The International Monetary Fund on Wednesday published its latest review of the top threats to global financial stability, saying risks to the system had increased since last year. The fund cited a long list of potential trouble spots around the world, from currencies to monetary policy. Here are eight major risks on the fund’s radar.
Rising Volatility: Wide, damaging swings in exchange rates and bond markets “could become more common and more pronounced” as the financial industry evolves. Events such as the flash crash in U.S. Treasurys last October and the surge in the value of the Swiss franc are the harbingers of such volatility. “Low market liquidity may act as a powerful amplifier of financial stability risks,” the fund said. New technology such as high-frequency trading, stronger regulation of the traditional banking sector and the changing makeup of market participants are creating new vulnerabilities.
Deflation and Bad Loans: Policymakers in the eurozone and Japan could foment instability if they rely too much on easy-money policies and fail to address problem loans and overhaul their economies to make them more competitive. “Failure to support current monetary policies will leave the economy vulnerable and risks tipping it into a downside scenario of increased deflation pressure, a still-indebted private sector, and stretched bank balance sheets,” the fund warned.
Oil Price Plummet: Consumers, especially in net oil importers such as the U.S., China, India, Europe and Japan, are getting a windfall from falling energy costs. But oil companies and their creditors are facing losses on their cash-intense investments in production. Many companies are finding it increasingly hard to pay their debts.
Dollar Debt: Emerging-market firms and governments that borrowed in dollars, but whose revenue is largely denominated in local currencies, that are depreciating against the dollar are facing strained finances. That has fomented investor flight during periods of investor anxiety and could do so again.
Rough Fed Exit: If investors are surprised by the U.S. Federal Reserve’s strategy to normalize interest rates, it could send tremors throughout the global financial system as portfolios are adjusted across the spectrum of assets and markets. Raising rates more sooner or more quickly than markets anticipate could cause a rapid spike of longer-term interest rates and a whirlwind of volatility.
Market Bubbles: Low interest rates fueled by mass central bank easing are perpetuating a search for yield and “stretching some asset valuations.”
Risk Conjunction: If the dollar surges again, U.S. borrowing costs rise sharply and geopolitical risks worsen, emerging markets could get hit with outbreak of financial turmoil. “After a prolonged period of inflows, foreign investors could abruptly reduce their holdings of local currency debt, thereby adding to turbulence and creating debt rollover challenges.
China Real Estate: The IMF estimates that banking system exposures to real estate in the world’s No.2 economy totals nearly 20% of gross domestic product. Falling property prices could not only strain China’s financial sector, but feed through into other financial markets as well, the fund said.
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