investment risk / gremlin

Global financial markets face an array of threats to their stability, from high debt levels to inflated asset valuations, as well as liquidity mismatches at investment funds, says the Financial Stability Board (FSB) in a letter to G20 policymakers.

Ahead of the upcoming G20 meeting of finance ministers and central bank governors, the chair of the FSB and president of De Nederlandsche Bank, Klaas Knot, warned policymakers of the challenging outlook for global financial stability, despite continued economic growth and signs of easing inflation.

“As inflation has been moderating toward target in many countries, global financial conditions are showing signs of easing,” the letter said. “But caution is warranted. Past interest rate hikes are still passing through to borrowers, so debt service challenges could increase.”

In particular, sectors that are facing prevailing headwinds, such as commercial real estate, “bear close monitoring,” the FSB said.

Also, an abrupt shift in asset valuations, which are inflated in some key markets, could expose vulnerabilities in the financial system, such as leverage stresses and liquidity mismatches in the shadow banking sector, it warned.

“Last year’s banking turmoil was a further reminder that we cannot be complacent in the current environment,” it said, adding that the banking sector turmoil in March 2023 marked the most serious threat to financial stability since the global financial crisis.

In the face of these ongoing threats, the FSB called on the G20 leaders to implement the FSB’s policy recommendations to address vulnerabilities in the open-ended investment fund sector as soon as possible, along with the revised policies on liquidity management tools from the International Organization of Securities Commissions (IOSCO).

The letter also said the FSB will continue to work on implementing the international framework for ensuring that the regimes for resolving failing financial institutions are effective.

The FSB’s priorities for the coming year include ensuring that policymakers absorb the lessons from the March 2023 turmoil, which highlighted the need for work on backstop funding mechanisms, better operationalization of different resolution options, and the impact of social media and digital innovation on resolution.

To that end, the FSB said it’s doing work on interest rate and liquidity risk in the financial system and exploring the evolving risk of bank runs amid the emergence of new technologies and social media. These reports are due in October.

It also continues to work on addressing vulnerabilities in the shadow banking sector, and it’s assessing the impact of macro trends, such as the ongoing digitalization of the financial sector, along with growing climate-related risks.

“Harnessing the opportunities of digital innovation while containing associated risks is critical for financial stability and prosperity,” it said. It will continue to monitor the financial stability implications of innovations such as the evolving cryptoasset markets, tokenization and the rise of artificial intelligence (AI).

On climate, in the year ahead the FSB said it’s deepening its analysis of climate-related financial risks to financial stability and examining the relevance of transition plans for financial stability.

It plans to report on the implementation of international standards for climate risk reporting, along with IOSCO and the International Sustainability Standards Board, in November. And in July, it will report on planned regulatory and supervisory initiatives on dealing with nature-related financial risks.