by Don Alexander, MBA
Associate, RSD Solutions Inc.
The latest Global Financial Stability Report (GFSR) from the IMF noted financial stability risks have increased for the first time since early 2008. The weaker growth prospects have had an adverse impact on private and public balance sheets that are coping with heavy debt burdens. The financial system has been buffeted by market turbulence emanating from peripheral Europe, a U.S. credit downgrade with political gridlock and an adverse feedback loop between the banking system and the real economy. The IMF estimates that the need to recapitalize European banks and insurance could eventually be as high as euro 350 billion (US$400-500 billion). The continued political gridlock in Washington is already damaging financial market prospects.
Low policy rates are required under current conditions, but carry long-term threats to financial stability. Some sectors of the advanced economies remain in repair-and-recovery phase of the credit cycle as balance sheet repair remains incomplete, while the search for yield is pushing some segments to become more leveraged and vulnerable. Low rates are pushing credit creation into non-traditional sources such as the shadow banking system.
Emerging markets provide a better story as they are in a more advanced phase of the credit cycle, but could be vulnerable to contagion, especially from advanced countries. The combination of low rates and capital inflows leave emerging markets vulnerable to a gradual buildup of financial imbalances and potential fallout from a sharp reversal of financial flows.
The GFSR notes that risks are elevated and time is running out to tackle vulnerabilities that could affect the financial system and fragile recovery. The IMF offered four areas for policy action: (1) reduce sovereign risk in advanced countries and prevent contagion; (2) strengthen the resilience of financial system and contain against excesses; (3) in emerging market policymakers need to guard against overheating and a buildup of financial imbalances through the use of prudent macroeconomic and financial policies; and (4) the completion of financial reform agenda implemented internationally in a consistent manner.
For more on the IMF’s views click on the link: http://tinyurl.com/62hwbgn
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