The COVID-19 crisis has already taken a large toll on Latin America and the Caribbean in terms of confirmed cases and deaths as well as sharp declines in economic activity—and it is far from over. It is still unclear how long the health crisis will persist and how soon and how fast economies will recover. The deep recession and the serious income losses for families and firms may provoke significant challenges for financial systems. Unlike recent financial or balance of payments’ crises, this may be more of a slow-moving event in which credit risks take center stage. Good policies will be critical to navigate the coming months. The purpose of this report is twofold: to identify and discuss a set of challenges, and to develop key recommendations. The overarching goal is to provide support to policymakers in the region who may face difficult decisions to ensure that banks play a constructive role and support families and firms through and beyond the current crisis. Most financial systems remain dominated by banks and will undoubtedly see nonperforming loans rise and suffer losses on other assets as well. Moreover, countries in the region have limited fiscal resources and debt positions had already risen significantly before the COVID-19 crisis hit. However, monetary frameworks have improved considerably. In most countries, inflation and inflation expectations remain well anchored and more countries have gained exchange rate flexibility by introducing inflation targeting regimes. Financial systems were also in relatively good shape before the crisis hit and banks had high capital and liquidity buffers. But the crisis and the immediate response present a set of subtle but extremely important dilemmas for policymakers dealing with financial sector issues.

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