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Risks to global financial stability have increased and financial
markets have been volatile as European policymakers grapple with the ongoing
crisis, the IMF said in its latest assessment of the global financial sector.
The Eurozone crisis has moved from a sudden stop into a capital-flight phase
despite substantial policy interventions, as cross-border private capital is
being repatriated from the periphery back to the core of the currency union.
Faltering market confidence has led to capital flight from countries on the
‘periphery’ to the core of the Eurozone. This has meant higher borrowing costs
and a growing wedge between the economic and financial ‘haves’ and ‘have-nots’.
European policymakers have taken a number of important steps in recent months
to help reverse the fragmentation of Eurozone financial markets and strengthen
the European Monetary Union, the IMF said in its latest
'Global Financial Stability Report'. The most recent action, in
September, was the announcement by the European Central Bank to buy government
bonds on a conditional basis.
These actions have helped markets stabilize in recent months. However,
policymakers need to take additional measures to restore confidence. If they do
not, the result will be an acceleration in deleveraging, which raises the risk
of a credit crunch as banks make fewer loans, and an ensuing economic recession,
the IMF said.
“Further policy efforts are needed to gain lasting stability,” said José
Viñals, financial counsellor and head of the IMF’s Monetary and Capital Markets
Department, which produced the report. Viñals was a senior official at
Banco de España, during the Spanish property bubble.
Eurozone: restore confidence and reverse fragmentation
The IMF said delays in resolving the crisis have likely increased the amount
of asset deleveraging by banks, which may further constrain the supply of bank
credit and reinforce financial and economic fragmentation in the Eurozone.
Unless additional, decisive policy measures are taken urgently, the latest
report says that mounting pressure on banks in Europe could result in asset
shrinkage by as much as $2.8 tn to $4.5 tn through the end of 2013,
with the largest burden of credit supply contraction falling on the Eurozone
“Commitment to a clear roadmap on a banking union and fiscal integration are
needed to restore confidence, reverse the capital flight, and reintegrate the
Eurozone,” said Viñals.
Countries need to do their part by implementing policies that promote growth
and complete the clean-up of the banking sector, said Viñals.
Policy actions needed
To restore confidence, policymakers in the Eurozone need to swiftly complete
the work they’ve begun, including:
Reduction of government debts and deficits in a way that supports growth;
Implementation of structural reforms to reduce external imbalances and
promote growth; and
Clean-up of the banking sector, including recapitalizing or restructuring
viable banks and resolving nonviable ones.
Policymakers need to complement these efforts with actions at the Eurozone
level, according to the IMF. The European Central Bank should continue to ensure
sufficient funding is provided to banks through their liquidity framework. More
fundamentally, concrete progress toward a banking union in the Eurozone will
help break the pernicious link between sovereigns and domestic banks.
Over the longer term, a successful banking union will require sufficient
pooling of resources to provide a credible fiscal backstop to the bank
resolution authority, and a joint deposit insurance fund.
Beyond the Eurozone
The report says the risks to financial stability are not confined to the Eurozone. Both
Japan and the United States face significant fiscal challenges,
which, if unaddressed, can have negative financial stability implications,
according to the IMF. Both countries require medium-term deficit reduction
plans that protect growth and reassure financial markets.
The IMF says the key lesson of the last few years
is that imbalances need to be addressed well before markets start signaling
credit concerns. If there is no credible medium-term plan, markets will force an
adjustment over a compressed period, with adverse effects on growth and
Thus far, emerging economies have adeptly navigated through
global shocks, but need to guard against potential shockwaves from the Eurozone
crisis, while managing slowing growth in their own economies. Many central and
eastern European economies are vulnerable as a result of their high direct
exposure to banks in the Eurozone and some similarities with weaknesses in the
periphery. At the same time, the IMF says several economies in Asia and Latin America are
also prone to risks associated with being in the later stages in a credit cycle.
If spillovers were to intensify, rising domestic vulnerabilities and a reduction
in policy space could pose increased challenges, the IMF said.
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