The report starts from the premise that private and sovereign balance sheets will continue to strengthen in a gradually improving economic environment and that policy measures to address legacy problems in key banking systems are implemented alongside important stabilization policies. Nonetheless, higher downside macroeconomic risks, sovereign financing pressures, and intensifying funding strains could produce a difficult environment, requiring adept policy manoeuvring.
In Europe, coordinated support programs and the announcement of ambitious fiscal reforms in countries facing the greatest funding difficulties helped contain the turmoil in the Euro Area after its rapid escalation in May. Nevertheless, sovereign risks remain elevated as markets continue to focus on high public debt burdens, unfavourable growth dynamics, increased rollover risks, and linkages to the banking system. Second-tier institutions and banks in countries whose sovereign spreads remain under pressure continue to have only limited access to funding markets and face rising costs. Although governments have put in place national and supranational backstops to ensure that markets remain open, continuing forceful policy measures are needed to remain firmly on track toward building financial system resilience.
· The baseline scenario is for a gradual improvement in financial stability as the ongoing economic recovery continues but substantial downside risks remain.
· Without further bolstering of balance sheets, banking systems remain susceptible to funding shocks that could intensify deleveraging pressures and place a further drag on public finances and the recovery.
· Sovereign risks remain elevated as markets continue to focus on high public debt burdens, unfavorable growth dynamics, and linkages to the banking system.
· Policy actions need to be intensified to contain risks in advanced and emerging economies, tackle the legacy challenges of the crisis for the banking system, and put in place a new regulatory and institutional landscape to ensure financial stability.
© International Monetary Fund
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