Global financial markets stable, but risks loom amid policy uncertainty: IMF

Global banking and financial markets are showing signs of stability with low volatility as central banks begin easing interest rates after taming inflation, the International Monetary Fund said on Monday.

However, the IMF warned of rising financial stability risks stemming from economic policy uncertainty and tightening global financial conditions.

“Our assessment is that the global financial stability risk has increased significantly due to heightened economic policy uncertainty and rising market volatility,” said Tobias Adrian, financial counselor at the IMF. “The decline in investor confidence that we have seen has triggered recent sell-offs in equity markets. The tightening of global financial conditions is putting downside pressure on economic activity.”

The IMF’s remarks were part of the release of its Global Financial Stability Report, issued during the Spring Meetings of the IMF and World Bank in Washington.

Asset valuations and leverage pose vulnerabilities

Adrian flagged three forward-looking vulnerabilities that could affect markets. “Despite recent market turmoil, some asset valuations remain elevated. If the economic outlook continues to deteriorate, these valuations could decline further, leading to tighter global financial conditions. Such tightening may adversely impact currencies, asset prices and capital flows to emerging markets,” he said.

Financial conditions have shifted from being accommodative to neutral, with a risk of further tightening, Adrian said. “In conditions of prolonged volatility, financial institutions with high leverage may experience significant stress.

“Non-bank financial institutions could struggle during market turbulence, potentially impacting the broader financial system. In weaker and poorly managed banks, vulnerabilities could reemerge.”

Sovereign debt risks and emerging markets in focus

The IMF also pointed to the risk of further turbulence in sovereign bond markets, especially in economies burdened by high levels of government debt.

“If market functioning were to become strained in major advanced economies, and with the unwinding of leveraged trades in key sovereign bond markets, volatility could be further exacerbated,” Adrian warned. “Emerging market economies already facing the highest real financing costs in the decade may need to refinance their debt and finance fiscal expenditures at increased costs.”

Investor concerns over public debt sustainability and financial sector vulnerabilities may intensify as a result, he added.

IMF calls for policy action to safeguard financial stability

To ensure continued financial resilience, Adrian urged policymakers to prepare for potential disruptions.

“It is crucial that we prepare for potential challenges ahead, equipping authorities to manage financial instability effectively,” he said. “The policy toolkit should encompass measures that ensure market functioning, support prudential supervision and regulation of financial institutions, and provide emergency liquidity and crisis resolution tools.”

He added that financial institutions and regulators should focus on risk identification and mitigation through stress testing and scenario analysis.

Emerging market and developing economies, in particular, should strengthen their financial markets while maintaining adequate fiscal space and international reserves to cushion against external shocks.

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