INSIGHT: The Eurozone Crisis, Covid-19 and the Financial Services Sector

The current Covid-19 pandemic has seen many economies around the world adopt a wartime-like status. Similar to how a government would decide on the allocation of resources as it geared up for conflict, countries across the globe are coming to terms with the reality that they need additional funding to prop up their economies, support businesses and keep people safe during the crisis.

We have seen this in peacetime before, albeit that was to address issues relating to liquidity and solvency of banks. Following the 2008 financial crash, governments stepped in to bail out the banks with emergency measures like underwriting their debt. Indeed, the U.K. government specifically implemented the Special Liquidity Scheme to inject billions of pounds of liquidity into the economy.

The impact of Covid-19 has also seen an array of necessary measures put in place, which in turn will lead to a huge accumulation of debt. The Coronavirus Business Interruption Loan Scheme (CBILS) is a prime example of such measures and is one of the various loan schemes the U.K. has put in place to support the economy. The EU has confirmed that state aid rules will not prevent the implementation of measures which seek to address the Covid-19 crisis. This is either because banks are not being supported (funding to banks is intended for end borrowers and not to stabilize the banks themselves) or because the measures are permitted to address the broader economic impact.

Following the 2008 crash, new regulations came into force that gave governments a much broader range of powers to intervene with banks, who were also required to prepare and maintain living wills. These measures were intended to address the specter of banks being “too big to fail.” The measures taken also resulted in increased capital requirements for banks and other financial institutions. Due to the work done in the period since the last crisis, banks are now much better capitalized and better placed to deal with a real-world stress test scenario.

There is already a huge amount of debt in the system, and it has taken the pandemic to once again highlight the impact extensive borrowing can have on an economy and unresolved issues with the European banking system. This is an issue now and will be should another crisis hit.

The large amount of debt in the financial system pre-dates even the previous financial crisis. Some of the issues are, of course, attributed to the introduction of the euro, which allowed certain member state governments to build up unsustainable levels of debt. The recent decision of the German Constitutional Court on the public sector purchase program and EU competencies highlights the potentially unresolved issues with the euro project and the bifurcation of responsibility for fiscal and monetary policy.

Therefore, the question now is whether or not these governments will be able to raise the money required to deal with Covid-19.

The EU Commission

The level of government spending required to effectively combat the virus in economic and health terms will inevitably lead to an increase in borrowing once more. The EU’s own communication on the impact states, in no uncertain terms, that some businesses will face “a sudden shortage or even unavailability of liquidity,” and that banks will have a central role to play in limiting the damage by keeping credit flowing into the economy. The framework is consistently updated in line with the latest developments and clearly sets out the limits and conditions of the central aid being offered by the EU to member states in the current climate. As just one example, it stipulates that aid supplied by the European Central Bank (ECB) from the national budgets of EU member states cannot exceed 800,000 euros ($871,621) and must be administered before December 31, 2020.

And there’s no denying that this aid will be desperately needed. The eurozone crisis meant that some countries, such as Greece, were downgraded in their credit ratings, and are still feeling the impact. Their low credit rating deems that they are considered likely to default and so any fiscal borrowing will come with a high interest rate. The best way around this is to borrow from the ECB, which has a much lower interest rate.

The U.K.

Where the U.K. stands in all of this is uncertain. The current crisis may put Brexit on the back-burner, though political considerations might equally result in the U.K. pushing on with exiting the current transitional period. It should be borne in mind that the U.K. has already ceased to be an EU member state.

The negotiations over the terms of the U.K.’s exit from the EU are continuing and the reports suggest that agreement might be difficult to reach given the polarized positions of the EU and the U.K. Business are continuing to take steps to mitigate the risk of Brexit, including through establishing operations within the EU, albeit that a large number of jobs are not likely to migrate from the U.K. to the EU.

The economic and political consequence of the Covid-19 crisis will have ramifications for the future shape of the EU and the U.K.’s relationship with it.

Take the issue of U.K. equivalence, on which the EU is currently considering its position. The U.K. wants to maintain some kind of favorable market access after the end of the transition period, to ensure it is on a level playing field in terms of banking regulations and activity. Logically, it makes sense for the U.K. to continue to have access to the EU given that its laws are compliant with, and derived from, EU standards. However, the granting of access to the Single Market is ultimately a political decision and it will be interesting to see how the shifting internal dynamics of the EU impact on these issues. Whether or not this is granted could have a colossal impact on financial services and how the sector does business.

The ideal outcome of the now-resumed talks would also include some kind of trade deal to maintain the U.K.'s links to the continent. However, the U.K. might also decide that it is now more favorable to leave the EU come December, with no deal, to avoid shouldering some of the financial burden the pandemic has imposed on other economies.

The impact the virus will have on the world economy is huge. The government has brought in a multitude of measures to help sustain businesses, including the option for them to elect to defer any VAT payments due between March 20, 2020 and June 30, 2020.

In addition, HM Revenue & Customs (HMRC) will not charge interest or penalties on any amounts deferred as a result of the Chancellor’s announcement and businesses and those who are self-employed with outstanding tax liabilities may be eligible to receive support and pay off their debt by installments through HMRC’s Time to Pay Service. These arrangements could include debts that relate to value-added tax, employer’s pay as you earn (PAYE) or corporation tax. It should be noted that such arrangements are agreed on a case-by-case basis. These are all necessary measures, but against the background of the unresolved eurozone crisis, the level of borrowing from central banks is increasing to provide a much-needed injection of liquidity, and help support economies through the uncertainty.

Furthermore, with Brexit now coming back into the fold, a question mark remains over how involved the U.K. will be in the recovery of Europe. The financial services sector is still fighting for equivalence, but must now weigh it up with the possibility that it might now be financially beneficial to leave without a deal. Either way, it is clear the impact of Covid-19 is not just on our health—the financial repercussions for all are still hanging in the balance.

Arun Srivastava is a Fintech and Regulation Partner and Arun Birla is a Tax Partner and Chair of the London Office at Paul Hastings, London.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.