12 June 2002

IMF: Global Financial Stability Report

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The economic recovery that began during the first quarter of 2002 has brought improvements in financial market conditions. Mature equity and bond markets have further stabilized. Most emerging market countries continue to have access to international capital markets, and their bond spreads have declined. The near-term outlook thus appears largely free of imminent threats to global financial stability.

However, one important source of uncertainty remains: the recovery and quality of corporate profits in mature markets. In fact, it is the main common theme shaping the major issues discussed in this report. In the period ahead, the level of corporate profitability will significantly influence capital expenditure, which so far is the missing component in the current recovery.

Questions surrounding the quality of reported corporate profits, in the aftermath of Enron’s failure, continue to have an adverse impact on international equity and corporate bond markets. Also, weak corporate profitability has had a negative effect on the quality of the balance sheet of some banks and, to a lesser degree, insurance companies. In the latter case, this highlights an emerging risk, as insurance companies have substantially expanded their financial market activities in recent years.

In the medium term, significant shifts in relative profitability between countries and regions may also give rise to changes in the pattern of international capital flows. Were this to occur abruptly or in a disorderly manner, it could represent a potential risk to financial stability.

First Quarter Analysis—At a Glance:

The near-term outlook appears largely free of imminent threats, but one source of uncertainty remains: corporate profitability.

Banks felt the pinch from sluggishness in the corporate sector, with those relying on wholesale banking performing rather poorly. Poor revenues, credit provisions, and the slow pace of cost reduction will likely prompt consolidation, especially in Europe. These developments translated into noticeably reduced syndicated bank lending to emerging markets.

Emerging bond markets rallied, outperforming most asset classes in mature markets. But because of a sharp decline in syndicated bank lending, gross financing flows to emerging markets totaled $35.3 billion—less than that of the fourth quarter of 2001.

Insurance companies have expanded their financial market activities, becoming more exposed to market and credit risks. Thus, they are more vulnerable to financial shocks, and their own profitability and occasional failures are now a source of potential vulnerability for global financial markets.

Link to full Report

© International Monetary Fund