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LATEST GLOBAL RISK REPORT 2022 OUT NOW
Global Risks Report analyses the risks from societal fractures—manifested through persistent and emerging risks to human health, rising unemployment, widening digital divides, youth disillusionment, and geopolitical fragmentation. Businesses risk a disorderly shakeout which can exclude large cohorts of workers and companies from the markets of the future. Environmental degradation—still an existential threat to humanity—risks intersecting with societal fractures to bring about severe consequences. Yet, with the world more attuned to risk, lessons can be drawn to strengthen response and resilience. In 2020, the risk of a pandemic became reality. As governments, businesses, and societies grapple with COVID-19, societal cohesion is more important than ever.
LATEST GLOBAL RISK REPORT
2022 OUT NOW
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Financial Stability Risk Study
Near-term global financial stability risks have been contained as unprecedented and timely policy response to the coronavirus (COVID-19) pandemic has helped avert a financial meltdown and maintain the flow of credit to the economy. But the outlook remains highly uncertain, and vulnerabilities are rising, representing potential headwinds to recovery. Vulnerabilities have increased in the nonfinancial corporate sector as firms have taken on more debt to cope with cash shortages and in the sovereign sector as fiscal deficits have widened to support the economy. As the crisis unfolds, corporate liquidity pressures may morph into insolvencies, especially if the recovery is delayed. Small and medium-sized enterprises (SMEs) are more vulnerable than large firms with access to capital markets. Although the global banking system is well capitalized, some banking systems may experience capital shortfalls in an adverse scenario, even with the currently deployed policy measures. Nonbank financial institutions have managed to withstand the market turmoil thanks to swift policy interventions, but fragilities remain, and the damage could be more extensive in a more prolonged period of market stress. Some emerging and frontier market economies already face financing challenges, which may lead to rising debt distress or financial instability. Looking ahead, it is imperative that policy support is maintained for the recovery to take hold. As economies reopen, accommodative monetary and financial conditions, credit availability, and targeted solvency support will be essential to sustaining the recovery.
Emerging and Frontier Market Risk Study
The COVID-19 pandemic has hit emerging and frontier market economies hard, but the policy response has been equally strong. Policymakers have taken steps to soften the hit to economic activity, ease financial conditions, and reduce stress in domestic markets. For the first time, many emerging market central banks have launched asset purchase programs to support the smooth functioning of financial markets and the overall economy. Asset purchases have been effective in reducing bond yields and have not contributed to currency depreciation, but they appear to have taken longer to reduce broader domestic bond market stress. This chapter examines the effectiveness of these unconventional policy measures and concludes that asset purchases with credible monetary policy frameworks and good governance may be a useful addition to the policy toolkit of central banks in emerging and frontier market economies, although a careful ongoing evaluation of associated risks is needed, especially for open-ended programs. In frontier market economies, the policy focus has been on addressing the effect of the pandemic while dealing with high debt. This chapter examines the potential impact on investor perception of sovereign risk as a result of the expected treatment of different classes of creditors in future debt restructurings.
Corporate Funding: Liquidity Strains
The COVID-19 pandemic has adversely affected nonfinancial corporate sector cash flows, generating liquidity and solvency pressures. In the G7 economies borrowing surged in March and into the second quarter of 2020, thanks to credit line drawdowns and unprecedented policy support. This allowed firms to build cash buffers to cope with a period of reduced cash flow and high uncertainty. In the United States, the bond market has been buoyant since the end of March, but credit supply conditions for bank loans and the syndicated loan market have tightened. In other G7 economies, credit supply conditions eased somewhat across markets during the second quarter. Among listed firms, entities with weaker solvency or liquidity positions before the onset of COVID-19, as well as smaller firms, suffered relatively more financial stress in some economies in the early stages of the crisis. However, residual signs of strain remained as of the end of June, when the stock market underperformance of French, UK, and US firms with pre–COVID-19 liquidity vulnerabilities ranged between 4 and 10 percentage points. Policy interventions, especially those directly targeting the corporate sector, had a beneficial effect overall. Looking ahead, premature withdrawal of policy support could jeopardize the success achieved so far in broadly meeting the nonfinancial corporate sector’s funding needs.
Bank Capital: 2023 Challenges
Banks entered the post-COVID-19 crisis with higher levels of capital than before the global financial crisis, and policymakers have quickly deployed policies to support economic activity and the ability of banks to lend. However, the sheer size of the shock and the likely increase in defaults from firms and households may challenge banks’ profitability and capital positions. A forward-looking simulation of capital ratios in a sample of 350 banks from 29 jurisdictions, accounting for 73 percent of global banking assets, shows that capital ratios would decline as a result of the COVID-19 crisis, but remain, on average, comfortably above regulatory minimums. However, there are differences across and within regions. A weak tail of banks, accounting for 8.3 percent of assets in the sample, might fail to meet minimum regulatory capital requirements in an adverse scenario. Government loan guarantees and other bank-specific policies help relieve the decline of reported capital ratios and reduce bank capital shortfalls. Policymakers should pay attention to intertemporal trade-offs, as policies that reduce the financial stability risks of a transitory shock may increase longer-term vulnerabilities to banks’ loss-absorbing capacity. Policies to limit capital distributions and ensure adequate funding for deposit guarantee programs, as well as contingency plans for response to possible pressures, would help address the consequences of a potentially adverse scenario.