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Warwick Knowles

Global Financial Instability: Still with Us after All These Years

by Warwick Knowles | Dun & Bradstreet Editor

May 6, 2015 | No Comments »

Global-finance-instability_1100pxBusinesses are still living with the consequences of the global financial crisis, which burst onto the public consciousness with the collapse of Lehman Brothers in September 2008. Few businesspeople would have thought that the risks associated with global financial stability would still be elevated more than seven years later.

However, the IMF Global Financial Stability Report released in mid-April 2015 highlights that this is indeed the case. In fact, the report indicates that risks to the global financial system have risen since the previous report in October 2014, against a background of moderate/uneven growth, rates of inflation that are too low in many countries, depressed oil prices, volatility in the currency markets, and divergent central bank policies.

The latest Global Financial Stability Report highlights three key issues. First, risks in the global financial system have risen since October 2014. Moreover, these risks have shifted: from banks to shadow banks, where worryingly they are harder to assess and address; from solvency to market-liquidity risks; and from advanced to emerging economies. Second, advanced economies have to ensure that accommodative monetary policies gain traction, while simultaneously mitigating the undesirable effects of low interest rates. Third, emerging economies must increase the resilience of their financial system by addressing domestic vulnerabilities against a background of weaker growth, lower commodity prices, and a stronger US dollar.

José Viñals, head of the IMF’s Monetary and Capital Markets Department, highlights five key challenges that must be met in order to safeguard global financial stability:

“QE-Plus Policies” in Advanced Countries

Although the European Central Bank’s and Bank of Japan’s bold monetary policies appear to be easing disinflationary pressures, Viñals argues that other measures must be taken in addition to quantitative easing. In the euro area this requires addressing the €900 billion stock of nonperforming loans that is acting as a drag on the financial sector. In Japan, the report highlights that Prime Minister Abe’s second and third arrows of fiscal and structural reform still need to be completed.

In the US, the Federal Reserve has to safeguard that a return to “normal” monetary policy is smooth; i.e., it needs to ensure not only that the timing is correct, but also that the pace is appropriate, without creating divergences between the market and official views of inflation prospects.

Mitigating the Risks of Low Interest Rates for Too Long

The report highlights that in Europe almost one-quarter of midsized life insurers will be unable to meet their solvency capital requirements in the future if low interest rates persist. Because of high and rising interconnectedness, the risk of spillover into the wider financial system is increasing, potentially creating another subprime crisis.

Emerging Economies Face Stiff External Headwinds

To manage the risks to their financial sectors caused by the crosscurrents of lower commodity prices, continued weak global demand, and sharp US dollar appreciation, the authorities have to enhance micro- and macroprudential measures. Among the policies recommended by the report is that regulators conduct bank stress tests related to foreign currency and commodity price risks. Regulators also should more closely monitor corporate leverage and unhedged foreign-currency exposures, including derivatives positions.

Unpredictable Geopolitical Risks

Unpredictable geopolitical risks such as those associated with Russia/Ukraine, the Middle East and North Africa, and Greece challenge the coping skills of the global community.

Illiquid Markets

In times of crisis, market liquidity can dry up rapidly, increasing the risk of contagion across national borders, according to the report.

So what does this mean for business? Are we going back to the dark days of not being able to borrow from the banks? At present, Dun & Bradstreet does not think this will be the case. However, it must be acknowledged that the headwinds from the 2008-09 global financial crisis are still buffeting policymakers, which will keep business risk challenging, changing, and elevated over the next 18 months at least. Not a pleasant thought.


Dr. Warwick Knowles is the Deputy Chief Economist on D&B’s Global Data, Insight & Analytics team. Based in Marlow, UK, he covers global issues and the Middle East and North Africa for D&B Macro Market/Country Insight Products. Previously he taught Middle East politics and political economy for almost a decade at both Newcastle and Durham Universities and has published widely on regional issues and the hydrocarbon sector.

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