In October 2019, the International Monetary Fund (IMF) published the Global Financial Stability Report (GFSR). The report, which, it publishes twice a year focuses on the financial implications of economic issues across the world. In the usual generic rendition, October edition is entitled “Global Financial Stability Report-Lower for Longer”. This edition highlights some key vulnerabilities in the global financial system with recommendations to policy-makers. This terse script attempts to share with you, including avid readers some of the trending nuggets in the 109-page report. Let’s be informed! Here we go!
The report identified some striking vulnerabilities in the global economy with a pointer. That is, “financial markets have been buffeted by the ebb and flow of trade tensions and growing concerns about the global economic outlook. It continued, “weakening economic activity and increased downside risks have prompted a shift toward a more dovish stance of monetary policy across the globe. This development has been accompanied by sharp declines in market yields. As a result, the amount of bonds with negative yields has increased to about $15 trillion.” Hence, investors now expect interest rates to remain very low for longer than anticipated at the beginning of the year.
Besides, investors’ search for yield has left asset prices in some markets overstretched and fostered a further easing in financial conditions. Accommodative monetary policy according to the report is supporting the global economy in the near term, but easy financial conditions are encouraging financial risk-taking and are fueling a further buildup of vulnerabilities in some sectors and countries.
Again, corporate sector vulnerabilities have escalated in several systemically important economies as a result of rising debt burdens and weakening debt service capacity. “In a material economic slowdown scenario, half as severe as the global financial crisis, corporate debt-at-risk (debt owed by firms that are unable to cover their interest expenses with their earnings) could rise to $19 trillion—or nearly 40% of total corporate debt in major economies—above crisis levels. Very low rates are prompting investors to search for yield and take on riskier and more illiquid assets to generate targeted returns.”
In the same vein, the vulnerabilities among non-bank financial institutions have risen higher in 80% of economies with systemically important financial sectors (by GDP). According to the report, this share (80%) is similar to that, which happened at the height of the global financial crisis. The report, therefore, notes: “vulnerabilities also remain high in the insurance sector. Institutional investors’ search for yield could lead to exposures that may amplify shocks during market stress; similarities in investment funds’ portfolios could magnify a market sell-off, pension funds’ illiquid investments could constrain their ability to play a role in stabilising markets as they have done in the past, and cross-border investments by life insurers could facilitate spill-overs across markets. Capital flows to emerging markets have also been spurred by low-interest rates in advanced economies”.
What’s more, the capital inflows have supported additional borrowing: median external debt in emerging market economies has risen to 160% of exports from 100% in 2008. In some countries, this ratio has increased to more than 300%. In the event of a sharp tightening in global financial conditions, increased borrowing could raise roll-over and debt sustainability risks. For example, some over-indebted state-owned enterprises may find it harder to maintain market access and service their liabilities without sovereign support. Again, the Fund notes that greater reliance on external borrowing in some frontier market economies could also increase the risk of future debt distress.
Another trending nugget is that regulation put in place in the wake of the global financial crisis has improved the overall resilience of the banking sector. The report, however, observed that pockets of weaker institutions remain. Thus, negative yields and flatter yield curves—along with a more subdued growth outlook—have reduced expectations of bank profitability, and the market capitalisation of some banks has fallen to low levels. Banks are also exposed to sectors with high vulnerabilities through their lending activities, leaving them susceptible to potential losses. Apart from that, environmental, social, and governance (ESG) principles continue to trend and becoming increasingly important for borrowers and investors in their decision-making. In effect, environmental, social, and governance (ESG) factors could have a material impact on corporate performance and may give rise to financial stability risks, particularly through climate-related losses. Therefore, authorities have a key role to play in developing standards for ESG investing.
In extenso, the report states, “against the backdrop of easy financial conditions, stretched valuations in some markets; elevated vulnerabilities; medium-term risks to global growth and financial stability continue to be firmly skewed to the downside. Macroeconomic and macroprudential policies should be tailored to the particular circumstances facing each economy. In countries where economic activity remains robust but vulnerabilities are high or rising amid still easy financial conditions, policymakers should urgently tighten macroprudential policies, including broad-based macroprudential tools (such as the countercyclical capital buffer). In economies where macroeconomic policies are being eased in response to a deterioration in the economic outlook, but where vulnerabilities in particular sectors are still a concern, policy-makers may have to use a more targeted approach to address specific pockets of vulnerability. For economies facing a significant slowdown, the focus should be on more accommodative policies, considering available policy space.”
The Fund advised policy-makers to take action to tackle financial vulnerabilities that could worsen the next economic downturn. This includes:
- Rising corporate debt burdens: Stringent supervision of bank credit risk assessment and lending practices should be maintained. Efforts should be made to increase disclosure and transparency in non-bank finance markets to enable a more comprehensive assessment of risks. In economies where overall corporate sector debt is deemed to be systemically high, in addition to sector-specific prudential tools for banks, policy-makers may consider developing prudential tools for highly leveraged firms. Reducing the bias in tax systems that favours debt over equity financing would also help reduce incentives for excessive borrowing.
- Increasing holdings of riskier and more illiquid securities by institutional investors: The oversight of non-bank financial entities should be strengthened. Vulnerabilities among institutional investors can be addressed through appropriate incentives (for example, to reduce the offering of guaranteed return products), minimum solvency and liquidity standards, and enhanced disclosure.
- Increased reliance on external borrowing by emerging and frontier market economies: Indebted emerging market and frontier economies should mitigate debt sustainability risks through prudent debt management practices and strong debt management frameworks.
The report further asserts that global policy coordination remains critical. In this regard, it states” policy-makers should also complete and fully implement the global regulatory reform agenda, ensuring that there is no roll-back of regulatory standards. Continued international coordination and collaboration is also needed to ensure a smooth transition from LIBOR (London Inter-bank Offered Rate) to new reference rates for a wide range of financial contracts around the world by the end of 2021.”
Here we land! It is always good to be informed. Thank you for reading. I welcome your feedback or comments on this script. God bless You!
This script was written by a Chartered Banker with a flair for feature writing. He works for a company which provides financial services. Apart from his work schedules, he edits or proof-reads corporate material for his colleagues, executive managers – including distinguished professionals working in various fields outside Banking. Through this column, his articles feature on third-party online media platforms in Ghana and outside. Email: Kwaku.Anumu@gmail.com