Global Financial Stability Report

Safeguarding Financial Stability amid High Inflation and Geopolitical Risks

April 2023

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Financial stability risks have increased rapidly as the resilience of the global financial system has been tested by higher inflation and fragmentation risks.

Chapter 1 analyzes the recent turmoil in the banking sector and the challenges posed by the interaction between tighter monetary and financial conditions and the buildup in vulnerabilities since the global financial crisis. The emergence of stress in financial markets complicates the task of central banks at a time when inflationary pressures are proving to be more persistent than anticipated. Smaller and riskier emerging markets continue to confront worsening debt sustainability trends. Chapter 2 examines nonbank financial intermediaries (NBFIs) and the vulnerabilities that can emerge from elevated leverage, liquidity mismatches, and high levels of interconnectedness.  Tools to tackle the financial stability consequences of NBFI stress are proposed, underscoring that direct access to central bank liquidity could prove necessary in times of stress, but implementing appropriate guardrails is paramount. Chapter 3 analyzes the effect of geopolitical tensions on financial fragmentation and explores their implications for financial stability—including through potential capital flow reversals, disruptions of cross-border payments, impact on banks’ funding costs, profitability, and credit provision, and more limited opportunities for international risk diversification. Based on the findings, it draws policy recommendations aimed at strengthening financial oversight, building larger buffers, and enhancing international cooperation.

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Key Highlights

Chapters in the Report

Chapter 1: A Financial System Tested by Higher Inflation and Interest Rates

Financial stability risks have increased rapidly as the resilience of the global financial system has faced a number of tests. Recent turmoil in the banking sector is a powerful reminder of the challenges posed by the interaction between tighter monetary and financial conditions and the buildup in vulnerabilities since the global financial crisis. The emergence of stress in financial markets complicates the task of central banks at a time when inflationary pressures are proving to be more persistent than anticipated. Large emerging markets have so far avoided adverse spillovers, but smaller and riskier economies continue to confront worsening debt sustainability trends.

Chapter 2: Nonbank Financial Intermediaries: Vulnerabilities amid Tighter Financial Conditions

Nonbank financial intermediaries (NBFIs) play a key role in the global financial system, enhancing access to credit and supporting economic growth. Also, NBFIs’ financial vulnerabilities might have increased in the past, amid low interest rates. Case studies presented in this chapter show that NBFI stress tends to emerge with elevated leverage, liquidity mismatches, and high levels of interconnectedness that often spill over to emerging markets. In the current environment of high inflation and tighter financial conditions, central banks can face complex and challenging trade-offs during market stress, between addressing financial stability risks and achieving price stability objectives. Policymakers need appropriate tools to tackle the financial stability consequences of NBFI stress. NBFI direct access to central bank liquidity could prove necessary in times of stress, but implementing appropriate guardrails is paramount.

Chapter 3: Geopolitics and Financial Fragmentation: Implications for Macro-Financial Stability

Rising geopolitical tensions among major economies have intensified concerns about global economic and financial fragmentation, which could have potentially important implications for global financial stability. Fragmentation induced by geopolitical tensions could affect the cross-border allocation of capital, international payment systems, and asset prices. This could pose macro-financial stability risks by increasing banks’ funding costs, reducing their profitability, and lowering the provision of credit to the private sector. Greater financial fragmentation could also exacerbate capital flow and macro-financial volatility by limiting international risk diversification. Policymakers need to be aware of potential financial stability risks associated with a rise in geopolitical tensions and assess and quantify geopolitical shock transmission to financial institutions. Financial institutions may need to hold adequate capital and liquidity buffers against rising geopolitical risks. The global financial safety net also needs to be buttressed through adequate levels of international reserves held by countries, central bank liquidity swap arrangements, and precautionary credit lines from international financial institutions.

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