Stress relief? Funding structures and resilience to the Covid Shock

Abstract

This paper explores whether different funding structures – including the source, instrument, currency, and counterparty location of funding – affected the extent of financial stress experienced in different countries and sectors during the early stages of the Covid-19 pandemic. We measure financial stress using a new data set on changes in credit default swap spreads for sovereigns, banks, and corporates during the Covid Shock – the period of acute financial stress in early 2020. Then we use country-sector and country-sector-time panels to assess if these different forms of financial intermediation and internationalisation tended to mitigate – or amplify – the impact of this risk-off shock. We find that banks with a higher share of funding from non-bank financial institutions (NBFI) and that were more reliant on US dollar funding were significantly more vulnerable. In contrast, whether funding was obtained in loans (instead of debt markets) or cross-border (instead of domestically) did not significantly impact resilience. The results suggest that macroprudential regulations should broaden their current focus to take into account reliance on NBFI and dollar funding, with less priority for regulations focusing on residency (ie, capital controls). Moreover, policies directly targeting these structural vulnerabilities (ie, focused on NBFIs and USD swap lines) can have significant effects even after controlling for broader macroeconomic responses and appear more successful at mitigating stress related to these funding structures than easing more generalised banking regulations.

Keywords: Covid-19, financial stress, funding structure, non-bank financial institutions, shadow banks, macroprudential policy, swap lines

JEL Classification: E44, E65, F31, F36, F42, G18, G23, G38