Risks to Financial Stability Increase, Bold Action Needed
IMF Blog, July 17, 2012
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- Authors: Jose-Vinals
- Published: July 17, 2012
Overview
- Author: José Viñals
- Date: July 17, 2012
- Three key messages from the Global Financial Stability Report update:
- Financial stability risks have increased because of escalating funding and market pressures and a weak growth outlook.
- Measures agreed at the recent European leaders’ summit provide significant steps to address the immediate crisis, but more is needed; timely implementation and further progress on banking and fiscal unions must be a priority.
- Time is running out; strong political leadership and tough decisions are needed now to restore confidence and ensure lasting financial stability in both advanced and emerging economies.
Why financial stability risks have increased
- Government bond yields in Southern Europe have sharply increased, while funding conditions for many European banks have deteriorated.
- The beneficial effects of the European Central Bank’s extraordinary long-term refinancing operations have decreased in recent months amid renewed policy uncertainty and growing concerns about the health of banks, leading to a substantial flight to safe assets.
- Financial fragmentation has exacerbated the adverse feedback loop between weak banks and governments and threatens to undermine the currency union:
- Private capital outflows have continued to erode the foreign investor base for government debt in countries such as Italy and Spain.
- Governments have increased their reliance on domestic banks to finance their public debt.
- Banks have increasingly turned to the European Central Bank to meet their liquidity needs as wholesale funding markets remain closed to them.
- Sovereign and bank funding pressures have spilled over to the corporate sector in the periphery of the euro area:
- Corporates face rising wholesale funding costs, a drop in bank lending, and a large amount of maturing bonds in the near term that will likely exacerbate their funding squeeze.
- Growth prospects in other advanced economies and emerging markets are a bit weaker, leaving them more vulnerable to spillovers from the euro area and reducing their ability to address home-grown fiscal and financial vulnerabilities.
- Uncertainties about the fiscal outlook in the United States present a particular latent risk to global financial stability.
Policy priorities — euro area
- Immediate stabilization, deeper integration, and policies to support growth are needed.
- Stabilization actions recommended:
- Strengthen the balance sheets of viable banks, where needed, through recapitalizations and restructurings; in some cases this may involve direct equity injections from Europe’s rescue fund, the European Stability Mechanism.
- Strengthen sovereign balance sheets by implementing well-timed fiscal consolidation strategies and by enacting sweeping structural reforms.
- Maintain supportive monetary and liquidity policies.
- Consider actions at the euro area level to stabilize funding conditions in sovereign debt markets, such as the reactivation of the European Central Bank’s Securities Markets Program.
- Further integration requires progress toward a full-fledged banking union and deeper fiscal integration:
- The planned, unified supervisory framework is the first building block of a future banking union.
- Additional building blocks will be needed, including a pan-European deposit insurance guarantee scheme and bank resolution mechanism with common backstops.
Policy priorities — United States
- The U.S. is facing an important fiscal turning point: by early next year, the U.S. is expected to reach the current debt ceiling.
- Financial market consensus suggests that the ceiling will be raised in time to avert a default, but a significant adverse market reaction cannot be excluded, especially if there is political gridlock over raising the ceiling.
- Credible medium-term fiscal consolidation is needed to avoid further sovereign rating downgrades and to preserve the stability of the U.S Treasury market.
Policy priorities — emerging economies
- Emerging economies face a twin challenge: dealing with spillovers from advanced economies’ troubles while confronting increasing home-grown vulnerabilities.
- Observed impacts:
- Equity markets and capital flows have responded to slowing global growth and euro area spillovers.
- Home-grown vulnerabilities include rapid bank asset and credit growth in recent years, which may eventually trigger a significant increase in non-performing loans.
- Slowing domestic growth could erode bank profitability and pose risks to financial stability in countries such as Brazil, China, and India.
- Recommended focus:
- Pay special attention to the health of domestic financial systems.
- Preserve and increase the room for policy maneuver to respond to potentially large domestic and external shocks.
Key recommendations and closing message
- Bold political actions are needed to address the balance sheet problems of banks and sovereigns.
- Monetary policy has bought valuable time and provided essential liquidity to financial systems, but solvency concerns for banks and governments cannot be addressed through liquidity measures alone.
- Now is the time for bold and concrete actions in advanced economies to achieve sustained balance sheet repair and institutional reform.
- Tough decisions will need to be made to restore confidence and ensure lasting financial stability in both advanced and emerging economies.
Source: Risks to Financial Stability Increase, Bold Action Needed — José Viñals, July 17, 2012
Content in this bundle
- iMFdirect 博客: 金融稳定风险上升，需要采取果断行动, 2012年7月17日
- iMFdirect ブログ: 高まる金融不安定化のリスク、果断な措置が必要, 2012年7月17日
- Риски для финансовой стабильности усиливаются, требуются решительные меры
