Global Financial Stability Update:
The IMF (International Monetary Fund) said today in Johannesburg, South Africa,
that nearly four years after the onset of the largest financial crisis since the
Great Depression, global financial stability is still not assured and
significant policy challenges remain to be addressed. Bank balance sheet
restructuring is incomplete and proceeding slowly, and leverage is still high.
The Fund says the interaction between banking and
sovereign credit risks in the Eurozone remains a critical factor, and policies
are needed to tackle fiscal and banking sector vulnerabilities. At the global
level, regulatory reforms are still required to put the financial sector on a
sounder footing. At the same time, accommodative policies in advanced economies
and relatively favorable fundamentals in some emerging market countries are
spurring capital inflows. This means that policymakers in emerging market
countries will need to watch diligently for signs of asset price bubbles and
The IMF says despite improvements in market
conditions since the October 2010 GFSR (Global Financial Stability Report),
sovereign risks within the Eurozone have on balance intensified and spilled over
to more countries. Government bond spreads in some cases reached highs that were
significantly above the levels seen during the turmoil last May. The economists
say that pressures on Ireland were particularly severe and led to an EU-ECB-IMF
program. Correlations between the average sovereign yields of Greece and Ireland
and the yields of Portugal have remained high, but correlations have increased
sharply in recent months with the yields of Spain, and to a lesser extent,
Italy, as the tensions spread.
The Fund says most countries’ banking systems
have reduced their vulnerabilities by increasing their Tier 1 capital ratios.
However, improvements in the structure of funding have been more difficult to
achieve. Moreover, some Eurozone banking systems are particularly vulnerable
to deterioration in the credit quality of their sovereign debt holdings. Even
for countries that look better positioned along both these dimensions, there are
still risks. In the United States, nonperforming loans related to commercial and
residential real estate continue to pose downside risks to banks’ balance
sheets, and the government debt-to-GDP ratio remains high.
The update says the effective size of the
Eurozone bailout fund, the European Financial Stability Facility, should be
increased and it should have a more flexible mandate. For countries where the
banking system represents a large proportion of the economy, it is now even more
essential to ensure access to sufficient funds, going beyond national backstops
The IMF says macroprudential policymaking, which
aims to preserve the stability of the financial system as a whole, is still in
its infancy in most countries, and there are concerns
that systemic vulnerabilities may build up again before solid progress is made
to prevent such a build-up.
Financial systems will need to adjust to the new
reforms, including as the recovery takes hold and interest rates rise. This will
be more challenging for those countries, such as Japan, that have had low
interest rates and a build-up of debt over a long period of time.
The need for macroprudential policymaking is also very relevant
for emerging market economies facing absorptive constraints on capital inflows.
The Fund says these policies are complements, not substitutes, for traditional
macroeconomic policies. So far, evidence of asset price bubbles and credit booms
is still isolated to a few countries in a few sectors, but equity inflows and
carry-trade activity are generally quite strong and these flows have to be
watched carefully, particularly where leverage may be involved.
Global Financial Stability Update