IMF Says Financial Stability Risks Have “Sharply” Risen

Financial stability risks have risen “sharply” in recent months, as slower economic growth, market turbulence in Europe, and the credit downgrade of the United States have weighed on the global financial system, according to new analysis by the International Monetary Fund (IMF).

The IMF said in its latest Global Financial Stability Report that “financial markets have begun to question the ability of policymakers to command broad political support for needed policy actions.” According to the report, balance sheets are “strained by mounting debt or assets that have lost value. ” It added that “the lack of progress to repair balance sheets has raised concerns about the financial health of governments in advanced economies, banks in Europe, and households in the U.S.”

In Europe, concerns about government debt levels “have spilled over to the region’s banking system, raising the cost of borrowing for many banks and reducing their market value. ”

The IMF estimates the sovereign credit risk experienced by banks in a number of European countries has increased since the start of 2010 by about USD 200 billion, where the report said that “this figure is not a measure of banks’ capital needs, but rather it approximates the increase in sovereign credit risk experienced by banks over the past two years.”

In the U.S., there have been “increased concerns about the longer-term sustainability of U.S. government debt.” These concerns, if left unaddressed, could “potentially reignite sovereign risks, with serious global consequences,” the IMF said.

The IMF said low interest rates, “while necessary to help advanced economies support growth, can carry longer-term threats to financial stability.

“It added that “the search for higher investment returns is pushing some sectors in advanced economies, such as carry traders and hedge funds, to borrow more money to invest.”

“This raises the risk of greater deterioration in asset quality in the event of new financial or economic shocks,” it noted.

It continued that many emerging markets are experiencing “rapid loan growth and borrowing more money to finance their investments,” saying “this could result in overheating pressures, a progressive buildup of financial imbalances, and worsening credit quality.”

“Should global stability risks further intensify, emerging markets could face sudden capital outflows and financial strains,” it affirmed. Furthermore, the IMF stressed that public balance sheets in the U.S., Europe, and Japan need to be bolstered through “credible strategies to reduce government debts and deficits over the next few years.”

It said that banks in the European Union need to continue “to build adequate capital buffers to help them cope with the spillovers from riskier governments. They also need to have stronger balance sheets to support the economic recovery.”

It added that emerging economies should “limit the buildup of financial imbalances to maintain resilience to future financial shocks, and continue to build solid financial systems that will help develop their economies.”

Also, global financial regulatory reforms need “to be concluded and implemented consistently across countries. This includes the treatment of systemically important financial institutions and market infrastructures, and addressing the challenges posed by the shadow banking sector.”

Meanwhile, the IMF said that “while the path to a sustained recovery has narrowed, it has not disappeared.”

The report was released ahead of the forthcoming meetings of the IMF and World Bank annual meetings, held from September 23-25 in Washington D.C., which bring together global policymakers in Washington, D.C. for a series of discussions on the global economy.