In late 2011, the euro area's banking and government bond markets came under stresses that pushed financial stability risks to a new peak of intensity. Subsequent policy actions eased bank funding strains and helped stabilize sovereign markets, but the risks to global financial stability remain elevated. This report calls on policymakers to utilize recent stabilization gains to swiftly implement a comprehensive set of policies to achieve durable stability.
Emerging markets generally have substantial buffers and policy room to cope with fresh external shocks - as reflected in the unchanged, moderate level of emerging market risk. So far, these economies have been well able to manage the deleveraging coming from European banks, but looking ahead, there is a potential for deleveraging to have a global impact on the supply of credit. Although the pressures are likely to be most intense in emerging Europe, a sharp pullback in credit could expose existing external vulnerabilities throughout emerging markets, triggering additional portfolio outflows and upending domestic financial stability.
Why is a disorderly process of deleveraging so threatening? The risks to growth and financial stability during the deleveraging process are magnified by the fact that balance sheet repair often extends across several economic sectors.
Governments need to acknowledge their exposure to longevity risk; put in place methods for better risk sharing between governments, private sector pension sponsors, and individuals; and promote the growth of markets for the transfer of longevity risk.
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