.e. the European Central Bank (ECB) extended its QE program by more than EUR750 billion. The ECB Banking Supervisor has also allowed significant institutions to operate temporarily below the Pillar 2 guidance, the capital conservation buffer, and the liquidity coverage ratio. A delay in the banking stress test scheduled for 2020 and in some supervisory activity, have also been announced to allow banks to focus on the tasks they need to perform to support the economy during such a difficult context.

4.  UK: The central bank of UK, i.e. the Bank of England slashed interest rates by 65 basis points to 0.1 per cent, expanded its holding of government bonds by GBP200 billion, and made GBP330 billion of loans and guarantees available to businesses.

5.  Australia: The central bank of Australia cut rates by 25 basis points twice during March, to 0.25 per cent. It established a swap line with the Fed for the provision of US dollar liquidity in amounts up to US$60 billion and established a term funding facility of at least AUS90 billion for SME lending.

6.  India: The central bank of India i.e Reserve Bank of India (RBI) First time in a history RBI has also done a tremendous job by constantly changing the schemes during lockdown for the betterment of individual and businessmen.

1. Loan freezing: Lenders were allowed to freeze the repayment for three months on term loan which were outstanding for march 1.
2. Special windows: Initially Rs 1 lakh crore of targeted long term funds from the central bank to banks for investing only in corporate bonds, aimed at easing cash crunch at firms, and many other were also taken during the COVID-19.

In addition to the above various other policies was introduced, a deal was agreed between six major central banks including the Fed and the ECB to lower their rates on currency swaps to help financial markets function normally.

This is the first time where Central banks, regulators and supervisors have been acting more quickly than ever before to take the necessary measures, overthrowing the limits of the past. They are using all the tools in their armoury to support banks so that they, in turn, can support businesses and families struggling to survive. Monetary policy interventions, delays and waivers on the application of banking regulations, and relaxation on the supervisory expectations on the application of some accounting rules — these are all coming into play.

It is important to underscore that these actions are not intended to help the banks but to help the one who is in a very difficult condition of survival because various families lost their jobs and just because of that they were not able to pay their debt timely and even not able to feed himself properly.