Government finances could come under even more pressure and banks further squeezed as emerging economies, including Nigeria continue to slow, the International Monetary Fund (IMF) said on Tuesday in its April 2022 Global Financial Stability Report (GFSR).
Large holdings of sovereign debt expose banks to losses if government finances come under pressure and the market value of government debt declines. That could force banks, especially those with less capital to curtail lending to companies and households.
Consequently, the IMF’s Andrea Deghi, Fabio Natalucci and Mahvash S. Qureshi say authorities should act quickly to minimise the risks.
“The sovereign-bank nexus could lead to a self-reinforcing adverse feedback loop that ultimately could force the government into default,” they said.
According to the report, financial conditions have tightened and risks to the global economy have increased as a result of the war in Ukraine.
The lingering Russia-Ukraine wars, coupled with the effects of inflation have significantly worsened global growth prospects, the IMF noted in its April 2022 World Economic Outlook (WEO) released on Tuesday.
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Soaring commodity prices pose challenging trade-offs for central banks. Many emerging and frontier markets are facing especially difficult conditions. In China, financial vulnerabilities remain elevated amid ongoing stress in the property sector and new COVID-19 outbreaks.
The Washington-based fund said central banks should act decisively to prevent inflation from becoming entrenched without jeopardising the recovery and address financial vulnerabilities. Policymakers should intensify their efforts to implement the 2021 United Nations Climate Change Conference (COP26) road map while taking appropriate steps to address energy security concerns, the IMF said.
The Russian invasion of Ukraine and ensuing sanctions have already had an impact on financial intermediaries, firms, and markets directly or indirectly exposed to the war.
Europe bears a higher risk than other regions due to its proximity, reliance on Russia for energy needs, and non-negligible exposure of some banks and other financial institutions to Russian financial assets and markets. But the war is also generating broader concerns well beyond Europe. Rising risk aversion has led to flight-to-quality flows and signs of strains in dollar-funding markets.
Direct exposures of foreign banks to Russia and Ukraine appear to be relatively modest, in aggregate. As of the third quarter of 2021, claims of foreign banks on Russian residents totalled about $120 billion, with 60 percent in foreign currencies.
For Ukraine, exposures were relatively small at $11 billion. The vast majority of these exposures were held by euro area banks. For some countries, these exposures were economically significant, as individual banks play an active role in the Russian banking system, the IMF said.
The report noted that foreign nonbank financial intermediaries (NBFIs) had sizable investments in Russian assets, holding about one-fifth of its total sovereign debt, half of its corporate debt, and more than 40 percent of Russian equities as of the fourth quarter of 2021.
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