Know in Detail Highlights & Recommendations Global Financial Stability Report

The Global Financial System was tested by Higher Inflation and Interest Rates

• The report projects higher financial stability risks. 

• The failures of the two banks and the loss of confidence in Credit Suisse are mentioned. These are attributed to challenges posed by the interaction between financial conditions. It also mentioned the increases in vulnerabilities since the global financial crisis.

• Failure of banking institutions causes Shifting patterns of deposits across different institutions. This could raise funding costs for banks and restrict their ability to provide credit to the economy.

• The tighter monetary and financial conditions may pose a stability threat. The threat was raised because of financial leverage, liability liquidity, and asset mismatches. Another reason is the high interconnectedness between non-bank financial and traditional banking institutions. 

• Some sectors, like venture capital, technology, and commercial real estate, have been affected more, mostly by the removal of ample liquidity spilling over to the rest of the financial system.

• The buffers by households and corporations during the pandemic boosted their shock-absorption capacity. These buffers are deteriorating, leaving them more vulnerable to default risk.

• Several steps can be taken if financial stresses intensify. One such step is a significant pullback from global risk-taking that could trigger capital outflows. 

• Small emerging market economies continue to confront worsening debt sustainability trends. Many are already facing strains and funding challenges.

• The prospect of higher inflation and interest rates has profound implications for asset prices. It also impacts asset allocations and the resolution of vulnerabilities.

• Poor liquidity in bond markets could sharply amplify asset price moves and shocks.

Non-bank Financial Intermediaries- Vulnerabilities during Tighter Financial Conditions

• Due to low-interest rates, the financial vulnerabilities of NBFIs might have increased in the past.

• The stress among the NBFIs emerges due to elevated leverage. Other factors include liquidity mismatches and high levels of interconnectedness. These factors often spill over to emerging markets.

The Implication of Geopolitics and Financial Fragmentation For Macro-Financial Stability

• Financial fragmentation is due to geopolitical tensions. It affects the cross-border allocation of capital, international payment systems, and asset prices.

• The investing countries give less capital to countries with different foreign policies.

• An increase in geopolitical tensions causes a sudden reversal of cross-border capital flows. This impact is larger for emerging markets and developing economies than for advanced economies.

• The Financial fragmentation could pose macro-financial stability risks to banking infrastructure. It causes an increase in banks' funding costs, a decline in profitability, and lower credit availability for the private sector. Banks with lower capitalization ratios are affected more by these factors.

• The financial fragmentation could exacerbate macro-financial volatility in the longer term. It could reduce international risk diversification opportunities. It can also help an economy that is already facing adverse domestic and external shocks.

The Global Financial System was tested by Higher Inflation and Interest Rates

• Clear communication about the objectives of the central bank and policy functions is essential. This can minimize economic and financial uncertainty. 

• The available tools to address financial stability risks should help central banks. They can be used to separate monetary policy objectives from financial stability goals. It will allow central banks to continue to tighten policy to address inflationary pressures.

• Policymakers should act in a swift manner to prevent any systemic event. It may hamper market confidence and harm the resilience of the global financial system. 

• Policymakers should communicate their primary goal to bring inflation back to target as soon as possible.

• Bank supervisors should ensure that banks have governance and risk management. They should have the adequacy of capital and liquidity stress tests.

• Regulatory bodies should also strengthen resolution regimes and crisis management frameworks.

• Policymakers should close data gaps in the non-bank financial intermediation sector. They should incentivize proper risk management practices, set appropriate regulations, and intensify supervision.

Non-bank Financial Intermediaries- Vulnerabilities during Tighter Financial Conditions

• NBFI's direct access to central bank liquidity could prove necessary during stressful times. This should be done with appropriate protection.

• Robust surveillance, regulation, and supervision of NBFIs are essential. 

• Priorities should be given to close key data gaps and incentivize risk management by NBFIs. 

• The central bank should intervene to address liquidity issues only and not solvency problems. 

• The central banks should avoid conflicting with the monetary policy stance.

• Clear communication is vital. Central banks should make announcements for liquidity support. 

• The announcements should clearly explain the financial stability goal and the program's parameters.

• Coordination between the central bank and financial sector regulators is very vital. It is important for the identification of risks and the management of crises.

The Implication of Geopolitics and Financial Fragmentation For Macro-Financial Stability

• Closely monitoring the relations between geopolitical risks and "traditional" risks. These risks include credit, interest rate, market, and liquidity. It also includes operations that could help prevent fallout from geopolitical events.

• Adopting a systematic approach to stress testing and scenario analysis. This helps to assess and quantify transmission channels of geopolitical shocks.

• The banks and NBFIs are needed to hold the required capital and liquidity buffers. This helps to mitigate the negative consequences of rising geopolitical risks.

• The adequacy of the global financial safety net must be ensured. 

• Countries should engage and dialogue to resolve geopolitical tensions. This can prevent economic and financial fragmentation.

• International regulatory and standard-setting bodies should continue promoting common financial regulations. This helps to prevent increased financial fragmentation.

• Policymakers should be aware of imposing financial restrictions for national security. It can have unintended consequences for global macro-financial stability.

Miscellaneous 

• The IMF's Integrated Policy Framework can help manage capital flow and exchange rate volatility. It addresses underlying macroeconomic imbalances and allows for adjustments.

• Country authorities should enhance efforts to contain risks associated with high debt vulnerabilities.

• Bilateral and private sector creditors should coordinate. This should be done in cases of debt distress.