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Medium-term risks to the global financial system persist, but are unlikely to materialise fully. Both cyclical and structural factors have helped international financial markets create cushions that provide “a longer fuse to crises”, Mr. Haeusler said. The global financial system may also face medium-term risks from a gradual increase in the credit risks in the sovereign, corporate and household sectors, Haeusler said.
Low inflation, low bond yields and solid global growth have allowed corporations to cut costs, restructure and post huge and sometimes record, profits. Businesses and banks have repaired balance sheets severely damaged by the bursting of the high-tech bubble in 2000 and 2001.
But the IMF warned that the very factors that support a favourable short-term environment are increasing the potential vulnerability to a sharp market correction in the medium term. The same benign forces underpinning continued growth and buoyant financial markets, however, have also created larger global imbalances and built up higher levels of debt, particularly by the household sector.
The IMF report noted that exceptionally low bond yields across asset classes and the flat yield curve have allowed corporate and government borrowers to lower their financing costs and improve their debt profiles. But this also leaves financial markets vulnerable to correction.
The fast-growing credit derivatives and collateralised debt obligation (CDO) markets could be particularly vulnerable, because these complex and leveraged instruments depend on relatively untested models. This requires regulators to upgrade their skills to monitor risks, it said.
At the same time, the IMF report said that the increased presence of pension funds and institutional asset managers in financial markets increases market depth and liquidity and creates more financial stability. Additionally, it said that increasingly sophisticated investors, plus greater disclosure in financial markets, can reduce the 'knee-jerk' contagion seen in recent years.
On hedge funds, Haeusler said the IMF continues to regard them 'by and large positive'. 'They add liquidity, they allow people to offload risk, they take risks. I think the system needs risktakers, you cannot have a financial system that is viable without risktakers,' he argued. Although he admitted that there could be more transparency, he argued it is not the IMF's job to focus on consumer protection or on the pros and cons of shareholder activism.
Summing Up by the Chairman
Preface
Overview
Global Financial Market Developments
Aspects of Global Asset Allocation
Development of Corporate Bond Markets in Emerging Market Countries
Glossary
Statistical Appendix