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Global Finacial Stability Report Update 2009

Global Finacial Stability Report Update 2009

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Published by: pedrogor on Jun 26, 2009
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 January 
 
2009
 Global Financial Stability Report Market UpdateJanuary 28, 2009
Financial markets worldwide reflect ongoing deleveraging pressures amidst a deepening economicdownturn. In spite of extensive policies, the global financial system remains under intense stress. Moreover, worsening economic conditions are producing new, large writedowns for financialinstitutions. In response, balance sheets are being cut back through asset sales and the retiring of maturing credits. These actions have increased downward pressure on asset prices and reduced credit availability. Restoring financial sector functionality and confidence are necessary elementsof economic recovery. However, more aggressive actions by both policymakers and market  participants are needed to ensure that the necessary deleveraging process is less disorderly. Abroad three-pronged approach—including liquidity provision, capital injections, and disposal of  problem assets—should be implemented fully and quickly so as to encourage balance sheet cleansing. At the same time, international cooperation will be required to ensure the policycoherence and consistency needed to re-establish financial stability.
Risks to financial stability have intensifiedsince October 2008. Macroeconomic risks haverisen as global growth has fallen precipitouslyalongside a sharp slowdown of global trade.Credit risks have also risen as a deterioration of economic and financial conditions have resultedin rising loan losses. At the same time, theflight from risky assets and illiquid marketconditions has increased funding costs, even asrisk-free rates have declined with monetaryeasing. Emerging market countries are alsofeeling the effects of the advanced economies’financial and economic difficulties, and there isthe potential that the abrupt pullback fromemerging market assets by investors andheightened financing costs will erase some of the economic gains these countries have madein recent years.With the help of extensive governmentsupport, market functioning toward the end of 2008 improved in a number of asset classes.However, the negative interaction between theeconomy and the financial sector hasintensified as the credit crunch bites harder andextends globally, with confidence amongfinancial counterparties remaining strained.Indeed, the recent shock to bank earnings andother bad economic news has put furtherdownward pressure on bank equity prices, andthe width of credit default swap spreads pointsto still-elevated systemic risks (Figures 1.1 and1.2). Notwithstanding public injections of capital, many banks around the world mayhave an insufficient capital cushion to weathera deep global economic downturn.
 
2
Figure 1.1 CDS Spreads for High-Grade European Financials(bps)
0306090120150180
    J   u    l  -    0    7    A   u   g  -    0    7    S   e   p  -    0    7    O   c    t  -    0    7    N   o   v  -    0    7    D   e   c  -    0    7    J   a   n  -    0    8    F   e    b  -    0    8    M   a   r  -    0    8    A   p   r  -    0    8    M   a   y  -    0    8    J   u   n  -    0    8    J   u    l  -    0    8    A   u   g  -    0    8    S   e   p  -    0    8    O   c    t  -    0    8    N   o   v  -    0    8    D   e   c  -    0    8
 
    J   a   n  -    0    9
 Bear StearnsCollapse Lehman Bankruptcy Banksdebt usinstart issuingg govt.guarantee programs Bleak economreleases globically
Source: Bloomberg
Figure 1.2 CDS Spreads for High-Grade US Financials (bps)
0100200300400500600
    J   u    l  -    0    7    A   u   g  -    0    7    S   e   p  -    0    7    O   c    t  -    0    7    N   o   v  -    0    7    D   e   c  -    0    7    J   a   n  -    0    8    F   e    b  -    0    8    M   a   r  -    0    8    A   p   r  -    0    8    M   a   y  -    0    8    J   u   n  -    0    8    J   u    l  -    0    8    A   u   g  -    0    8    S   e   p  -    0    8    O   c    t  -    0    8    N   o   v  -    0    8    D   e   c  -    0    8    J   a   n  -    0    9
 
 Bear StearnsCollapse Lehman Bankruptcy Banks start ssuing debt ing govt.iusguarantee programsBailout Citigroup
Source: Bloomberg
 The difficulty of keeping up with the increasingsize and breadth of writedowns borne byfinancial institutions, along with continued highfunding pressures, have hampered the ability of policymakers to address the crisis. Creditintermediation and confidence are severelyimpaired, which will weigh heavily on recoveryprospects and the ability of institutions to attractneeded capital from private investors. Absentfurther firm action from policymakers, thissituation threatens to worsen, given that banks,both advanced country and emerging marketcorporations, and to a lesser extent, sovereignentities, face risks that they will not be able toroll over large amounts of existing debt incoming years.Beyond the banking system, systemic concernsare rising for insurance companies and pensionfunds. Insurance companies have significantexposure to assets whose quality isdeteriorating sharply. Pension funds have alsobeen hit severely on the asset side.
Figure 2. Bank Writedowns and Capital Raised ($ bns)
0100200300400500600700800900WritedownsCapital Raised
 
Striped area represent public monies
$ 792 bn$ 826 bn$ 380 bn
Source: Bloomberg; Through January 26, 2009
 Writedowns Mounting
Until now banks have managed to obtainsufficient capital to offset existing writedowns,but that is mainly due to the massive publicsector injections of capital in the fourth quarter(Figure 2). The worsening credit conditionsaffecting a broader range of markets haveraised our estimate of the potentialdeterioration in U.S.- originated credit assetsheld by banks and others from $1.4 trillion inthe October 2008 GFSR to $2.2 trillion. Muchof this deterioration has occurred in the mark-to-market portion of our estimates (mostlysecurities), especially in corporate andcommercial real estate securities, butdegradation is also occurring in the loan booksof banks, reflecting the weakening outlook forthe economy.Going forward, banks will need even morecapital as expected losses continue to mount.On a global basis, estimates are quite difficultto construct, but for European and U.S. banks,(including their exposure to assets domicilednot only in the United States, but also in
 
3Europe and emerging markets), our roughestimates for expected writedowns during 2009and 2010, partly offset by the anticipatedrevenues over the same period, would result ina net capital shortfall in the order of magnitudeof at least half a trillion dollars. This impliesthat for U.S. and European banks taken togethersuch an amount in new capital is necessary justto prevent their capital position fromdeteriorating further. Moreover, forcefulmeasures to clean up banks’ balance sheets of troubled assets will be required to raise the levelof confidence in the banking system.Hedge funds and mutual funds have also beenhit hard, experiencing losses of assets undermanagement as investors shift to safer assetclasses. The combination of asset price declinesand redemptions suggest the hedge fundbalance sheets shrank by about half in the lastquarter of 2008, a particular concern for thosemarkets in which hedge funds provided asignificant proportion of market tradingliquidity.
Financing Gaps Widening
Despite capital injections and guarantees,funding markets are opening only slowly forbanks. Securitized forms of wholesaleborrowing are limited: current securitizationsare almost all retained on the balance sheet of the originators to use as collateral at centralbanks, while banks are unable to issue cost-effective unsecured debt unless it is governmentguaranteed. With the various governmentguarantee programs, banks have begun to raisesubstantial amounts of term funding to stabilizetheir balance sheets.Central bank liquidity injections and rate cutsare pushing down interbank rates, and furthergradual declines in term premiums areanticipated (Figure 3). However, despite mostbanks needing longer-term liquidity, much of the liquidity supplied by central banks is beingrecycled in the overnight market, or ends upback at the central banks, raising rollover riskseven further (Figure 4). This pattern reflectscontinuing worries about potential liquidityshocks and counterparty concerns, as well asuncertainty surrounding the amounts needed tofund future assets.
Figure 3. Spot and Forward LIBOR-OIS spreads* (bps)
0102030405060708090100USDEURGBP
Spot  Mar-09 Jun-09 Dec-09
Source: Bloomber
 
g; *On January 26 2009
 
Figure 4. Deposits at Central Banks (Billions of US Dollars)
0100200300400500600700800900Jan-07Apr-07Jul-07Oct-07Jan-08Apr-08Jul-08Oct-08
0100200300400500600700800900
Federal Reserve ECB Bank of England 
Source: Haver Analytics, Federal Reserve, EUROSTAT, Bank of England
 Looking forward, emerging market countries,particularly corporate borrowers, remainvulnerable to continued deleveraging andcredit retrenchment. Syndicated lending toemerging markets dropped sharply in thefourth quarter, as the contagion spread, withemerging Europe suffering a particularly sharpdecline. Emerging bond markets virtually shut

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