Today, in advance of its upcoming annual meetings to be held in Istanbul, Turkey, next week, the IMF released its second semi-annual Global Financial Stability Report. The Report reviews government interventions adopted to stem the financial crisis and provides an in-depth overview of some of the challenges that remain ahead on the road to financial recovery. The conclusions and recommendations made in the latest Report are in line with the IMF's recent internal study entitled “Review of Recent Crisis Programs,” which was released earlier this week. The IMF's first semi-annual Global Financial Stability Report was released in April.
The new Report acknowledges that the adoption of unprecedented government measures and policies to date have played a significant role in restoring the financial markets and reducing systemic risks, and that the IMF’s recent reform of its lending framework and creation of a new Flexible Credit Line has “helped lessen tail risks (those that are unlikely but with potentially devastating consequences) in vulnerable countries.” However, the Report stresses that “a plan to mitigate the buildup of systemic risks and to ground expectations is necessary for sustained economic growth.” Overall, despite marked improvement in the global economy since April and growing investor confidence, the Report “cautions that the road to financial rehabilitation is unlikely to be straight and that there will be significant policy issues [and challenges] ahead.” The Report also notes that “the risk of reintensification of the adverse feedback loop between the real and financial sectors remains significant as long as banks remain under strain and households and financial institutions need to reduce leverage.” IMF recommends the adoption of further measures to “repair bank balance sheets to [better] enable the institutions to make loans needed to support the economic recovery” and to prevent the emergence of further financial and economic risks and instability.
Emerging Stability in the Banking Sector
Recently banks and other financial institutions have experienced a “gradual increase in liquidity of capital and funding” that has improved earnings and lead to a marked decrease in actual and potential writedowns related to toxic assets. However, the IMF predicts that increases in earnings will not be substantial enough to fully offset the estimated writedowns projected for the next 18 months. The IMF still projects that total write-downs on bank holdings of loans and securities will total $2.8 trillion, of which approximately $1.3 trillion were taken through the first half of 2009 and another $1.5 trillion are yet to be taken. The IMF also concluded that "U.S. domiciled banks have recognized about 60 percent of anticipated writedowns, while euro area and U.K. domiciled banks have recognized about 40 percent," with the differences attributed to several factors, including lag in the credit cycle, different portfolio compositions, differences between U.S. GAAP and IFRS, and various reporting lags.
A combination of insufficient earnings and continuing deleveraging pressure will require banks to raise more capital to maintain and increase stability. In this regard, the Report states that continued policy intervention may be needed to facilitate the flow of credit in absence of bank financing and an inactive securitization market to prevent a future financing gap. Further, the Report highlights the critical importance of financial regulators in coordinating actions to both repair and restart the private securitization market under a framework of robust regulatory reform.
Although the balance sheets of many banks and financial institutions have stabilized over the last six months, the Report attributes much of the improvement to the injection of government capital and notes, and warns that banks still are not yet in a position to lend support to facilitate economic recovery and growth. The Report also cautions that banks need to “refinance a massive amount of maturing debt over the next two to three years,” noting that approximately “$1.5 trillion in bank borrowing is due to mature in the euro area, the United Kingdom, and the United States by 2012.”
Continued Risk to Governments Remain
The Report provides an overview of the impact of certain intervention measures taken by 13 advanced economies and acknowledges that some of the “bank liquidity guarantees introduced in several countries” and the Federal Reserve's Term Asset-Backed Securities Loan Facility have lowered spreads, reenergized issuances and promoted market movement. Many countries as a result of the interventions and fiscal stimulus measures implemented during the crisis remain vulnerable to future shocks due to the substantial private sector risk and public debt assumed. The Report notes that in particular “[c]ountries with high debt-to-GDP ratios and large contingent liabilities” are at a higher risk and recommends that such countries “reduce their exposure to systemic risks by designing and implementing medium-term fiscal consolidation plans that take into account the unwinding of the actual and contingent interventions in the financial sector.” Mr. José Vinals, Director of the IMF’s Monetary and Capital Markets Department stressed that "[i]f we fail to meet the challenges still being faced by the financial system in the present crisis, we risk reigniting systemic risks and even derailing the economic recovery now in train.”
Reforming the Financial Regulatory System
The Report emphasizes that “[a] macroprudential approach to global policymaking is needed [in order] to restore market discipline and ensure that the benefits of financial integration are preserved.” Further it states that financial regulation must be reformed in the following ways:
- Increasing the level and quality of capital and encouraging “shareholders to monitor risk-taking more carefully.”
- Enhancing the regulatory framework “to include systemically important institutions and assess some type of charge for the contribution they make to systemic risks.”
- Adopting a macroprudential approach to help reduce “regulations that amplify the ups and downs of the economic cycle and formulate policies that better account for the potential interactions of monetary, fiscal, and financial policies.”
- Improving and enhancing “international collaboration and coordination to cope with the challenges posed by cross-border institutions that function globally, but become the responsibility of the home government if they fail.”
Echoing the conclusions expressed in the recent IMF report entitled “Crisis-Related Measures in the Financial System and Sovereign Balance Sheet Risks,” the assessment on Global Financial Stability stresses that government should being presently “consider[ing] and articulate[ing] how and in what sequence policies may be unwound. Last week the leaders of the G-20 reaffirmed the IMF’s role in the financial crisis by “promoting global financial stability and rebalancing growth.” The Report acknowledges the role of the IMF but emphasizes that in achieving financial stability “[c]ooperation and consistency in the policy field must extend across borders.”