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International Monetary Fund. Monetary and Capital Markets Department

Abstract

Prepared by staff from the Monetary and Capital Markets Department (in consultation with other departments): The authors of this chapter are Anna Ilyina (Division Chief), Evan Papageorgiou (Deputy Division Chief), Sergei Antoshin, Yingyuan Chen, Fabio Cortes, Rohit Goel, Phakawa Jeasakul, Sanjay Hazarika, Kelly Eckhold, Frank Hespeler, Henry Hoyle, Piyusha Khot, Sheheryar Malik, Thomas Piontek, Akihiko Yokoyama, and Xingmi Zheng, under the guidance of Fabio Natalucci (Deputy Director). Magally Bernal and Andre Vasquez were responsible for word processing and the production of this report.

International Monetary Fund. Monetary and Capital Markets Department

Abstract

The following remarks by the Acting Chair were made at the conclusion of the Executive Board's discussion of the Global Financial Stability Report on March 14, 2003.

International Monetary Fund. Monetary and Capital Markets Department

Abstract

The global financial system has yet again gathered strength and resilience. As before, this trend has been fueled by continued balance sheet improvements in the financial and corporate sectors in most countries. The continuing global economic expansion, together with determined efforts to restructure and cut costs, has enabled many financial institutions and corporations to generate substantial, or even record, profits over the past three years. As a result, their balance sheets have strengthened to the extent that the financial and corporate sectors can absorb a significant degree of financial shock before coming under systemic stress. With global growth most likely to continue, inflation under control, and financial markets generally benign, we expect the resilience of the global financial system to improve even further. This improvement provides an important cushion in the event that any of the more medium-term risks discussed below were to materialize. This cushion against risks and vulnerabilities in the medium term may have expanded, but risks have not disappeared altogether.

International Monetary Fund. Monetary and Capital Markets Department

Abstract

Over the past six months, the global financial system, especially the health of financial intermediaries, has been further strengthened by the broadening economic recovery. The financial system has not looked as resilient as it does in the summer of 2004, in the three years since the bursting of the equity bubble. Financial intermediaries, banks and nonbanks alike, have strengthened their balance sheets to a point where they could, if necessary, absorb considerable shocks (see Chapter II, pages 64-73). While it is obviously feasible that one or the other financial institution, such as a hedge fund or even a bank, might succumb to serious mistakes in risk management or to outright fraud, such incidents should be isolated cases with limited, if any, contagion to the system as a whole. Short of a major and devastating geopolitical incident or a terrorist attack undermining, in a significant and lasting way, consumer confidence, and hence financial asset valuations, it is hard to see where systemic threats could come from in the short term. This positive assessment is focused on the financial sector, given its potential to create fast-moving knock-on effects through the wholesale markets. The household sector, in turn, could face certain financial problems going forward, despite its improved balance sheet position. However, from a systemic point of view, the household sector is the ultimate shock absorber.

International Monetary Fund. Monetary and Capital Markets Department

Abstract

A balance sheet is a financial statement showing a company's assets, liabilities, and equity on a given date. Typically, a mismatch in a balance sheet implies that the maturities of the liabilities differ (are typically shorter) from those of the assets and/or that some liabilities are denominated in a foreign currency while the assets are not.

International Monetary Fund. Monetary and Capital Markets Department

Abstract

The adjustment in financial markets and the real economy following the bursting of the asset price bubble continues to influence developments. This is reflected in the hesitant and uneven pace of global economic growth and the reluctance of corporations to boost capital expenditure. Risk appetite has also been curtailed, contributing to the unwillingness of investors to support a recovery of equities in mature markets, to continued tiering in the mature and emerging credit markets, and to uneven flows to emerging market borrowers. The negative influence, however, appears to be waning. Household balance sheets in the United States appear to have stabilized, U.S. corporate balance sheets have strengthened somewhat, and financial institutions are showing tentative signs of being less hesitant to take on risk.

International Monetary Fund. Monetary and Capital Markets Department

Abstract

During the period under review, a sharp erosion of investor confidence, heightened risk aversion, and growing concerns about the strength and durability of the global recovery and the pace and quality of corporate earnings had repercussions in all of the major equity, credit, and foreign exchange markets (see Chapter II). Market adjustments occurred against the background of the bursting of the telecom, media, and technology (TMT) bubble, which exposed a culture of irrational exuberance, and sometimes greed, among many buyers, sellers, and intermediaries, and most recently some senior executives who adopted business practices—some unethical and illegal—to boost their companies’ share prices at any cost. First, major equity market indices declined significantly and by early August were near or below levels not seen since the autumn of 1998, when global markets were unsettled by Russia’s default and the near-collapse of the global hedge fund, Long-Term Capital Management (Table 1.1). Second, as U.S. corporate bankruptcies hit records, institutional investors and banks discriminated more clearly between classes of borrowers and reduced lending to high-risk borrowers. As a result, corporate credit spreads widened, and speculative grade borrowers faced dramatically higher borrowing costs. The credit deterioration also created a record number of “fallen angels” whose outstanding bonds were downgraded from investment grade to junk status. Third, the dollar continued to depreciate against the other major currencies, reflecting reductions in foreign portfolio flows into U.S. equity markets and in foreign direct investment. The dollar’s decline, together with the continuous stream of accounting irregularities in the United States and the relative absence of them elsewhere so far, intensified concerns about how much further the major currencies would be realigned and doubts about the sustainability of capital flows needed to finance the U.S. current account deficit.

International Monetary Fund. Monetary and Capital Markets Department

Abstract

As mentioned in Chapter I, during 2001 the international financial system has shown remarkable resilience in the face of sizable disruptions. Moreover, recent economic data seem to support market expectations that the global economy will recover soon. Nevertheless, for the purpose of identifying vulnerabilities in international financial markets, this chapter considers the risks to international financial stability that could be associated with the potential financial fallout of several financial imbalances, which could be exacerbated by a subdued recovery. In light of accumulated financial imbalances that have not yet been worked off, the main uncertainties would seem to be associated with the resilience of household, corporate, and bank (and nonbank financial institution) balance sheets in the presence of the renewed declines in equity prices and deterioration in credit quality that might occur during a weaker-than-expected global recovery. If balance sheets are impaired and financial imbalances are aggravated as a result of such asset price adjustments during the recession, this could itself lead to a subdued recovery and could possibly delay it, which in turn could feed back to a further deterioration in financial conditions (and so on). This would lead to a less friendly operating environment for financial institutions, especially for those already weakened by the events of 2001, and to possible stress within the international financial system.

International Monetary Fund. Monetary and Capital Markets Department

Abstract

The favorable climate for emerging market financing that characterized the first quarter of 2002 deteriorated in the second, as investors reassessed the pace and durability of the global economic recovery, the valuation of U.S. and European equities, as well as the scope for policy continuity in core emerging markets.

International Monetary Fund. Monetary and Capital Markets Department

Abstract

The year 2001 has yet again demonstrated how resilient the international financial system was in the face of a number of serious challenges. In chronological order, the past year saw the continuing deflation of the telecom, media, and technology (TMT) bubble across global markets, the onset of a recession in the United States amid a synchronized global slowdown, a financial crisis in Turkey, the terrorist attacks on September 1 1, the record number of bankruptcies, and the default by Argentina after a long and drawn-out crisis. Throughout these events, several of which represented serious problems requiring prompt attention by the appropriate authorities, the international financial system has shown remarkable resilience. This capacity to absorb shocks has been bolstered by the robustness of the infrastructure of the financial system and the key players in it; the vigilance and ready action of the financial and monetary authorities to ensure the smooth functioning of the system, including through the timely provision of liquidity support; and the increasingly discriminating investment behavior of market participants. Going forward, this resilience would again be tested if a global economic recovery is subdued. However, the starting conditions this year would be weaker than those at the beginning of 2001.