Global banking is a bright spot – on challenges to Global financial system

Source– The post is based on the article “Global banking is a bright spot” published in the Business Standard on 10th November 2022.

Syllabus: GS3- Economy

Relevance– Economic situation around the world

News- The article explains the present economic situation across the world and future of the world economy. It also tells about the challenges to the world financial system.

What are the challenges to the world financial system by the IMF’s Global Financial Stability Report, October 2022?

China’s housing market woes: Stringent lockdowns in China have impacted home sales. Buyers do not want to make advance payments for the purchase of properties. As a result, developers face liquidity pressures and many have gone bankrupt. Banks’ exposure to the property is 28 per cent of total loans.

Poor market liquidity: Central banks are tightening monetary policy and shrinking their balance sheets. This has meant less liquidity in the market. Investors would like to sell securities when interest rates rise. Investors trying to exit their holdings of securities end up incurring losses that can trigger panic.

Corporate debt at risk: Rising interest rates pose challenges for firms with high debt. The IMF’s sensitivity analysis shows that under conditions of stress 50% of small firms would have difficulty servicing debt. Banks are bound to be impacted.

Leveraged finance under pressure: Leveraged finance is lending to companies with high debt or a poor credit history. It is, therefore, of the high-yield variety. An increasing share of leveraged finance in recent years is credit that is outside the regulated bank market and the financial markets and is of poor quality.

Housing price declines: Rising interest rates could trigger a steep decline in housing prices worldwide. This will have adverse implications for banks.

What is the present economic situation?

The Ukraine conflict poses the biggest challenge to growth since the global financial crisis of 2007. As per IMF, the world economy will grow at 3.2 per cent in 2022 and 2.7 per cent in 2023. Growth in 2023 will be the lowest since 2010, leaving aside the pandemic year of 2020.

GSFR report is that the world’s banks seem well-placed to cope with the very worst.

All growth forecasts at the moment are based on the economic conditions continuing same as present. Like, if the Ukraine conflict remains at the present level, oil prices will be around $92 per barrel, and inflation will start getting normal in the next couple of quarters.

What if the situation worsens?

Global economic growth will be severely hit. The IMF looks at this scenario. Growth will drop from the baseline projection of 3.2% to below minus 3% in 2023 before recovering to around 3 per cent in 2024.

The global Common Equity Tier I ratio in banking will be well above the regulatory minimum of 4.5%.

Banks in emerging markets would face a serious problem. Banks accounting for a third of banking assets would lack the minimum capital required.

How do we explain these outcomes?

There has been a big change in the banking system following GFC. Bankers have come to realise that it pays to have capital way above the regulatory norm. As a result, banks have performed well when it comes to capital adequacy. That is the reason for the robustness of the banking system even in these difficult times.

That is true of the Indian banking system as well. The 12 public sector banks together have reported a second quarter increase of more than 50 per cent in profit after tax  over the previous year. Loans in the banking system are growing at 17 per cent.