The International Most Monetary Fund (IMF) has expressed worry over financial stability risks posed by what it called the “sovereign-bank nexus.”
In its blog post obtained on Tuesday, the tiro of Andrea Deghi, Fabio Natalucci, and Mahvash S. Qureshi observed that emerging-market governments rely heavily on their banks for credit, and these banks rely heavily on government bonds as an investment that they can use as collateral for securing funding from the central bank.
According to them, this poses financial stability risks as Banks’ holdings of sovereign debt rise to a record high as governments spend to cushion pandemic impact.
“There is reason to worry about this nexus. 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, weighing on economic activity. As the economy slows and tax revenues shrivel, government finances could come under even more pressure, further squeezing banks. And so on,” the IMF stated.
Specifically, the pandemic left emerging-market banks holding record levels of government debt, increasing the odds that pressures on public-sector finances could threaten financial stability.
The IMF stated that authorities should act quickly to minimize that risk.
Governments around the world have spent aggressively to help households and employers weather the economic impact of the pandemic.
Public debt has mounted as governments have issued bonds to cover their budget deficits.
According to Chapter 2 of the IMF’s April 2022 Global Financial Stability Report, the average ratio of public debt to gross domestic product, a key measure of a country’s fiscal health rose to a record 67 percent last year in emerging market countries,
Emerging-market banks have provided most of that credit, driving holdings of government debt as a percentage of their assets to a record 17 percent in 2021. In some economies, government debt amounts to a quarter of bank assets.
Economists have a name for this interdependence between banks and governments. They call it the “sovereign-bank nexus,” because government debt is also known as sovereign debt a vestige of the Middle Ages, when kings and queens did the borrowing.
“The sovereign-bank nexus could lead to a self-reinforcing adverse feedback loop that ultimately could force the government into default. There is a name for that, too the ‘doom loop.’ It happened in Russia in 1998 and in Argentina from 2001-02.
“Now, emerging-market economies are at greater risk than advanced economies for two reasons. For one, their growth prospects are weaker relative to the pre-pandemic trend compared with advanced economies, and governments have less fiscal firepower to support the economy. For another, external financing costs have generally risen, so governments will have to pay more to borrow,” the report read in part.
The IMF noted that a sharp tightening of global financial conditions resulting in higher interest rates and weaker currencies on the back of monetary policy normalization in advanced economies and intensifying geopolitical tensions caused by the war in Ukraine could undermine investor confidence in the ability of emerging-market governments to repay debts.
“A domestic shock, such as an unexpected economic slowdown, could have the same effect,” it noted.
According to the IMF, “so far, we have discussed one channel of risk banks’ exposure to sovereign debt. Chapter 2 of the GFSR outlines two other potential channels through which risk is transmitted between the sovereign and banking sectors.
“One relates to government programs, such as deposit insurance, intended to support banks in times of stress. Strains on government finances could hurt the credibility of those guarantees, weaken investor confidence, and ultimately hurt banks’ profitability. Troubled lenders would then have to turn to government bailouts, further straining public-sector finances.
“Another channel works through the broader economy. A blow to public finances could push economy-wide interest rates higher, hurting corporate profitability and increasing credit risk for banks. That in turn would limit banks’ ability to lend to households and other corporate customers, curbing economic growth.”
It therefore recommends strengthening banking-sector resilience by conserving loss-absorbing capital buffers as important as this can be done by limiting the amount of money that banks distribute to shareholders through dividends and stock buybacks, given heightened uncertainty about the economic outlook.
In addition, asset quality reviews to guide adequate levels of capital may be necessary to quantify hidden losses and identify weak banks once forbearance has ceased.
“Solutions will have to be tailored to the circumstances of each country, which vary widely. But broadly, they should: Develop resolution frameworks for sovereign domestic debt to facilitate orderly deleveraging and restructuring in case they are needed; Improve transparency on all banks’ material sovereign exposures to assess the risks from possible sovereign distress; Conduct bank stress tests by taking into account the multiple channels of risk transmission in the nexus; Consider options to weaken the nexus such as capital surcharges on banks’ holdings of sovereign bonds above certain thresholds once the economic recovery is more firmly established and depending on market circumstances; Strengthen procedures to wind down banks in an orderly fashion if needed and to provide liquidity in a crisis and promote a deep and diversified investor base to strengthen market resilience in countries with underdeveloped local currency bond markets,” it added.
The IMF further said with the right policies, emerging-market economies can lessen the sovereign-bank nexus and reduce the risk of a financial or economic crisis.
YOU SHOULD NOT MISS THESE FROM NIGERIAN TRIBUNE
‘Officials initially offered to help but when the number of able-bodied citizens at the centre increased, they left us unattended to’
With the imminent disconnection of the SIM cards of Nigerian phone users who failed to enroll for the National Identification Number (NIN) registration, This report unearths the unsavoury treatment of persons with disabilities at NIMC enrolment centres in the six South-West states which is in disobedience of the provisions of the Disabilities Act and other laws.
Court Awards Nnamdi Kanu N1 Billion Over Invasion Of His Home By Military, Asks FG To Apologise
Justice Benson Anya of the Abia State High Court sitting in Umuahia on Wednesday awarded the sum of N1 billion to the IPOB leader, Nnamdi Kanu, over the 2017 invasion of his Afara Ukwu home by the military.
Why Ogun Tops List Of ‘Yahoo Boys’ In Nigeria ― Governor Abiodun
The Ogun State Governor, Dapo Abiodun, has said that the presence of many educational institutions in the state was one of the factors why the state tops the list of internet fraudsters popularly known as ‘Yahoo boys’ in the country.
and then