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Some global economies face debt distress, financial instability requiring official support: IMF - Daily News Egypt

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Some global economies face debt distress, financial instability requiring official support: IMF

Most banks will be able to absorb losses, but there is a weak tail, says international organisation

Some emerging markets and low-income countries face financing challenges, despite the easing of global financial conditions generally improving the outlook for portfolio flows to most emerging markets.

However, some low-income countries have still not regained access to capital markets. Some of them are so heavily indebted that they may face distress, as they confront borrowing costs at prohibitive levels.

The remarks were made in the International Monetary Fund’s (IMF) recently published report, “Global Financial Stability Report: Bridge to Recovery”, released on the sidelines of the IMF and World Bank’s annual meetings.

The report revealed that the novel coronavirus (COVID-19) pandemic has triggered a severe global economic crisis. It added that policymakers have taken bold action to protect public health, and contain the economic fallout from the pandemic.

“Near-term global financial stability risks have been contained for now,” the report said, “Unprecedented and timely policy response has helped maintain the flow of credit to the economy, and avoid adverse macro-financial feedback loops, creating a bridge to recovery.”

It said that the unprecedented policy actions taken in response to the pandemic have been successful in boosting investor sentiment, and maintaining the flow of credit to the economy. In addition, interventions by worldwide central banks have stabilised key markets by lifting investor risk appetite through both anticipated and actual central bank demand for safe and risk assets.

As the crisis continues to unfold, rising vulnerabilities may create headwinds to recovery. The report said that risks to growth are still tilted to the downside, with the probability of global growth falling below zero in 2021 close to 5%. This indicates that risks are elevated by historical standards, and that the economic future remains precarious amid huge uncertainties.

There is also a risk that the recent policy measures may have unintended consequences, beyond policymakers’ stated objectives.

The report said that most banks will be able to absorb losses, but there is a weak tail. It explained that banks entered the COVID-19 crisis with significantly stronger capital and liquidity buffers than they had at the time of the global financial crisis in 2008, thanks to regulatory reforms.

Policies aimed at supporting borrowers and encouraging banks to use the flexibility built into the regulatory framework have likely further supported their willingness to continue to provide credit to the economy. However, banks in some countries have started tightening their lending standards in response to deteriorating economic conditions and borrowers’ financial positions.

Looking ahead, the IMF assured that the resilience of banks will depend on the depth and duration of the COVID-19 recession, governments’ ability to continue to support the private sector, and the pace of loss recognition.

In the baseline scenario, most banks are able to absorb losses and maintain capital buffers above the minimum regulatory capital requirements. In the adverse scenario, characterised by a deeper recession and a weaker recovery, there is a sizable weak tail of banks whose capital falls below regulatory minimum.

In the October 2020 World Economic Outlook (WEO) adverse scenario, the capital shortfall relative to minimum capital requirements is about $110bn. The overall capital shortfall relative to broad capital requirements, which include the countercyclical capital buffer, the capital conservation buffer, and systemic risk buffers, could reach $220bn, after accounting for policy support.

This implies that the average capital shortfall in the adverse scenario is close to 1% of GDP. For comparison, the median government bank recapitalisation during the global financial crisis was about 3.6% of GDP.

However, the full fiscal cost of ensuring that banks are adequately capitalised must also include direct fiscal support to firms and households, which effectively reduced bank recapitalisation needs by projection rather than actual results.

It may also adversely affect the fiscal capacity to provide additional support in the future if needed. Furthermore, a more severe adverse scenario that would entail larger losses for the banking sector cannot be ruled out, given the high degree of uncertainty around the depth and duration of the COVID-19 recession.

“There are also concerns about non-bank financial institutions, which now play a growing role in credit markets in advanced economies, including its riskier segments,” the report said, “They have managed to cope with the pandemic induced market turmoil thanks to policy support, yet there are evident fragilities in this sector.”

It also said that the increased links between corporates, banks, and non-bank financial institutions imply that, at some point, fragilities could spread through the entire financial system.

Finally, the pandemic has led to the worst global recession since the Great Depression of the 1930s, and decisive and timely policy actions have so far cushioned its impact on households and firms. Policy has also managed to prevent economic stress from escalating into a fully-fledged financial crisis.

As the economic recovery takes hold, the policy focus will shift from dealing with liquidity pressures to managing a gradual reopening of the economy and supporting the recovery.

The report said that as economies reopen, continued policy support remains critical. Accommodative monetary and financial conditions, credit availability, and targeted solvency support will be essential to sustaining the recovery, facilitating the necessary structural transformation and transition to a greener economy.

“The post-pandemic financial reform agenda should focus on addressing fragilities unmasked by the coronavirus crisis, whilst also strengthening the regulatory framework for the nonbank financial sector,” it said.

The report noted that this should also see the stepping up of prudential supervision to contain excessive risk taking in a lower-for-longer interest-rate environment.

Topics: economies IMF

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