Enhancing Financial Stability for Resilience During Uncertain Times
IMF Blog, April 22, 2025
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- Authors: Tobias Adrian
- Published: April 22, 2025
Key findings on financial stability risks
- Global financial stability risks have grown significantly, driven by tighter financial conditions and heightened trade and geopolitical uncertainty.
- Three salient and forward-looking vulnerabilities:
- Capital markets concentration and stretched valuations:
- The United States makes up nearly 55 percent of the global equity market, up from 30 percent two decades ago.
- Valuations of some assets remain stretched despite recent sell-offs, increasing the risk that further asset price corrections could amplify market stress.
- Rising role and interconnectedness of nonbank financial institutions (NBFIs):
- NBFIs have become more active in channeling savings toward investments since 2008, and their nexus with banks has continued to grow.
- In the United States, NBFI borrowings have reached 120 percent of banks’ common equity tier 1 capital.
- Certain hedge funds’ highly leveraged trading strategies could backfire in volatile markets, prompting deleveraging that forces asset sales into falling markets and generates losses for banks that provided leverage.
- The private credit segment has grown substantially, typically lending to smaller corporate borrowers; banks partner with private credit funds via joint ventures or loan facilities, creating potential shared loss channels if borrower repayment deteriorates.
- Rising sovereign debt and market functioning risks:
- Sovereign debt now accounts for 93 percent of global economic output, up from 78 percent a decade ago.
- Financing costs have increased in both nominal and real terms.
- Disruptions in core government bond markets—especially in countries with high debt levels—could pose threats to financial stability.
- Riskier emerging markets have seen sovereign bond spreads rise during recent market turmoil, raising refinancing and spending risks.
Role of banks and systemic interconnections
- Banks are central to the financial system because of core lending functions and their role in facilitating capital markets.
- Large international banks act as important market-makers in securities and derivatives and are major providers of leverage to various NBFI segments:
- They lend directly against asset portfolios, provide credit lines, and facilitate leverage indirectly through repos and derivatives.
- G-SIBs and other leverage providers (including clearing houses for derivatives) use tools such as collateral requirements and arrangements to reduce gross exposures, but cannot control clients’ external borrowing, increasing systemic nexus risks.
Implications for market functioning and fiscal dynamics
- For advanced economies:
- Resilience depends on governments moderating large amounts of bond issuances and ensuring bank and nonbank broker-dealers have the capacity to intermediate them.
- For emerging markets:
- Credibility of debt management frameworks is essential—strengthening institutional capacity, establishing clear targets and strategies for issuing and redeeming bonds, and carefully calibrating currency composition of bonds are key.
- The Fiscal Monitor emphasizes growth-enhancing fiscal consolidation as a key measure to alleviate sovereign debt-related risks.
- Policies to ensure liquid and well-functioning bond markets are critical because government bonds are cornerstone instruments in capital markets.
Policy recommendations
- For NBFIs:
- Enhance reporting requirements so supervisors can develop a systemwide view of activities and distinguish between useful intermediation and excessive risk or poor governance.
- Strengthen policies that mitigate leverage and interconnectedness vulnerabilities, building on the Financial Stability Board’s and other standard-setting bodies’ minimum standards or recommendations.
- For banks:
- Ensure full, timely, and consistent implementation of Basel III and other internationally agreed bank regulatory standards to guarantee ample and adequate capital and liquidity and maintain a level playing field across jurisdictions.
- Prudently manage banks’ exposures to NBFIs.
- For government bond market resilience:
- Promote central clearing of bonds and reduce counterparty risks while further bolstering the resilience of central clearing.
- Ensure key intermediaries in government bond markets are sound and operationally resilient.
- For emerging markets specifically:
- Implement credible frameworks to meet government financing needs to strengthen bond markets.
- Use IMF-World Bank Medium-Term Debt Management Strategies for rolling over debt and assessing currency composition and financing cost.
- Consider developing domestic markets for government bonds to increase demand from long-term domestic investors and help contain financing costs and external pressures.
—Tobias Adrian, April 22, 2025; based on Chapter 1 of the April 2025 Global Financial Stability Report, “Enhancing Resilience amid Global Trade Uncertainty.”