The Danger Zone: Financial Stability Risks Soar

By José Viñals

(Versions in عربيFrançais日本語, and Русский)

We are back in the danger zone. Since the IMF's previous Global Financial Stability Report, financial stability risks have increased substantially—reversing some of the progress that had been made over the previous three years.

 Several shocks have recently buffeted the global financial system: unequivocal signs of a broader global economic slowdown; fresh market turbulence in the euro area; and the credit downgrade of the United States.

This has thrown us into a crisis of confidence driven by three main factors: weak growth, weak balance sheets, and weak politics.

1.  Weaker growth prospects and larger downside risks to growth have prompted investors to reassess the sustainability of the economic recovery—which appears increasingly fragile.

2.  The reduced pace of the economic recovery and incomplete policy actions have stalled progress in balance sheet repair. This has led to increased concerns about the financial health of government balance sheets in advanced economies, banks in Europe, and households in the United States.

In Europe, sovereign risks have spilled over to the region’s banking system. This has put funding strains on many banks operating in the euro area, and has depressed their market capitalization.

  • We have quantified the size of these spillovers on banks in the European Union since the outbreak of the sovereign debt crisis in 2010. During this period, banks have had to withstand an increase in credit risk coming from high-spread euro area sovereigns that we estimate amounts to about €200 billion. If we include exposures to banks in high-spread euro area countries, the total estimated spillover increases to €300 billion.
  • This analysis helps explain current levels of market strains. But it does not measure the capital needs of banks, which would require a full assessment of bank balance sheets and income positions.
  • Because of increased market pressures, banks may be forced to speed up deleveraging, curtail credit to the real economy, and thus worsen the economic drag. Clearly, this must be avoided.

In the United States, there have been concerns—and much debate—about the longer-term sustainability of U.S. government debt. These concerns, if left unaddressed, could potentially reignite sovereign risks, and could have serious, adverse domestic and global consequences. At the same time, U.S. households are still repairing their balance sheets—a process that has affected economic growth, house prices, and U.S bank balance sheets.

The third factor driving the confidence crisis is weak politics. Policymakers on both sides of the Atlantic have not yet commanded broad political support for the needed policy actions, and markets have begun to question their resolve.


There is another important issue facing policymakers. Incomplete balance sheet repair in advanced economies, coupled with a prolonged period of low interest rates, can pose financial stability risks for both advanced and emerging markets. Low policy rates are necessary to support economic activity under current conditions. They can also buy time to repair public and private balance sheets. But if time is not well used, and these repairs remain incomplete, low rates can pose risks to longer-term financial stability by:

  • encouraging the buildup of excess pockets of leverage;
  • diverting credit creation to the more opaque shadow banking system; and
  • pushing capital flows toward emerging markets.

What should policymakers do? They need to switch gears and shift their focus from treating the symptoms of the crisis to dealing with its underlying causes.

Advanced economies need to decisively and expeditiously resolve the current crisis of confidence. Their biggest problems—rising sovereign risks, weak banks, and the spillovers between them—can only be tackled through swift and comprehensive balance sheet repair.

  •  Public balance sheets in the United States, Europe, and Japan need to be bolstered through credible, medium-term fiscal consolidation strategies.  This is absolutely essential.
  • Overstretched U.S. household balance sheets might benefit from a more ambitious program of mortgage modifications involving principal write-downs.
  • And banks in the European Union need to cope with the spillovers from riskier sovereigns. They also need to have sufficient muscle to support the economic recovery through lending. While significant progress has been made recently, banks need to build adequate capital buffers. Some banks may need to do very little, but others—especially those heavily reliant on wholesale funding and exposed to riskier public debt—may need more capital. Private sources of capital should be tapped first. In those cases where this is not sufficient, injections of public funds may be necessary for viable banks. Weak banks need to be either restructured or resolved.

Emerging economies need to balance current risks to avoid future crises. Given the track record  of rapid credit growth in many emerging markets—often in the context of strong capital inflows —policymakers need to avoid a further buildup of financial imbalances where credit growth  remains elevated, even if capital flows have abated somewhat recently.

In addition to sound macroeconomic policies, macroprudential and capital flow measures can play a supportive role in addressing these concerns. At the same time, emerging markets face a potential global shock that could lead to a reversal of capital flows and a drop in economic growth. Our analysis shows that the impact on emerging market banks could be substantial and thus warrants a further buildup of capital buffers in the banking system.

The lack of sufficiently decisive policy action to finally address the legacy of the financial crisis has led to the present crisis of confidence. This has thrown us back into the danger zone, and poses a major threat to the global economy.

Yet, while the path to sustained recovery has considerably narrowed, it has not disappeared. It is still possible to make the right decisions that will help restore global financial stability and sustain the recovery. But for this, we need to act now; we need to act boldly; and we need to act in a globally coordinated manner.


2017-04-15T14:18:50-05:00September 21, 2011|


  1. joebhed September 21, 2011 at 9:35 pm

    When the bankers’ bankers’ banker tells the world that we have an increased level of financial instability, its time to recognize out loud that this is a financial and monetary crisis that presents unprecedented uncertainty, with the risk of calamity, to the world’s monetary policy makers.

    Sorry to say this gang, but, remember the Pogo schtick?

    The enemy of financial stability is the pro-cyclical, debt-based system of money and debt creation under fractional-reserve banking.

    The beginning of a solution will become evident when the IMF and BIS begin to analyze the working of their own debt-based system of creating the circulating medium of exchange for national economies.

    National economies need money – that circulating medium of exchange. But, as noted herein, we cannot afford any more debt.

    There’s a fork in the road ahead.
    One maintains the present “hunker-down” course and crashes miserably, leading to Depression II. Thanks a lot.

    The other is a reformed road, a new system of national monetary sovereignty where every nation creates its own national medium without creating any debt.

    Banks get back to lending real money – like people think they do now.
    So, guys, who’s working on the exit strategy?

    Here’s the proof it can work.
    Dr. Kaoru Yamaguchi’s macro-economic monetary system analysis titled: On The Workings of a Public Money System of Open Macro-Economics:….

    Thanks for listening.

  2. Dr. S A Visotsky September 22, 2011 at 1:35 am

    Why isn’t anyone talking about the “coup de grace” for the EU, meaning by Germany? Deutsche Bank, allegedly Germany’s strongest bank, has lost 50% share value, dropping from 47 Euros down to 23 Euros, and 35% of their market cap, from 35 billion down to 22 billion Euros, yet nobody is talking about it in public, why? They cannot cover their Tier 1 Capital requirement either, I called them personally and asked.T his is the headline right now. Germany has the mendacity to dictate to Greece, ECB, the IMF, and the EU with their “one sided” monetary policy, actually coupled with their own domestic policy, while their own financial state is insolvent? They were crying about Italy having 1.868 trillion in 2011 Q3 Goverment Debt, while they (Germany) have 2011 Q3 Giovernment Debt of 2.088 Trillion? (Check EUROSTAT) Deutsche Bank is the house bank for 85% of the German Industrials, who are also taking a beating right now, having sustained losses into the 100’s of Billions of Euros in the last 6 weeks. An all out short on all things German is being planned on the market as we speak. The DAX is still down 2000 pts. and showing no signs of relief. If Germany goes down, the EU goes with it. Germany is clearly out of control with a Debt/GDP of over 84%, Maastricht Treaty limits are 60%, or the offending nation is to be fined and/or suspended until they can meet the set limits. Why is this not happening? Every time Germany does something wrong, they get a pass. The Press always potrays Germany as stable and unified, nothing is further from the truth. Here in Germany, sentiment is dangerously negative and growing. You will see this again.

  3. Per Kurowski September 22, 2011 at 8:11 am

    The crisis explained in a Tweet:

    Golf, bad players get extra strokes, all can play. Bank regulations, the “risky” get extra weights, the economy stops

  4. wpangusc September 23, 2011 at 12:18 am

    On May 27, 2010, an IMF Counsellor in the field of capital markets initiated a blog highlighting the importance of financial institution supervision. It included the following words:

    “…as the global financial crisis taught us, supervision is incredibly important. Countries with the same set of rules had very different experiences during the crisis. Why? There are clearly many reasons but one of them is “better supervision.” After all, rules are only as good as their implementation. In some countries, the financial supervisor became the unsung hero of the crisis. One might say “It’s hip to be square!”

    When you think about it, the role of the financial supervisor is pretty unique. They are there during the birth, life, and death of the institutions they supervise. They license them, monitor them, lay out the rules, guide them, penalize them, and step in when they fail. The supervisor acts as a midwife, parent, mentor, cop, judge, and undertaker—all rolled into one.

    These are hefty responsibilities. And unfortunately, supervision often comes up short. In an assessment of standards across countries since 2000, we found that while most countries have adequate legislation, regulation, and supervisory guidance, a significant chunk do not do as well when it comes to the actual nuts and bolts of supervision.

    The problems that ordinary real sector actors in the various parts of the global economy are facing today are disappointingly similar to what we faced in the 2007-9 period. This is a truly grievous reality because we know that, although we real-sector actors have some big transitions to lead toward a juster, greener, fairer world, drops in confidence in the decision-makers in the financial sector, severely impede realization of the fruits of our creativity and energy.

    Intuitively, we know that millisecond trading to capitalize on insider rumours, securitized bundles of assets by parties who have speculated in the underlying price trends, and other financial innovations which do not serve our needs, are motivated by the need to obscure either fatuously optimistic thinking or dishonest rent-seeking by insiders. Economist Charles Kindleburger warned us, with empirical data, years ago that financial innovations invariably lead to crashes when their dishonest use becomes apparent. It is only reasonable for us all then to expect that those funding and directing the financial institution supervisors will take great care to be sure they do their job thoroughly.

    Frankly, we understand that the IMF cannot exactly insist that its shareholders to take policy actions for which the economic theories currently available are the subject of long-standing controversy. But the IMF surely can embarass its shareholders about shortcomings in financial institution supervision, which many real sector principals are increasingly adamant should include the prosecution of dishonest financial sector principals. We therefore have, to be quite frank, anger that IMF executives are not more vocal about glaring deficiencies in the actions taken by the authorities who are the IMF’s clients to catch and prosecute acts of outright dishonesty or of the use of irresponsibly misleading language.

    In short, it’s all very well to mount endless policy conferences. But events since the demise of Long Term Capital Management have repeatedly demonstrated that policy is less the issue than honesty in making sure that the products and services of the financial sector serve the real sector rather than use taxpayers as a convenient sink for slyly externalizing the responsibility for the financial sector’s experiments in executive wealth building.

    Given, therefore, that the IMF is now a key factor in the lives of the senior economic and financial policymakers of virtually every country, is it not time for IMF front-line executives to start summoning the fortitude to make much more frequent headlines of their observations concerning the different performances of its shareholders in assuring the very best practices in full-line supervision of the honesty of financial institutions? Would that not be a more effective solution to the world’s economic ills than the present rather overworked resort to policy advice?

  5. Rahul September 23, 2011 at 12:31 am

    Researched article and certainly for fixing this danger “we need to act in a globally coordinated manner”…reiterating the same statement…

    nice reading

  6. Dr. S A Visotsky September 23, 2011 at 3:39 am

    Strange, after my last comment on Germany yesterday, Handelsblatt comes out with an article called “The Truth” in which they state Germany has around 7 trillion Euros in hidden Goverment Debt. That only adds creedence to what I have been writing about The GFSR that was just released also shows them (Germany) with a Bank Leverage of 32, which is to say the ratio of tangible assets to tangible common equity, that is shocking in comparison with the US, listed at only 12. Watch for a run on the German Banks, both of them, or the only two left. With this German Debt news, their debt is 20 times higher than Greece. First domino,… GERMANY.

  7. Dr. S A Visotsky September 23, 2011 at 5:09 am

    Here’s the rub now. Handelsblatt has broken the story about Germany this morning. We all know they are leading the EU in Quarterly Govt Debt at 2.088 trillion Euros, what we did not know is there is another 5 tTrillion they have in hidden government debt. In a poster size fold out, they declare Germany at a hidden debt level of 4.81 trillion Euros or 185% of GDP, mind you, this is in addition to the 2.088 trillion listed, which accounts for 84% GDP. Total government debt of 6.97 trillion Euros, or 268% of GDP, this is ONLY Goverment Debt, (Pension, Unemployment, Handicapped, other unsecured). Staggering that is.

    When will the banks have their ratings dropped? Surely, this will happen as it has everywhere else, or? Afterall, the EU Largest Debtor Nation status will vault Germany to the top of the EU Debt heap.

  8. […] el blog del Fondo Monetario Internacional (FMI) se advierte de que los riesgos sobre la estabilidad financiera se han vuelto a incrementar y ello nos ha conducido a una crisis de confianza con tres elementos fundamentales: crecimiento […]

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