Systemic risks have been substantially reduced following unprecedented policy actions and nascent signs of improvement in the real economy, said the International Monetary Fund in its Global Financial Stability Report (full report), but called for more efforts to to strengthen financial intermediation, restore health to the financial system, and eventually reduce the private risks now borne by sovereign balance sheets.
There is growing confidence that the global economy has turned the corner, underpinning the improvements in financial markets. Nonetheless, the risk of a reintensification of the adverse feedback loop between the real and financial sectors remains significant as long as banks remain under strain and households and financial institutions need to reduce leverage.
Although indicators of sovereign risk are lower than six months ago, the transfer of financial risks to fiscal authorities, combined with the financing burden of fiscal stimulus, has raised concerns over crowding out the private sector and the sustainability of public sector finances.
These vulnerabilities underscore the need to strengthen financial intermediation, restore health to the financial system, and eventually reduce the private risks now borne by sovereign balance sheets. Great care in disengaging from public support will be necessary to avoid either sparking a secondary crisis through premature withdrawal or endangering monetary and fiscal credibility through a belated exit.
Complacency now becomes a risk—banking system problems could go unresolved and much-needed regulatory reforms may be delayed or diluted. Policymakers should promptly provide a plan for the future regulatory framework that mitigates the buildup of systemic risks, grounds expectations, and underpins confidence, thereby contributing to sustained economic growth.