Global Financial Markets Remain Calm, but Risks are Rising
The global banking and financial markets remain calm, with low volatility, as central banks have begun to ease interest rates after bringing inflation close to their target, the International Monetary Fund (IMF) reported on Monday, April 21, in Washington.
Risks to Financial Stability Have Increased
"Our assessment shows that risks to global financial stability have increased significantly, due to growing uncertainty surrounding economic policies and rising market volatility. The decline in investor confidence we have observed has triggered waves of selling on stock markets. The tightening of global financial conditions is exerting downward pressure on economic activity," said Tobias Adrian, Financial Counselor of the IMF.
This analysis is featured in the IMF's Global Financial Stability Report, published on the occasion of the IMF and World Bank Spring Meetings.
Three Key Vulnerabilities to Watch
"We identify three major vulnerabilities to monitor. Despite recent turbulence, some asset valuations remain elevated. If economic prospects continue to deteriorate, these valuations could fall further, leading to a further tightening of global financial conditions. This could have a negative impact on currencies, asset prices, and capital flows to emerging markets," Adrian explained before the report's publication.
Financial Conditions Have Shifted from Accommodative to Neutral
"Currently, financial conditions have shifted from an accommodative context to a neutral stance, with potential for future tightening. In the event of prolonged volatility, highly indebted financial institutions could face significant strains. Non-bank financial institutions could also encounter difficulties in times of turbulence, which could affect the entire financial system. In the most fragile and poorly managed banks, vulnerabilities could re-emerge," he warned.
Other Turbulence Could Affect Sovereign Bond Markets
"Other turbulence could also affect sovereign bond markets, particularly in regions with high levels of public debt. If market functioning were to deteriorate in major advanced economies, and if leveraged positions were to be unwound on key bond markets, volatility could amplify further. Emerging market economies, which are already facing the highest real financing costs in a decade, may need to refinance their debt and finance their public expenditures at increased costs. As a result, investor concerns about the sustainability of public debt and vulnerabilities in the financial sector could intensify," Adrian cautioned.
What Should Policymakers Do to Preserve Financial Stability?
"It is crucial to prepare for the challenges ahead, in order to enable authorities to effectively manage any financial instability. Policy tools should include measures to ensure the smooth functioning of markets, support prudent supervision and regulation of financial institutions, and provide emergency liquidity and crisis resolution instruments. We recommend that financial institutions and regulators mobilize resources to identify and mitigate risks, using stress tests and scenario analyses. Emerging and developing economies should strengthen their financial markets while maintaining sufficient budgetary margins and international reserves to cope with geopolitical shocks," Adrian concluded.
