How bank regulators could mitigate coronavirus fallout

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WASHINGTON — The market strain from the coronavirus outbreak has prompted some financial services observers to focus on which tools regulators and could deploy if the system faced heightened risks.

Unlike in the 2008-10 financial crisis, when a mortgage market crash nearly brought the industry to its knees, bank regulators are limited in their ability to respond to a nonfinancial event. But observers said should the spread of coronavirus disrupt normal banking operations, regulators could encourage institutions to allow loan forbearance and to institute plans based on 2007 guidance to provide backup services if facilities or staff are affected.

The Federal Reserve on Tuesday reacted to concerns about the outbreak with a dramatic 50-basis point interest rate cut to address "evolving risks to economic activity." But when the 2008 crisis hurt confidence in the liquidity markets, regulators such as the Fed and Federal Deposit Insurance Corp. provided other forms of assistance to prop up the markets

Read more: Complete coverage of the coronavirus impact

Even though lawmakers took some steps to restrict regulators' emergency authorities in the 2010 Dodd-Frank Act, experts said agencies could still provide backing if needed.

“What is the biggest concern in terms of [a] crisis is maintaining that liquidity," said Ed Mills, a policy analyst at Raymond James. "I think that was an inflection point during the financial crisis as credit markets froze up. That's when [regulators such as] the Fed had to step in and provide various liquidity functions and credit facilities and unlimited guarantees on certain deposits."

As more coronavirus cases were discovered in the U.S., all three stock indexes fell into correction territory and the Dow logged its worst week since 2008. Yet the Dow was up roughly 2% as of Monday afternoon.
As more coronavirus cases were discovered in the U.S., all three stock indexes fell into correction territory and the Dow logged its worst week since 2008. Yet the Dow was up roughly 2% as of Monday afternoon.

As more coronavirus cases were discovered last week in the U.S., all three stock indexes fell into correction territory and the Dow logged its worst week since 2008. Yet the Dow was up roughly 2% as of Monday afternoon.

On Friday, Fed Chairman Jerome Powell said officials were "closely monitoring" coronavirus developments. In addition to the Fed's rate cut, a source familiar with regulators' discussions confirmed the Financial Stability Oversight Council has added coronavirus as an agenda item for the panel's meeting on Wednesday.

Some observers said regulators’ tools to mitigate the economic risks of the coronavirus outbreak could be limited.

"They can’t manufacture vaccines, they cannot purchase copper to stabilize commodity supplies,” said Karen Petrou, managing partner at Federal Financial Analytics. “What they can, and I believe will do, is work with financial institutions and, where necessary, emphasize the need for operational resilience and give banks at least some comfort on forbearance.”

Mills agreed that "the policy toolkit of the Fed to address a financial concern is different when they use it to address a nonfinancial concern."

"The coronavirus does not respond based upon monetary policy," he said.

Still, U.S. financial regulators can alleviate some of the economic repercussions of the coronavirus by providing confidence to the industry and market participants.

“As somebody who has handled several crises, I would say that the fundamental role that the bank regulators could play is to provide confidence in the financial system no matter what happens,” said Thomas Vartanian, founder and executive director of the Financial Regulation & Technology Institute of George Mason University’s Scalia Law School who served as chief counsel at the Office of the Comptroller of the Currency. “It’s a problem of what we don’t know. What we know so far is relatively controllable … relative to what the flu has done in this country this year.”

While the World Health Organization has yet to declare the coronavirus as a pandemic, Petrou pointed to 2007 guidance by the Federal Financial Institutions Examinations Council during the avian flu outbreak as “a great place to start” for financial regulators in the midst of the outbreak.

The FFIEC said that financial institutions should establish continuity plans for dealing with a pandemic. It recommended institutions implement a preventative program to reduce the likelihood that their operations would be significantly affected by a pandemic. Such a continuity plan could include a framework of backup facilities, systems or procedures to make operational if large numbers of staff members are unavailable for long periods.

Petrou said regulators could tell financial institutions that they “may forbear against troubled borrowers as long as it’s ‘prudent’ to do so.” She said forbearance would ease banks' concerns during examinations.

"That gives banks some comfort that they will not be attacked by examiners for allowing borrowers to go delinquent,” Petrou said.

In his statement last week, Powell signaled that the central bank would stand ready to act if the financial system suffered, saying that "we will use our tools and act as appropriate to support the economy."

Some observers say they do not see a liquidity crisis arising from the coronavirus at this point.

“It’s hard to envision a liquidity crisis at this point,” Vartanian said. “My sense is that it’s the unknown that’s driving this situation. It’s hard to imagine a full-scale national liquidity crisis arising out of this. … That doesn’t mean that they shouldn’t be prepared and signal that preparedness as they communicate.”

On the presidential campaign trail, Sen. Elizabeth Warren, D-Mass., a candidate for the Democratic nomination, has called for the establishment of "a Federal Reserve emergency lending program" to help counter any economic shock waves from the outbreak, among other things. Such a program could help companies that have their supply chains disrupted because of the coronavirus, according to the plan.

“An immediate announcement from the Fed of this type of program will give companies — and markets — confidence that the Fed is available as a lender of last resort if Congress fails to deliver, and could help avert a more severe downturn,” Warren says in her plan.

During the 2008-10 crisis, the Fed provided emergency loans through authority granted under the Federal Reserve Act, while the FDIC announced a temporary program to guarantee unsecured debt payments and uninsured transaction deposits. Despite some restrictions on the agencies' emergency powers imposed by Dodd-Frank, experts say the agencies would still have the legal authority to provide assistance if needed.

In a blog post Sunday, Georgetown University law professor Adam Levitin, who said he consulted with the Warren campaign on its plan, wrote that the Fed would still be in a position to help the markets.

"The Dodd-Frank Act placed some limitations on the Fed’s emergency lending power, but it largely preserved it," Levitin wrote. "The Dodd-Frank Act did not prohibit 'bailouts.' Instead, it amended section 13(3) to require that the Fed only lend as part of programs with 'broad-based eligibility.'"

Tony Fratto, a partner at Hamilton Place Strategies and former assistant secretary at the Treasury Department, suggested that the Fed's rate cut might be the extent of its monetary policy levers.

“The tools that monetary authorities have, they seem powerful but they are limited,” Fratto said. "Lowering the policy rate are about what they can do. It signals to market participants that monetary authorities are using the tools that they have … to mitigate the downside risks.”

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Coronavirus Risk management Liquidity requirements Monetary policy FSOC Federal Reserve Elizabeth Warren