Global financial and market conditions have improved in the past six months, but there’s more work to be done, the International Monetary Fund (IMF) says.
In a new report, the IMF notes that market conditions have improved, economic recovery, and sparking a rally in risky assets. However, it stresses that with global economic conditions remaining subdued, “the improvement in financial conditions can only be sustained through further policy actions that address underlying stability risks and promote continued economic recovery.”
In particular, it says that the financial sector must continue to repair its balance sheets, and there must be a smooth unwinding of public and private debt overhangs. “If progress in addressing these medium-term challenges falters, risks could reappear,” it says. “The global financial crisis could morph into a more chronic phase, marked by a deterioration of financial conditions and recurring bouts of financial instability.”
The report says that to limit corporate deleveraging, policymakers must continue to try to reduce fragmentation and lower funding costs, and ongoing restructuring plans to improve productivity are essential too. “In addition, a combination ofasset sales or cutbacks in dividends and investment may be needed to reduce debt burdens,” it says.
And, while U.S. banks have largely restructured their balance sheets, some European banks need to continue to work on this, it says. “Banks in the euro area periphery, in particular, face significant challenges that are impairing their ability to support economic recovery,” it notes.
Whereas, for banks in emerging markets, the IMF says their main challenge is to continue supporting growth while safeguarding against rising domestic vulnerabilities.
The report also warns that a prolonged period of extraordinary monetary accommodation “could push portfolio rebalancing and risk appetite to the point of creating significant adverse side effects.” And, it says that while these policies are still necessary, the possible side effects must be closely monitored and controlled.
“Of particular concern is the possible mispricing of credit risk, riskier positioning by weaker pension funds and insurance companies, and a rise in liquidity risk, particularly in countries where recoveries are more advanced,” it says.
Additionally, the report says that while much has been done to improve global and national financial sector regulations, the reform process remains incomplete. “Delays in completing the reform agenda are not only a source of continued vulnerability, but also a source of regulatory uncertainty that may impact the willingness of banks to lend,” it says. “They foster the proliferation of uncoordinated initiatives to directly constrain banking activity in different jurisdictions, given the strong political imperatives to take action.”
It says that policymakers must take decisive action to restructure weak banks and encourage the buildup of the new capital and liquidity buffers; improved financial reporting and disclosure by banks is also essential to improve market discipline and restore confidence in banks; effective resolution regimes also need to be established; and, further work is needed on the too-big-to-fail problem, over-the-counter derivatives reform, accounting convergence, and shadow banking regulation; it says.