IMF warns of debt risks, asset bubbles

08:50, April 21, 2010      

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A worsening of public debt sustainability in advanced economies, as well as fears of inflation and asset price bubbles in emerging markets could put risks on global financial stability, the International Monetary Fund said on Tuesday.

In its latest Global Financial Stability Report, IMF said the health of the global financial system has improved as the economic recovery has gained steam, but stability risks remain elevated.

However, IMF warned that advanced country sovereign risks could undermine stability gains and take the credit crisis into a new phase, while emerging market countries face the fears of inflation and asset price bubbles resulted from surge in capital inflows.

According to the report, the global banking system is coping with legacy problems and further challenges from the deleveraging process.

"Improving economic and financial market conditions have reduced banks' expected writedowns from 2.8 trillion to 2.3 trillion U.S. dollars, and bank capital positions have improved substantially," the report said. "But some segments of country banking systems remain poorly capitalized and still face significant downside risks."

IMF said that the credit recovery will be slow, shallow, and uneven as banks continue to repair balance sheets. It warned that notwithstanding the weak recovery in private credit demand, ballooning sovereign needs may bump up against limited credit supply.

The organization said that governments in advanced countries need to adopt policies that can reduce sovereign risks through well designed fiscal consolidation strategies, clean up the crisis legacy and facilitate a smooth deleveraging process by ensuring that a core of healthy, viable banks is able to support credit.

Meanwhile, the multi-speed global recovery poses stability challenges for emerging markets, IMF said. Prospects for strong growth, appreciating currencies, and rising asset prices are pulling portfolio capital flows into Asia Pacific (excluding Japan) and Latin American countries, while push factors, particularly low interest rates in major advanced economies, are also key.

To tackle the problems, a pragmatic approach using a combination of macroeconomic and prudential financial policies is advisable for emerging countries, IMF said.

IMF called upon world leaders to decisively move forward the regulatory agenda and complete the transition to a safer, more resilient and dynamic global financial system.

The organization acknowledged that "a flood of regulatory reform proposals" have been put forward to address the systemic risks after the financial crisis, but details on many of these proposals are still lacking.

The report argued that it is not enough to mandate that regulators "monitor" systemic connections, but that better tools would also be needed to combat systemic risks.

"Without such tools, regulators will have the tendency to be more lenient with systemic institutions in distress than others," the report said.

Regarding the introduction of systemic risk-based capital surcharges, IMF reiterated the importance of taking into account institutions' cross-border linkages, hence requiring supervisors in different countries to collaborate to design such surcharges.



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