Global Financial Stability Report, June 2002

• Author: Ramana Ramaswamy
• Pages: 16-

Page 16

The report argues that an important source of uncertainty in financial markets currently is the level and quality of corporate profits in mature markets. In the aftermath of Enron's failure, questions surrounding the quality of reported corporate profits continue to have an adverse impact on international equity and corporate bond markets-with weak corporate profitability negatively affecting the quality of some banks' and insurance companies' balance sheets. The report identifies the risk of an equity price correction, owing to disappointing corporate earnings, as the main danger for mature markets.

The GFSR notes that the spread compression in emerging bond markets, in the first quarter of this year, reached levels not seen since the Russian crisis, but argues that they remain vulnerable to corrections. The growing involvement of crossover investors in emerging bond markets creates the risk of rapid funds withdrawal should event risk appetites decline or other asset classes become relatively more attractive. Political factors also weigh on emerging bond markets.

Insurance and reinsurance companies are now an important and growing class of financial market participants. An analysis of this sector is provided in the report along with issues identified as likely to have medium-term implications for financial stability and efficiency.

Reaping strong investment returns has been particularly important for life insurance companies, which were able to offer high guaranteed returns on insurance policies in the 1980s and early 1990s. As nominal bond yields sank during the 1990s, insurers responded to an environment of lower real premium growth by managing asset portfolios more actively and shifting the asset mix into potentially more volatile investments. The GSFR makes the case that while the systemic risks associated with the financial market activities of insurance companies are relatively limited compared with that of internationally active banks, there remain uncertainties about insurers and whether they hold sufficient capital against financial risks, whether their management of market risk...