## Risks to Financial Stability Increase, Bold Action Needed

_IMF Blog, July 17, 2012_

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**Canonical URL:** [Risks to Financial Stability Increase, Bold Action Needed](https://www.imf.org/en/blogs/articles/2012/07/17/risks-to-financial-stability-increase-bold-action-needed)

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## Bibliographic details
- Authors: Jose-Vinals
- Published: July 17, 2012

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### 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*

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## References

- [https://www.imf.org/wp-content/uploads/2011/04/jv_spring-2011-gfsr.jpg](https://www.imf.org/wp-content/uploads/2011/04/jv_spring-2011-gfsr.jpg)
- [عربي](http://blog-montada.imf.org/?p=1638)
- [Global Financial Stability Report](http://www.imf.org/external/pubs/ft/fmu/eng/2012/02/index.htm)

_Source: https://www.imf.org/en/blogs/articles/2012/07/17/risks-to-financial-stability-increase-bold-action-needed_