Shockwaves from the War in Ukraine

Wednesday, June 8, 2022, 14:00-15:15 Vienna Time (CET) 

Fabio Natalucci, Deputy Director, International Monetary Fund
Andrea Deghi, Financial Sector Expert, International Monetary Fund
Hamid Reza Tabarraei, Economist, International Monetary Fund
Torsten Ehlers, Senior Financial Sector Expert, International Monetary Fund
Yingyuan Chen, Financial Sector Expert, International Monetary Fund

Patrick Imam, Deputy Director, Joint Vienna Institute

This webinar, organized jointly by the Monetary and Capital Markets Department of the IMF and the JVI, featured three presentations on the latest IMF Global Financial Stability Report, which reflects  the war in Ukraine and rising inflationary risks.

Fabio Natalucci presented the global financial stability outlook. He illustrated that global financial conditions tightened notably, and downside risks to the economic outlook have increased as a result of the Russian invasion of Ukraine. This occurred just as most of the world was slowly bringing the pandemic under control and the global economy was recovering from COVID-19. Financial stability risks have risen on several fronts, even though no global systemic event affecting financial institutions or markets has materialized so far. The war has already had an impact on financial intermediaries, nonfinancial firms, and markets directly or indirectly exposed to Russia and Ukraine. Europe was found to bear a higher risk than other regions due to its proximity. Banks’ direct exposures to Russia are relatively small except for some non-systemic European banks. Dedicated emerging market funds have maintained a cautious stance on their exposures to Russian debt since the occupation of Crimea in 2014.

However, a sudden repricing of risk resulting from an intensification of the war and an associated escalation of sanctions may expose, and interact with, some of the vulnerabilities built up during the pandemic, leading to a sharp decline in asset prices. With the sharp rise in commodity prices anticipated to add to preexisting inflationary pressures, central banks are faced with a challenging trade-off between fighting record-high inflation and safeguarding the post-pandemic recovery at a time of heightened uncertainty about prospects for the global economy. Bringing inflation back to target and preventing an unanchoring of inflation expectations require a delicate removal of accommodation while preventing a disorderly tightening of financial conditions that could amplify vulnerabilities and weigh on growth. 

Andrea Deghi and Hamid Reza Tabarraei documented how the COVID-19 pandemic brought the relationship between sovereigns and banks — the so-called sovereign-bank nexus — in emerging market economies to the fore as bank holdings of domestic sovereign debt surged. Their analysis finds that an increase in sovereign credit risk can adversely affect banks’ balance sheets and credit supply, especially in countries with less-well-capitalized banking systems. Sovereign distress can also constrain funding for the nonfinancial corporate sector. As global financial conditions tighten and geopolitical tensions intensify, a deeper nexus makes policy trade-offs in emerging markets more complex. The authors presented solutions to be tailored to each country’s circumstances to reduce the risks. These ranged from developing resolution frameworks for sovereign domestic debt to facilitate orderly deleveraging in case of need, to improving transparency and options to weaken the nexus, such as capital surcharges for banks’ holdings of sovereign bonds above certain thresholds.

Yingyuan Chen and Thorsten Ehlers showed how Fintech can increase efficiency and competition and broaden access to financial services. However, the fast growth of fintech firms into risky business segments and their inadequate regulation and interconnectedness with the traditional financial system can have financial stability implications. Three key types of fintech illustrate these risks: digital banks (“neobanks”), long-established fintech firms in the US mortgage market, and decentralized finance (“DeFi”). For neobanks, this means stronger capital, liquidity, and risk-management requirements commensurate with their risks. For incumbent banks and other established entities, prudential supervision may need to increase its focus on the health of less technologically advanced banks, as their existing business models may be less sustainable over the long term. The absence of governing entities means DeFi is a challenge for effective regulation and supervision. Here, regulation should focus on the entities that are accelerating the rapid growth of DeFi, such as stablecoin issuers and centralized crypto exchanges. 

In the ensuing discussion with the audience, a broad range of issues were discussed, such as whether central banks were behind their current pace of policy tightening, whether the Federal Reserve could achieve a soft landing, the role of foreign investors in the sovereign-bank nexus and the consequences of the recent rout in “stablecoins” on Fintech.

Patrick Imam, Deputy Director, JVI


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