Challenges and Concerns for Global Financial Stability

The recent increase in interest rates, inflation, and more stringent lending standards have caused some borrowers to experience stress, especially if economic growth slows down and labor market conditions weaken. Furthermore, geopolitical tensions also pose a risk to global economic activity and financial stability.

In March, three regional banks in the US - Silvergate, Silicon Valley Bank, and Signature Bank - experienced failures due to concerns about their vulnerability to rising interest rates, leading to a run on their deposit bases. Regulators and central banks acted promptly, but the impact extended to other banks in the US and even globally significant banks such as Credit Suisse. This made investors and depositors aware of vulnerabilities in some banks' business models.

Short-term funding markets worsened in March, with US regional banks seeking liquidity assistance from the Federal Reserve. Volatility in bank funding markets also resulted from the write-down of hybrid securities issued by Credit Suisse. As a result, conservative US money market funds saw significant inflows as a safe haven.

During this period, borrowing US dollars in the foreign exchange market became more expensive. However, the strains in foreign exchange swap markets have since eased.

Although banking systems have improved since the global financial crisis in 2008, with most banks maintaining high levels of liquid assets and capital, regulators including the Bank of England and the European Central Bank have expressed concerns about banks' risk management practices, especially related to large and concentrated credit exposures to single counterparties, particularly in their prime brokerage and capital markets services for non-bank financial institutions (NBFIs).

In March, government bond markets experienced significant volatility, with declines in yields for US Treasury and German bunds partly due to uncertainty surrounding policy rates in response to banking failures in the US. Although there are stresses in bank funding markets, they have not yet resulted in significant tightening of financial conditions. Investors remain optimistic about a soft landing from the current global monetary policy tightening cycle. However, there are concerns about inverted yield curves in major markets that could potentially result in wider risk premiums or sharp declines in prices of corporate securities and government bonds.

International regulators are focusing on the vulnerabilities posed by NBFIs, such as insurance companies, investment funds, and hedge funds, due to their potential to amplify shocks and disrupt markets. Efforts are being made to address these vulnerabilities, including reassessing margining practices and improving visibility over NBFI activities in systemically important markets.

China's economy has shown signs of improvement after COVID-19 restrictions were lifted in late 2022, supported by measures to boost growth in the distressed property sector. However, the confluence of higher interest rates, inflation, and tightening lending standards poses risks for household balance sheets, especially for those with little savings buffers and declining spare cash flow. Authorities have announced plans to strengthen oversight and regulation through the consolidation of financial regulatory agencies.

Source: (https://www.rba.gov.au/publications/fsr/2023/apr/global-financial-environment.html)