Pandemic debts could spark a financial ‘contagion’
Rising levels of corporate debt and mounting loan losses amid the coronavirus pandemic will prompt financial institutions to reimagine their role in economic recovery, according to the counsel of partners at
international law firm Shearman & Sterling, published in a selection of essays today.
Growing volumes of “bad” debt during the pandemic have magnified systemic risk throughout financial markets, increasing the chance of a financial ‘contagion’ similar to that of the 2007-08 global financial crash, according to the co-authors of Navigating Systemic Risk: Protecting Firms from Avoidable Losses.
The pandemic has acted as an accelerator, forcing entire industries to adopt contingency measures. As businesses fight to regain their footing, corporate debt levels are jumping. As governments wean firms off emergency funding support schemes later in 2020, firms may be left unable to fulfill their debt obligations.
Mounting loan losses represent just one aspect of the systemic risk facing financial decision-makers in the pandemic era, the authors of the report argue. Firms will be pressed to aid regulators and legislators by mitigating a range of problems themselves – ranging from anti-trust, to financial crime.
As the essays outline, due to the complex and interconnected nature of our financial markets, there exists a tangible risk of a cascade of defaults, sparking a ‘contagion’ that could affect markets significantly, as during the 2007-8 financial crisis.
“With society’s focus now shifting from damage limitation to recovery, financial institutions are considering how extensively their long-term strategies will be affected by the pandemic,” Barney Reynolds, partner at Shearman & Sterling, said:
“The 2007-08 financial crisis showed the dangers of unchecked systemic risk – an unbalancing of the financial system, enabled by the interconnectedness of our markets. With loan losses and levels of “bad debt” growing, the risk of financial contagion has returned.
“As they will be expected to lend a hand in national and international recovery efforts, financial institutions must ensure they have a holistic understanding of the problems facing the markets. Strong, informed eadership is vital for institutions looking to stay ahead in the “new normal” of post-pandemic industry.”
A minefield of risks and challenges
The essays identify ten problem areas that may arise as a result of Covid-19 and explain how each may be practically monitored and addressed to mitigate systemic risk.
One chapter charts the ramifications of Covid-19 on institutional strategies, detailing how strong governance and capital buffers will be critical for lenders steering through a tense regulatory environment.
Elsewhere, subsidisation and anti-trust concerns during Covid-19 recovery are discussed, including the dilemma of innovative British businesses being barred from recovery funds due to European state aid rules, which declare that governments may not provide aid to loss-making ventures.
Other highlights covered in the report include the magnified systemic risk of continuing a LIBOR transition in the wake of the Covid-19 crisis; and how financial institutions should deal with rapidly increasing levels of financial crime, as businesses are pressured and distracted in the “new normal” of the pandemic.
