Time Not On Our Side: Tough Decisions Needed to Strengthen Financial Stability
IMF Blog, October 10, 2012
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Bibliographic details
- Authors: Jose-Vinals
- Published: October 10, 2012
Overview
- Author: José Viñals
- Date: October 10, 2012
- Main message: Recent policy actions have improved investor sentiment, but confidence remains fragile and risks have increased since the IMF’s last report in April. Policymakers must take further, decisive actions to secure lasting financial stability.
Euro area risks and scenarios
- Principal risk: euro area fragmentation between core and periphery leading to pullback of cross-border private capital flows within the currency union.
- Consequences of fragmentation:
- Funding costs have risen for governments, banks, companies, and households.
- Risk of a vicious downward economic spiral.
- IMF quantitative scenarios and impacts:
- If pressures continue: total assets of major banks in Europe could shrink by as much as $2.8 trillion, possibly leading to a contraction in credit supply in the periphery by 9 percent by the end of 2013.
- Weak policies scenario: European Union bank assets could shrink by as much as $4.5 trillion, and lead to a reduction in the supply of credit in the periphery by up to 18 percent.
- Rapid move to complete policies would avoid this economic damage.
Policy recommendations for Europe
- Safer banks:
- Continue restructuring or resolving weak banks despite progress such as the European Banking Authority’s capital enhancement exercise.
- Safer sovereigns:
- Implement well-timed fiscal consolidation and structural reforms to make economies safer.
- Strong firewalls:
- Ensure the European Stabilization Mechanism and the European Central Bank’s bond purchasing program have credible conditions so markets regard them as real, not “virtual.”
- A stronger union:
- Implement the Single Supervisory Mechanism without delay.
- Provide a clear roadmap to a complete banking union to guide market expectations and break the link between sovereign and bank balance sheets.
United States and Japan: risks and needed actions
- Key lesson: Delaying policy adjustments until market strains become evident leads to financial turmoil and harsher economic outcomes.
- United States:
- Fiscal imbalances are amenable to medium-term adjustment, but a blueprint for policy actions must be developed immediately.
- Risk of political impasse could repeat 2011 debt ceiling strains and potentially push the economy over the fiscal cliff; policymakers should avoid these risks and policy uncertainties.
- Japan:
- High sovereign debt and rising concentration of government bond holdings in the banking system are important stability risks.
- Projection: bank holdings of government bonds could rise to about one-third of banks total assets in five years time.
- Recommendations: macroprudential vigilance, strengthen bank balance sheets and bank business models, and pursue much-needed fiscal consolidation.
- Global monetary context:
- Safe haven flows and easy monetary policies have led to record low interest rates and suppressed risk premia in government and corporate bond markets.
Emerging markets
- Overall assessment: emerging markets have navigated global risks skillfully but must remain vigilant.
- Vulnerabilities:
- Several central and eastern European countries are most vulnerable due to direct exposure to European bank deleveraging and some weak private balance sheets.
- Asian and Latin American emerging markets are less impacted by European shocks but are not immune to adverse external spillovers.
- Following rapid credit growth, some key economies in Asia and Latin America have reached late stages of the credit cycle, often accompanied by peaking asset prices and early signs of worsening loan quality.
- Recommendation: use available policy space wisely and address domestic vulnerabilities in the face of the global slowdown.
Conclusion
- Progress has been made by banks, policymakers, and regulators, but confidence remains fragile.
- Governments must complete and build on actions already taken by central banks.
- The choice is between making necessary tough policy and political decisions now, or delaying and risking harsher outcomes—time is not on our side.
IMF blog post by José Viñals, October 10, 2012.
Content in this bundle
- 时不我待：为增强金融稳定性需作出艰难决定
- 残された時間は尐ない： 金融の安定性の強化には厳しい決断が必要
- Время не на нашей стороне: необходимо принять трудные решения для укрепления финансовой стабильности
