## Risk and Resilience in the Global Foreign Exchange Market — Chapter 2 Summary

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**Canonical URL:** [Risk and Resilience in the Global Foreign Exchange Market — Chapter 2 Summary](https://www.imf.org/-/media/files/publications/gfsr/2025/october/english/ch2sum.pdf)

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### Overview
- The foreign exchange (FX) market has become the world’s largest and most liquid financial market, driven largely by rising participation of nonbank financial institutions and increased use of derivatives for hedging currency risks and funding.
- Growth has enhanced market liquidity and diversified risk but introduced greater complexity and tighter interconnections, increasing vulnerability to stress episodes.
- The chapter uses a unique cross-country dataset on FX spot and swap trades in major currencies to analyze how heightened macro-financial uncertainty affects FX market functioning and implications for financial stability.

### Key findings on market behavior under uncertainty
- Periods of uncertainty tend to trigger flight-to-quality flows and stronger hedging demand.
- These dynamics drive up foreign-currency funding costs.
- Bid-ask spreads widen during stress episodes.
- Excess exchange rate return volatility increases, particularly for emerging market currencies.
- Structural vulnerabilities amplify these pressures:
  - Larger currency mismatches on the balance sheets of financial institutions.
  - Reliance on a few dealers.
  - High participation of nonbank financial institutions in trading activity.

### Transmission to broader financial system
- Stress in the FX market can transmit rapidly to other financial markets, posing broader macro-financial stability risks.
- Rising funding and hedging costs can affect risk premiums of stocks and bonds.
- Increased costs may limit the ability of financial institutions to intermediate, tightening financial conditions.
- Impacts are magnified in countries with elevated macro-financial vulnerabilities, such as significant currency mismatches or high fiscal risk.

### Operational and settlement risks
- FX markets are highly exposed to operational disruptions such as cyber incidents.
- Settlement risk is the possibility that one party will deliver its currency without receiving what the counterparty owes.
- Settlement risk is particularly relevant for emerging market and developing economies.
- Many emerging market and developing economies are outside risk mitigation arrangements, such as payment-versus-payment (PvP) mechanisms that settle both sides of an FX transaction simultaneously.

### Policy recommendations to bolster resilience
- Strengthen surveillance to monitor systemic risks arising from FX market stress.
- Use enhanced liquidity stress tests and scenario analysis to assess how FX market disruptions could transmit across the financial system.
- Close critical data gaps to support effective monitoring, prioritizing data on:
  - Positions of nonbank financial institutions.
  - Settlement exposures.
- Ensure institutions maintain adequate capital and liquidity buffers, supported by a robust crisis management framework.
- Strengthen operational resilience by improving cyber security and contingency planning to ensure key FX market participants and infrastructures can recover quickly from disruptions.
- Reduce settlement risk through broader adoption of PvP arrangements.
- Strengthen the design and resilience of trading and post-trade platforms to:
  - Lower transaction costs.
  - Dampen volatility.
  - Limit both counterparty and settlement risks.

*To see the full report, please refer to the English version here: https://www.imf.org/gfsr-october2025*

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_Source: https://www.imf.org/-/media/files/publications/gfsr/2025/october/english/ch2sum.pdf_