Financial Sector the 'Achilles’ Heel' of Global Recovery

Financial system still vulnerable despite ongoing recovery

Funding risks for banks and governments a major concern

Financial reforms remain unfinished

While the outlook in the Global Financial Stability Report is for continued recovery and a gradual improvement in financial stability, considerable risks remain. Rising public debt burdens, funding challenges for banks, and increased uncertainty about the next phase of the recovery have prevented a return of confidence.

José Viñals, Financial Counselor and Director of the IMF’s Monetary and Capital Markets Department, said the financial system remains the “Achilles’ heel of the recovery” because of unfinished repairs to bank balance sheets and the need for further regulatory reforms.

“As a result, financial markets remain sensitive to negative surprises, and can quickly shift back to crisis mode,” said Viñals.

Sovereign risks and financial fragilities

Coordinated government support programs and the announcement of ambitious fiscal reforms have helped contain the market turmoil that broke out in April and May this year. However, fiscal risks remain elevated, particularly in advanced economies where public sector balance sheets have significant weaknesses.

• Public debt is still high and rising in many advanced economies, and more needs to be done to ensure sustainability;

• High levels of debt refinancing and a reliance on a narrow investor base means greater funding risks;

• The fiscal outlook is clouded by uncertainty about the outlook for growth;

• Government guarantees of banks have heightened concerns about the transfer of risks to the public coffers in a number of countries.

If left unaddressed, these sovereign risks could spill over to banks through funding markets and a variety of other channels, the report said.

Banking challenges

Banks in different parts of the world face distinct problems. In the United States, weaknesses in real estate markets are an ongoing problem, while banks in some parts of Europe struggle with higher funding costs due to increased sovereign risks. Japanese banks suffer from low capital, weak profitability, and are increasingly exposed to Japanese government bond markets.

The report cuts its estimates of crisis-related writedowns of bad loans and securities that banks mostly in Europe, the United Kingdom, and the United States will have to take from $2.3 trillion in April to $2.2 trillion. Banks have already realized about three quarters of these...