The war in Ukraine and its global financial stability risks

The International Monetary Fund released its latest “Global Financial Stability Report” providing an assessment of the global financial system and markets” and recommendations to policy makers and supervisory authorities. In this edition it includes a chapter analysing “the financial stability implications of the war in Ukraine” on worldwide basis, which overall have tightened notably global financial conditions, implying downside risks to the economic outlook, and rising financial stability risk.

Key messages from the report:

• Financial stability risks have risen along many dimensions, although no global systemic event affecting financial institutions or markets has materialized so far.
   
• Commodity prices pose challenging trade-offs for central banks. Central banks should act decisively to prevent inflation from becoming entrenched without jeopardizing the recovery.
   
• Repercussions of the war continue to reverberate globally and will test the resiliency of the financial system through several channels, for instance:
  
  - Increasing pressure to bank asset quality: Supervisory authorities should ensure that banks accurately reflect credit risk and losses. Any significant decline in capital ratios should be accompanied by a credible capital restoration plan.
  - Risks from nonbank financial intermediation (Shadow banking): It should be addressed by policymakers urgently, developing appropriate macroprudential tools.
  - Cyberattacks have become a first-order concern for financial institutions and policymakers alike.
  - Capital markets and global payment system could become more fragmented.

• Foreign Banks’ Direct Exposures to Russia and Ukraine is relatively modest, in aggregate, however Banks’ indirect exposures are more difficult to identify and assess because they are less well known (especially the extent of interconnectedness) and hard to quantify.
   
• Emerging and frontier markets are facing tighter financial conditions and a higher probability of portfolio outflows.  In China, financial vulnerabilities remain elevated amid ongoing stress in the property sector and new COVID-19 outbreaks. And Emerging market sovereigns have become more reliant on domestic banks for funding, and bank holdings of domestic sovereign debt have surged to historic highs.
   
• The geopolitics of energy security may put climate transition at risk. Policymakers should intensify efforts to implement the 2021 United Nations Climate Change Conference (COP26) roadmap to achieve net-zero targets.
   
• Some businesses and households may need short-term fiscal support to navigate the consequences of the war. Fiscal support should be targeted to those most affected and to priority areas