Global financial stability has improved in recent months on the back of a strengthening recovery, but vulnerabilities remain due to high government debt levels in advanced economies that are putting pressure on banks' balance sheets even as the effort to repair the financial system remains incomplete, the International Monetary Fund said in a report Wednesday.
Surging capital inflows into emerging markets, which could lead to the buildup of financial imbalances and create challenges for central bankers in conducting monetary policy, are another threat to global financial stability, the IMF said.
The fragile state of public finances in most advanced countries, where governments remain saddled with high debt levels after pumping billions into the economy to stem the global recession, is still a key worry for investors, the IMF said in its Global Financial Stability report released Wednesday, ahead of the fund's spring meetings in Washington later this week.
"Market concerns about the sustainability of public debt can prompt a sharp repricing of assets that damages banks' balance sheets and creates an adverse feedback loop through the real economy," the fund said in its report.
This is particularly true in the euro area, still grappling with a year-long sovereign debt crisis that has led to the consecutive bailouts of Greece and Ireland by their euro zone peers--with another rescue package currently in the offing for Portugal. Prospects for the financial sector remain closely tied to sovereign stress in the euro area, the IMF said.
Government debt woes in financially troubled countries may stoke uncertainty over government funding and possibly drive sovereign funding costs up, the IMF warned, which in turn would have an adverse impact on banks, as the value of their government bond holdings goes down.
Further down the line, rising government bond yields could lead to an increase in borrowing costs across the whole economy, potentially feeding back into financial instability through higher credit losses in banks, the IMF said.
Decreased demand from foreign investors for sovereign bonds of debt-troubled peripheral euro zone countries also risks concentrating bond holdings in the hands of domestic banks, which would be another potential source of financial instability, the IMF noted. Portugal was eventually pushed by the country's main banks to ask for financial support from the euro area, as Portuguese banks had become increasingly reluctant to buy government debt in the face of soaring credit spreads.
To stem potential risks to financial stability, governments should outline credible medium term fiscal consolidation plans, the IMF said. Multilateral backstops to assist financially distressed countries such as the bailout mechanism recently put in place by euro zone countries are also useful, the fund added.
Compounding risks to global financial stability, banks are having to deal with lingering sovereign debt problems even as their balance sheets remain fragile in the aftermath of the financial crisis and the clean-up of the banking system is still incomplete, the IMF pointed out.
"Incomplete policy actions and inadequate reform of the banking sector have left segments of the global banking system vulnerable to further shocks," the IMF said. In particular, the fund noted that the recapitalization of banks has proceeded at an uneven pace across the world, with European banks lagging their U.S. peers in terms of rebuilding their capital buffers.
Therefore, the IMF stressed it is essential for banks to improve the quality and quantity of their capital cushions to avert future crises, while at the same time urging governments to encourage the weakest financial institutions to recognize their losses and sell assets, and in some cases wind them down through orderly mechanisms.
In emerging markets, the IMF identified increasing capital inflows lured by buoyant growth prospects and higher returns as the main risk to financial stability, especially at a time when inflation is rising in these countries.
"The flows complicate efforts to manage local demand through tighter monetary policy, as rate hikes could spur additional capital inflows," the IMF said, adding these flows may "exacerbate domestic dynamics and add to financial imbalances and vulnerabilities."
While recognizing that macroprudential measures and in some cases capital controls can be useful in curbing potentially disruptive capital inflows, the IMF cautioned these are no substitute for macroeconomic policy action, which it said is being delayed in some emerging countries.
Acting on interest rates to address rising inflation and strong credit growth, allowing local currencies to appreciate and having tighter fiscal policies in place could prove a more adequate response to surging capital inflows, the IMF said.
Source: http://online.wsj.com
Surging capital inflows into emerging markets, which could lead to the buildup of financial imbalances and create challenges for central bankers in conducting monetary policy, are another threat to global financial stability, the IMF said.
The fragile state of public finances in most advanced countries, where governments remain saddled with high debt levels after pumping billions into the economy to stem the global recession, is still a key worry for investors, the IMF said in its Global Financial Stability report released Wednesday, ahead of the fund's spring meetings in Washington later this week.
"Market concerns about the sustainability of public debt can prompt a sharp repricing of assets that damages banks' balance sheets and creates an adverse feedback loop through the real economy," the fund said in its report.
This is particularly true in the euro area, still grappling with a year-long sovereign debt crisis that has led to the consecutive bailouts of Greece and Ireland by their euro zone peers--with another rescue package currently in the offing for Portugal. Prospects for the financial sector remain closely tied to sovereign stress in the euro area, the IMF said.
Government debt woes in financially troubled countries may stoke uncertainty over government funding and possibly drive sovereign funding costs up, the IMF warned, which in turn would have an adverse impact on banks, as the value of their government bond holdings goes down.
Further down the line, rising government bond yields could lead to an increase in borrowing costs across the whole economy, potentially feeding back into financial instability through higher credit losses in banks, the IMF said.
Decreased demand from foreign investors for sovereign bonds of debt-troubled peripheral euro zone countries also risks concentrating bond holdings in the hands of domestic banks, which would be another potential source of financial instability, the IMF noted. Portugal was eventually pushed by the country's main banks to ask for financial support from the euro area, as Portuguese banks had become increasingly reluctant to buy government debt in the face of soaring credit spreads.
To stem potential risks to financial stability, governments should outline credible medium term fiscal consolidation plans, the IMF said. Multilateral backstops to assist financially distressed countries such as the bailout mechanism recently put in place by euro zone countries are also useful, the fund added.
Compounding risks to global financial stability, banks are having to deal with lingering sovereign debt problems even as their balance sheets remain fragile in the aftermath of the financial crisis and the clean-up of the banking system is still incomplete, the IMF pointed out.
"Incomplete policy actions and inadequate reform of the banking sector have left segments of the global banking system vulnerable to further shocks," the IMF said. In particular, the fund noted that the recapitalization of banks has proceeded at an uneven pace across the world, with European banks lagging their U.S. peers in terms of rebuilding their capital buffers.
Therefore, the IMF stressed it is essential for banks to improve the quality and quantity of their capital cushions to avert future crises, while at the same time urging governments to encourage the weakest financial institutions to recognize their losses and sell assets, and in some cases wind them down through orderly mechanisms.
In emerging markets, the IMF identified increasing capital inflows lured by buoyant growth prospects and higher returns as the main risk to financial stability, especially at a time when inflation is rising in these countries.
"The flows complicate efforts to manage local demand through tighter monetary policy, as rate hikes could spur additional capital inflows," the IMF said, adding these flows may "exacerbate domestic dynamics and add to financial imbalances and vulnerabilities."
While recognizing that macroprudential measures and in some cases capital controls can be useful in curbing potentially disruptive capital inflows, the IMF cautioned these are no substitute for macroeconomic policy action, which it said is being delayed in some emerging countries.
Acting on interest rates to address rising inflation and strong credit growth, allowing local currencies to appreciate and having tighter fiscal policies in place could prove a more adequate response to surging capital inflows, the IMF said.
Source: http://online.wsj.com
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