IGTA Journal - Winter 2020/2021

29/01/2021 The sovereign-bank-corporate nexus – virtuous or vicious? https://www.ecb.europa.eu/press/key/date/2021/html/ecb.sp210128~8f5dc86601.en.html 1/13 SPEECH The sovereign-bank-corporate nexus – virtuous or vicious? Speech by Isabel Schnabel, Member of the Executive Board of the ECB, at the LSE conference on “Financial Cycles, Risk, Macroeconomic Causes and Consequences” Frankfurt am Main, 28 January 2021 One year after the first cases were reported in Europe, the coronavirus (COVID-19) pandemic continues to take a tragic human toll and to pose enormous challenges to workers, firms, the financial system and policymakers in the euro area. [1] Without the forceful responses of fiscal, monetary and prudential authorities the economic and social costs of this crisis would have been significantly higher. Governments, in particular, have stabilised aggregate demand and incomes by absorbing economic and financial risks of the private sector as the crisis unfolded. Through the generous issuance of guarantee schemes, governments secured a continuous flow of credit to firms, which supported economic growth and protected financial stability. Monetary policy has complemented these efforts by providing ample liquidity and restoring favourable financing conditions. As a consequence, the policy response to the pandemic has visibly intensified the interdependencies between sovereigns, banks and firms. It has created a “sovereign-bank-corporate” nexus. [2] In my remarks today, I will argue that the extent to which such interdependencies may create challenges in the future depends, to a large extent, on the types of feedback loops they create. Broad fiscal and monetary policy support today minimise the realisation of contingent liabilities in the future, and thus limit the scarring effects of the pandemic on the economy, creating a virtuous circle. So, contrary to the vicious “sovereign-bank” nexus [3] that plagued the euro area throughout most of the last decade, the current nexus, if managed properly, can be an engine for a faster recovery, which also supports the ECB’s price stability mandate. A virtuous circle between sovereigns, banks and corporates At the onset of the pandemic, the strict lockdown measures hit large parts of the corporate sector hard, raising its vulnerability to levels last seen during the global financial crisis ( Chart 1 ). Many firms saw their revenues collapse and were facing acute liquidity shortages that threatened to turn into solvency problems. Chart 1 Composite indicator of corporate vulnerabilities and underlying driving factors in the euro area Z-scores IGTA eJournal | Winter 2020/21 | 6