Financial stability risks may have eased, reflecting improvements in the economic outlook and continuing accommodative policies. But those supportive policies—while necessary to restart the economy—have also masked serious, underlying financial vulnerabilities that need to be addressed as quickly as possible.
* Many advanced economies are “living dangerously” because the legacy of high debt burdens is weighing on economic activity and balance sheets, keeping risks to financial stability elevated. * At the same time, many emerging market countries risk overheating and the build-up of financial imbalances—in the context of rapid credit growth, increasing asset prices, and strong and volatile capital inflows.
Here is our suggested roadmap for policymakers to address these vulnerabilities and risks, and achieve durable financial stability.
Heeding the warning signs
Challenges in four key areas put financial stability at risk.
Confidence in the banking system has yet to be fully restored, nearly four years since the start of the global financial crisis. Progress in strengthening capital positions and reducing leverage has been uneven. There is considerable uncertainty about the quality of some bank assets, particularly exposures to higher-risk sovereigns and real estate in some countries. And a weak tail of undercapitalized banks remains. We have analyzed the sample of banks that European authorities used in last year’s stress tests. This snapshot of end-2010 data revealed that 30 per cent of these banks—representing a fifth of their total assets—have Core Tier 1 capital ratios of less than 8 percent. This makes them less able to withstand shocks and secure cost-effective funding.
To solve these problems, we need comprehensive policies to increase bank transparency, raise capital buffers, and restructure and resolve weak banks. The forthcoming stress tests by the European Banking Authority are an important opportunity to assess the health of the EU banking system. But the tests need to be credible, stringent, and part of a broader crisis management strategy that includes backstops against capital shortfalls.
Sovereign balance sheets remain under strain in several advanced economies. Certain countries in the euro area are especially at risk, because market concerns about the sustainability of public debt have prompted a sharp increase in funding costs and restricted credit supply, creating an adverse feedback loop with the real economy. These financial stability risks need to be addressed through strategies that combine medium-term budget deficit reduction with adequate multilateral backstops for crisis countries.
Financial stability risks may have eased, reflecting improvements in the economic outlook and continuing accommodative policies. But those supportive policies—while necessary to restart the economy—have also masked serious, underlying financial vulnerabilities that need to be addressed as quickly as possible.
ReplyDelete* Many advanced economies are “living dangerously” because the legacy of high debt burdens is weighing on economic activity and balance sheets, keeping risks to financial stability elevated.
* At the same time, many emerging market countries risk overheating and the build-up of financial imbalances—in the context of rapid credit growth, increasing asset prices, and strong and volatile capital inflows.
Here is our suggested roadmap for policymakers to address these vulnerabilities and risks, and achieve durable financial stability.
Heeding the warning signs
Challenges in four key areas put financial stability at risk.
Confidence in the banking system has yet to be fully restored, nearly four years since the start of the global financial crisis. Progress in strengthening capital positions and reducing leverage has been uneven. There is considerable uncertainty about the quality of some bank assets, particularly exposures to higher-risk sovereigns and real estate in some countries. And a weak tail of undercapitalized banks remains. We have analyzed the sample of banks that European authorities used in last year’s stress tests. This snapshot of end-2010 data revealed that 30 per cent of these banks—representing a fifth of their total assets—have Core Tier 1 capital ratios of less than 8 percent. This makes them less able to withstand shocks and secure cost-effective funding.
To solve these problems, we need comprehensive policies to increase bank transparency, raise capital buffers, and restructure and resolve weak banks. The forthcoming stress tests by the European Banking Authority are an important opportunity to assess the health of the EU banking system. But the tests need to be credible, stringent, and part of a broader crisis management strategy that includes backstops against capital shortfalls.
Sovereign balance sheets remain under strain in several advanced economies. Certain countries in the euro area are especially at risk, because market concerns about the sustainability of public debt have prompted a sharp increase in funding costs and restricted credit supply, creating an adverse feedback loop with the real economy. These financial stability risks need to be addressed through strategies that combine medium-term budget deficit reduction with adequate multilateral backstops for crisis countries.