Risks to global financial stability have increased, as confidence in the system has become “very fragile”, warns a new report from the International Monetary Fund (IMF).
The IMF says that, despite the fact that significant new efforts by European policymakers have allayed investors’ biggestfears, the euro area crisis remains the primary source of concern. It notes that while the European Central Bank’s efforts to provide almost unlimited liquidity initially eased the pressure on banks to shed assets, that pressure have risen again. And, it suggests that delays in solving the underlying concerns have increased the expected amount of asset shrinkage at the banks.
The previous report on financial stability, published in April, called on euro area policymakers to build on improvements they’ve made with the region’s sovereign debt problems, and the latest report says “more speed is needed now”, in order to restore confidence, reverse capital flight, and reintegrate the euro zone.
“Key elements at the national level include implementation of well-timed and growth-friendly fiscal consolidation, structural reforms to reduce external imbalances and promote growth, and completion of the banking sector cleanup,including further steps to recapitalize or restructure viable banks where necessary and to resolve nonviable banks,” it says. And this needs to be bolstered at the euro area level by sufficient funding to banks, coupled with progress toward establishing a banking union in the euro area “to break the pernicious link between sovereigns and domestic banks and help improve supervision.”
Additionally, while all of the pressure in Europe has generated safe-haven flows to other jurisdictions, notably the United States and Japan. The report stresses that these countries continue to face significant fiscal challenges of their own. And, it says, the steps toward medium-term fiscal adjustment need to be laid out without further delay in both countries. “The key lesson of the past few years is that imbalances need to be addressed well before markets start flagging credit concerns,” it says.
And, emerging market economies “need to guard against potential further shockwaves while managing a slowdown in growth that could raise domestic financial stability risks”, it says.
The report also says that the post-crisis regulatory reforms designed to make the financial system safer, by improving transparency of financial institutions and markets, and reducing complexity and leverage, have not yet achieved their objectives. “They are still overly complex, with strong domestic interbank linkages, and concentrated, with the too-important-to-fail issues unresolved,” it warns.
While the reforms that are under way are likely to produce a safer banking system over time, the report says there needs to be more work on: examining direct restrictions on business activities to address the too-important-to-fail issue; segments of the nonbank system that may be posing systemic risks; and, developing recovery and resolution plans for large institutions, especially those that operate across borders.