In the aftermath of the financial crisis of 2007-09, policymakers were intent on making the financial system able to weather an extremely severe storm. The authorities had two complementary goals: increase the financial system’s reliance on equity financing and enhance the ability of institutions to recapitalize themselves after a shock. Well, COVID-19 is upon us, and the shock looks to be bigger than the most adverse scenarios in supervisory stress tests.
Our view is that we have made limited progress in promoting resilience. In a recent post, we emphasized how COVID-19 economic disruptions are eroding banks’ capital buffers (that already were slim in parts of Asia and Europe). As the full impact economic and financial impact of COVID 19 becomes apparent, we suspect that some banks will need a form of recapitalization. They were not able to do this in 2008-09 on their own. Will this time be different …?
Many people seem to think that – as a new BIS working paper concludes – banks benefit when monetary policy tightens and interest rates rise (especially from a low level). Do they? In some instances, perhaps, but as a general principle, surely not.
A casual glance at recent U.S. stock market behavior seems to support the idea that higher interest rates would be good for banks now. When the Federal Open Market Committee decided not to hike interest rates on September 17, the S&P500 dropped by 1.85% over two days, while the KBW index of bank stocks fell by 4.85%. A week later, when Fed Chair Yellen speaking about inflation dynamics expressed her continued expectations for a rate hike this year, the S&P500 edged lower, but the bank index rose by nearly 2%...
