Global Financial System Risks Escalate

Weak growth, balance sheets and political resolve cause crisis of confidence

Large number of countries affected by government debt risks

Policymakers need to act to repair household, government and financial balance sheets

Financial markets have begun to question the ability of policymakers to command broad political support for needed policy actions, the IMF said in its latest Global Financial Stability Report.

“We are in the middle of a crisis of confidence, which is taking its toll on both the economy and the financial system” said José Viñals, Financial Counsellor and head of the IMF”s Monetary and Capital Markets Department, which produced the report. Improvements in financial stability over the past three years have been partly reversed, said Viñals.

The report said balance sheets—a snapshot of the assets and liabilities held by a government, financial institution or household—are strained by mounting debt or assets that have lost value.

The Global Financial Stability Report was released the day after the IMF issued its outlooks on global growth and government debts and deficits, which show a weak and bumpy recovery from the crisis.

Global challenges

The lack of progress to repair balance sheets has raised concerns about the financial health of governments in advanced economies, banks in Europe, and households in the United States.

In Europe, concerns about government debt levels have spilled over to the region’s banking system, raising the cost of borrowing for many banks and reducing their market value.

The IMF estimates the sovereign credit risk experienced by banks in a number of European countries has increased since the start of 2010 by about €200 billion. This figure is not a measure of banks’ capital needs, but rather it approximates the increase in sovereign credit risk experienced by banks over the past two years.

In the United States, there have been increased concerns about the longer-term sustainability of U.S. government debt. These concerns, if left unaddressed, could potentially reignite sovereign risks, with serious global consequences. At the same time, U.S. households are still repairing their balance sheets—a process that has weighed on economic growth, house prices, and U.S. banks.

Low interest rates

The IMF said low interest rates, while necessary to help advanced economies support growth, can carry longer-term threats to financial stability. The search for higher investment returns is pushing some...