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Russia’s invasion of Ukraine has profoundly changed the global economic and financial market backdrop. Uncertainty around the outlook for a sustained and broad-based recovery from the COVID-19 pandemic has grown and inflationary pressures have risen. So far, global financial markets have been functioning in an orderly manner and no major financial institution has shown signs of distress, notwithstanding bouts of high volatility and large price swings in commodity markets.
Yet global financial stability cannot be taken for granted going forward. Currently, the most important direct impact on the global economy is the sharp rise and large fluctuations in commodity prices. This not only affects oil and gas, but also many metals and agricultural products. A related issue is the unexpectedly large margin calls for commodity derivatives, which can put strain on the market and cause spillover effects. In addition, the current leverage in the non-bank financial sector could amplify adverse developments and lead to periods of stress, such as the one we experienced during March 2020. Finally, cyber risks remain a key area of concern.
The Financial Stability Board (FSB) is responding to the current financial stability challenges in two main ways. One is intensified monitoring of current market developments and emerging vulnerabilities, with a focus on the resilience of critical nodes in the global financial system. The other is in-depth analysis and assessment of specific potential vulnerabilities, with a particular focus on commodity markets, margining and leverage.
The FSB is at the centre of a multilateral approach to financial stability. Some say the current events could fundamentally change the geopolitical landscape. Could this also have a lasting effect on the global financial system?
There is clearly a great deal of uncertainty about the future geopolitical landscape and whether this will change fundamentally or not. It is difficult to speculate on developments in this crisis and the long-term effects on the global financial system.
However, what this crisis does highlight is the importance of global cooperation. The international reforms that were initiated by the G20 after the global financial crisis of 2008, and coordinated by the FSB in subsequent years, have been crucial in strengthening our global financial system. In particular, banks and financial market infrastructures have been more resilient in recent years and were better able to absorb rather than amplify the different macroeconomic shocks, including the onset of the COVID-19 pandemic. Any new challenges that may arise will also require a joint international response. Moreover, some key structural challenges within the financial sector, like digitalisation, climate change and crypto-assets, are inherently cross-jurisdictional by nature.
The FSB will, therefore, continue to fulfil a coordinating role to promote financial stability, avoiding any sudden change in the integration of the global economy and financial system.
Banks were able to absorb the March 2020 turmoil caused by the pandemic, but non-bank financial institutions amplified the stress. What needs to be done to make the NBFI sector more resilient?
The March 2020 episode provided important lessons for the resilience of the global financial system. In particular, the financial market turmoil showed that our NBFI-specific reform efforts following the 2008 global financial crisis were not sufficient. The episode demonstrated how systemic risks within the NBFI sector can evolve and how liquidity risks in different markets can be amplified by interactions within the NBFI ecosystem and interconnectedness with banks.
Our NBFI work programme to date has focused on assessing and addressing vulnerabilities in specific areas that may contribute to the build-up of liquidity imbalances and their amplification. These include money market and open-ended funds, margining, bond market structure and liquidity, and cross-border dollar funding.
We will use the insights from these areas to develop a systemic approach to assessing and addressing risks in NBFI and a policy toolkit that is effective from a system-wide perspective. Our upcoming conference, in June, is an important input into this work.
But we are not totally off the hook in terms of the banking sector either. Our lessons learned report noted that the functioning of bank capital and liquidity buffers may warrant further consideration. Some concerns about excessive financial system procyclicality also remain. Recent experience has underscored the need to ensure that the core banking system remains resilient to stress and is able to support financing to the real economy as we progressively unwind support measures – so implementing the final Basel III reforms in a full, timely and consistent manner is a key priority...
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