The Bangko Sentral ng Pilipinas (BSP)-led Financial Stability Coordination Council (FSCC) has shifted the way they assess, review and forecast systemic risks because the global COVID-19 pandemic has changed consumer preferences and market risk behaviors, and using “older norms” and previously-sufficient economic models will no longer be as effective or relevant.
“Our goal is to reduce the uncertainties so that all stakeholders can make well-informed decisions,” BSP Governor Benjamin E. Diokno said Wednesday, when the FSCC released its latest Second Semester Financial Stability Report (FSR).
Diokno, also FSCC chairperson, said systemic risk is a complex topic and they had needed to adjust their lens to “account for systemic risks when we oversee the functioning market.”
BSP Assistant Governor Johnny Noe E. Ravalo of the Office of Systemic Risk Management, who presented the latest FSR, said the pandemic is unquestionably a systemic shock, and it is crucial to communicate its challenges to the market.
He emphasized the need for the FSCC to have a more granular and more timely data because markets have become more interconnected, and shocks will have an immediate impact on risk behaviors and they need not wait for the next quarterly macro data which has a lag of two months to assess the evolving situation and conditions. It is not just a question of the direction of change but more of how and where the critical changes are happening, said Ravalo.
To address uncertainties as the world shifts to the “New Economy” during and post-pandemic, the FSR suggests the following: defining the market landscape for the New Economy as the prerequisite condition; deciding the extent to which the New Economy reflects fundamental changes in the behaviors and confidence of both households and businesses, which will then impact the way fiscal,
monetary, banking, and economic policies are currently framed and executed; and institutionalizing the interconnections between industries and between firms when assessing economic prospects and in managing the unfolding credit concerns.
The FSR also recommends doing these: distinguishing welfare support expenditures from conventional fiscal policy accounting; assessing the viability of a multi-year perspective for our fiscal policy stance; managing risk aversion by addressing the uncertainty premium by institutionalizing spot yields
which can be used in either credit or securities markets; and engaging all stakeholders on emerging systemic risks, including the need for more timely and granular data as well as the more frequent exchange of information.
Ravalo said incomes are impaired due to the pandemic, both for businesses which were suspended during the lockdowns, and for households that have debt obligations before the outbreak. Employment numbers and cashflows have shifted and the impact of the health crisis is uneven as sectors that are already “economically vulnerable” found itself in a worse situation.
“COVID-19 is a natural test case for how we now handle systemic risks. Yet, various experts have noted that COVID-19 is different. Rather than directly impacting the financial markets, the authorities must now address the pandemic-cum-recession spillovers, from the real economy to the financial market, and possibly back. This is a challenge because we are tasked to respond, even if the core issue is not in finance, at least not yet,” said Diokno as introduction to the FSR.
Diokno said systemic risks come from constantly evolving market conditions and FSCC has always been into out-of-the-box interventions.
He said the FSR offers what he called a “distinct vision of tomorrow” which they have “crafted after considerable reflection.”
“We believe that the future will continue to carry a premium on physical space and the trend towards digitization is irreversible. We also believe that there will be more granular changes in risk behaviors and consumer preferences,” said Diokno. All these will mean changes in how products and services will be produced and consumed, while preferences for investments will be affected by income and risk aversion.
The FSCC’s vision of the New Economy will help markets transition but it is not just a for post-COVID world. “We expect it to be defined by a different set of market arrangements, changed business models, and distinguished by new behaviors,” said Diokno.
Among the challenges brought about by COVID-19 is how the Philippines can sustain a recovery when it comes, especially since this will be a changed economy.
“We traditionally forecast into the future by using economic models which are empirically estimated based on behaviors displayed during normal times,” said Diokno. “Together with the premium on physical space and an irreversible trend towards digitization, the changing behaviors give the FSCC reason to re-assess.”
The FSR noted that although COVID-19 began as public health crisis, the real economy and the financial market are symbiotic. “Thus, the adverse impact of COVID-19 on the macroeconomy will be reflected in the financial market in some form.” There is “risk off” stance by creditor institutions and while “liquidity is available (the) appetite is predominantly for short-term issues. These manifestations of risk aversion are a natural response under uncertain conditions, but what may be best for the individual parts may indeed be adverse for the whole system. This is the current scenario, coupled with higher risk premiums and the outflow of portfolio investments.
The objective of the FSCC — an inter-agency council of the BSP, the Department of Finance (DOF), the Insurance Commission (IC), the Philippine Deposit Insurance Corp. (PDIC), and the Securities and Exchange Commission (SEC) and created in 2011 — is to mitigate systemic risks which will adversely affect both the economy and the financial market.
With the pandemic, the previously released annual FSR was revised and it is now released on a semestral basis to respond to the fast-changing market conditions due to COVID-19.
The FSR presentation was attended by Finance Secretary Carlos Dominguez III, PDIC President Roberto B. Tan, SEC Chairman Emilio B. Aquino, and IC Commissioner Dennis B. Funa.
Dominguez said the most significant point to the FSR is that the FSCC is “effectively mitigating the adverse effects of the pandemic on our domestic economy”.
Tan, former National Treasurer and DOF Undersecretary, for his part said that “the good news for the banking industry is that it remains strong despite COVID-19” but cautioned that financial systems should not be complacent and stressed on the “slow burn contagion where vulnerabilities at the firm level could spread to other firms.”
SEC’s Aquino, in the meantime, said “liquidity is coveted, credit has slowed, and risk premiums have risen” that led to “rational risk-aversion for a market under uncertainty.” He also noted that “issuers are facing discerning investors who are searching for yield, the same investors who are deciding between mobilizing or retaining liquidity.”
Funa of IC, on the other hand, said that “we should not confuse stagnation for stability or look at having systemic risks as basis to stay by the sidelines.”