The October 2018 Global Financial Stability Report (GFSR) by the IMF reveals that global near-term risks to financial stability have increased somewhat, reflecting mounting pressures in emerging market economies and escalating trade tensions.

These risks, while still moderate, could increase significantly. An intensification of concerns about emerging markets, a broader rise in trade tensions, the realization of political and policy uncertainty, or a faster-than-expected tightening in monetary normalization could all lead to a sharp tightening in financial conditions. Medium-term financial stability risks remain elevated, driven by high non–financial sector leverage in advanced economies and rising external borrowing in emerging markets.

Although the global banking system is stronger than before the crisis, it is exposed to highly indebted borrowers as well as to opaque and illiquid assets and foreign currency rollover risks. This all raises the urgency for policymakers to step up efforts to boost the financial system’s resilience by completing the financial regulatory reform agenda as well as developing and deploying macro prudential policy tools.

The GFSR also takes stock of global regulatory reform 10 years after the global financial crisis. It reviews the main pre-crisis failings in financial sector oversight and assesses the progress in implementation of the reform agenda designed to address these failings.

It also looks at whether shifts in market structure and risks in the global financial system since the crisis have been in the direction the new regulatory agenda intended, that is, toward greater safety. It finds that the broad agenda set by the international community has given rise to new standards that have contributed to a more resilient financial system, one that is less leveraged, more liquid, and better and more intensively supervised, especially at large banks. The forms of shadow banking more closely related to the global financial crisis have been curtailed, and most countries now have macro prudential authorities and some tools with which to oversee and contain risks to the whole financial system. The chapter also identifies areas in which consolidation or further progress is needed and warns against rolling back reforms, which might make the global financial system less safe.

Ms. Ilyina, Division Chief, Monetary and Capital Markets Department addressing newsmen, noted that Nigeria, like many other emerging market countries, has come under market pressure since mid-April. “It was a combination of factors that basically affected emerging and frontier markets. It started with the sharp appreciation of the U.S. dollar in the context of rising U.S. interest rates and, of course, emerging markets and frontier markets being active borrowers, and hard currencies are very sensitive to changes in external financing conditions, so that affected sort of the broad market asset class. But what we can see very clearly is that those countries that had stronger economic fundamentals and policy frameworks and less external financing needs and external imbalances have been clearly less affected. Also, some of the outsized currency moves that we have seen, like in the case of Argentina and Turkey, have been driven largely by country-specific factors that are not necessarily related to the global environment”.

“In the case of Nigeria, there is one other important driver that always affects its external borrowing costs and economic conditions more broadly, and that is oil, so Nigeria being an oil exporter is obviously very sensitive to changes in oil prices”.

“In terms of policy responses, of course, flexible exchange rate is the first line of defense. Allowing the exchange rate to act as a shock absorber is helping the economy adjust to the new external environment. In terms of FX interventions, of course, FX interventions might make sense in certain circumstances, but then one has to consider how exchange rate is valued relative to fundamentals, what is the level of reserves, whether there may be other policy tools that might be more appropriate in country-specific circumstances, and so on so forth”, Ilyina stated.

“Another thing that I wanted to mention is that given that we are still sort of in the relatively early stage of monetary policy normalization in advanced economies, one can expect global financial conditions and external financial conditions for emerging markets to remain challenging going forward. So this is likely to be a sort of relatively protracted period of volatile capital flows and pressures in the markets, and therefore in this situation, one should use foreign exchange reserves judiciously while thinking about future, maybe more extreme periods and bouts of volatility”, .

According to Tobias Adrian, Financial Counsellor and Director, Monetary and Capital Markets Department, “Looking ahead, it remains crucial to strengthen the resilience of the financial system by addressing financial vulnerabilities. Policymakers should ensure that the post-crisis regulatory reform agenda is completed and implemented. They should resist calls for rolling back reforms. Central banks should continue to normalize monetary policy gradually, and they should communicate their decisions clearly. Emerging market and low-income economies should build buffers against external risks, should pursue exchange rate flexibility, and should consider timely targeted foreign exchange interventions”.

Adrian advised that “regulators should address vulnerabilities by deploying micro and macro prudential policy tools, including supervisory capital buffers where appropriate. They should also develop new tools to address vulnerabilities outside the banking sector. For example, they should tackle underwriting standards and non-bank credit intermediation and liquidity risks among asset managers”.

“Regulators and supervisors must remain attuned to new risks, including possible threats from cyber risks. They should also support fintech’s potential contribution to innovation, efficiency, and inclusion, while safeguarding against risks to the financial system. This is a time for more proactive measures to safeguard financial stability. Confidence must not become complacency”, he said.

(IMF)