The origins of central banking can be traced back to the Swedish Riksbank that was established as a joint stock company in the seventeenth century. Most central banks of that era served two major purposes – to act as the lender of last resort or to deal with monetary disarray. For instance, the Banque de France was established to stem hyperinflation in France after the Napoleonic wars. However, in the last 100 years the roles and responsibilities of central banks have increased tremendously. Most modern central banks apart from being the most prominent national economic institutions, take up a myriad of tasks – ensuring price stability, maintaining robust growth and regulating financial institutions to name a few. Be it the Great Depression or the sub-prime crisis, central banks have played key roles in aiding recoveries after catastrophic economic downfalls.

Nevertheless, the world today is besieged with a malaise that few could even imagine. As the COVID-19 epidemic continues to inflict thousands, the world around us has come to a standstill. Many countries across the world have asked businesses to shut shop in an attempt to stem the spread of this extremely contagious virus. And while ‘social distancing’ might currently be our best response to the coronavirus, it is a death pill for economies around the world. Most global economies are set to see a fall in their growth rates and many might even slip into recession if this virus prevails for long. The Indian economy, that was already in a slow-down before this pandemic, is well on course to record its lowest GDP growth numbers in a very long time. This current macroeconomic scenario beckons a very pertinent question –

Can the lender of last resort act as the SAMARITAN of last resort?

The closest that the world came to such a disaster was the 2008 sub-prime crisis, the disruption from which is estimated to be a fraction of the possible ramifications that could emanate from the current epidemic. To prevent the current pandemic from having an acute debilitating impact on millions, central banks need to prioritize three things – beef up liquidity, assuage debt burdens and help governments raise funds to fight the virus.

Beef up liquidity

With many countries in lock-down and businesses being shut, the global growth story has come to a crushing halt. In the days to come many workers around the world, especially the most marginal ones are bound to lose their jobs while the luckier ones might escape with pay cuts. This fall in income will be accompanied with a fall in demand that can drive economies into recessions. To prevent the world from going into an outright crisis, central banks would have to shore up liquidity, the same way they did in 2008. The Reserve Bank on India through a slew of measures that included steep cuts in benchmark rates and by introducing sophisticated instruments such as the ‘Targeted Long Term Repo Operations’ (TLTRO) aimed to inject INR 3.75 lakh crore in the domestic market over the next three months.

However, many developed countries do not have this option. A series of rate cuts post 2008 has pushed most of the developed world near the zero-lower bound – a point where it is no longer possible to usher in liquidity by cutting interest rates. Central bankers in these countries therefore have to come up with more innovative ways to hand-out cash to the public. Open market purchases and capitalizing distressed banks are some of the measures that central banks must deliberate to ensure sufficient liquidity.

Assuage debt burdens

With prospects of heavy job losses especially among contractual and informal workers, central banks would have to adopt a much more accommodating stance. Loss of incomes is bound to lead to defaults on EMI payments. Corporates too, reeling from fall in sales would struggle to honor their debt obligations. These defaults can further have a cascading impact of the overall asset quality of banks that are already dealing with huge NPA problems.

To mitigate this, some central banks are implementing a temporary moratorium of debt repayments. The RBI announced a three-month relief, where banks would have an option of allowing debtors to defer debt repayments for three months. It is also encouraging short term debt restructuring by encouraging lenders to re-assess the margins and duration of outstanding working capital loans. The United States also announced a nationwide halt to foreclosures and evictions in an attempt to protect millions of Americans from becoming homeless. Many European countries like Italy and Spain – current hotspots of the pandemic, are also deliberating such moves.

Help governments raise money

Ever since the breakout of the coronavirus, global markets have been in turmoil, many of them losing over 20% of their value in the last month. Regulators in a bid to stem this massive sell-off have taken unprecedented steps like halting trading and even deliberating about closing stock markets till this crisis abates. In this current environment of tremendous volatility, sovereign bonds can only suffice the global appetite for investment. Before the onset of the coronavirus, the global economy had a savings glut that drove bond yields to historic lows – almost half of all European government bonds had a negative yield. This pandemic however, is set spike bond yields. Business shutdowns are bound to take a toll on this savings glut which can reduce the demand of sovereign bonds thus increasing yields. This would have a huge impact of the future debt obligations of governments, who will see their borrowings balloon in the days to come.

Central banks need to take cognizance of this fact and indulge in bond buying to keep yields suppressed. The Federal Reserve has announced an unlimited bond buying plan to ensure continuous public funding. The Australian Central bank also bought USD 1.8 billion worth of government bonds through its quantitative easing program in a bid to keep short term yields close to 0.25%. The RBI is also set to buy INR 10,000 crore (~ USD 1.35 billion) worth of government securities through open market operations.

Central bankers do not need to fret about the possibility of high inflation emanating from this liquidity boost – at best this excess cash would just be enough to offset the current slump in demand. However, this idea of central banks buying government securities might be seen as many as an attack on the banks’ autonomy.

Nevertheless, a truly independent central bank should possess the authority and ability to work in unison with the dispensation to ward off this crisis.

Will this be enough?

However, can central banks with all their might and resources somehow conjure a quick recovery? The answer to this depends on the intensity, spread and duration of the coronavirus pandemic. However, central banks can take some steps to provide relief, albeit a short-lasting one to crumbling national economies. Its primary responsibility is to keep the global economy ready to boom once we see the end of CORONA. Only time will tell if they would succeed in this quest.