The financial system: a structural revolution
G20 Summit

The financial system: a structural revolution

The past year has seen the sharpest tightening of financial conditions since the 2008 global financial crisis and the first real test of the international resolution framework. Promoting financial resilience amid the current challenges and structural changes is key

The events that occurred in the banking sector in the first quarter of 2023 in Switzerland, the United States and the United Kingdom constitute a disturbing reminder of the speed at which underlying financial system vulnerabilities can be exposed. So far, the global system has remained resilient thanks to the post-crisis financial reforms introduced by the G20. These reforms included considerable increases in the levels of bank capital and liquidity, an international framework for effectively resolving failing institutions, and strengthened cross-border regulatory and supervisory cooperation. Without these reforms, the stress faced by individual banks could have led to broader contagion within the financial system.

But every test of financial resilience involves new challenges. The Financial Stability Board and other standard-setting bodies are carefully analysing recent events to draw out lessons for the banking sector, for the resolution of systemically important banks and for the financial system more broadly.

And although concerns about financial system resilience have eased, there are continued concerns about the confluence of interest rate, liquidity and credit risks against a background of monetary tightening, high debt burdens and economic slowdown. In addition, volatile market conditions and rising interest rates could lead to strains in segments of non-bank financial intermediation that have high leverage and large liquidity mismatches. Indeed, market stresses over the past year, including strains in both interest rate and commodities markets, underscore the need to address vulnerabilities in NBFI.

An ambitious approach

Over the past two years, the FSB has taken forward an ambitious work programme to strengthen the resilience of NBFI. A key element of that programme is policy work to address vulnerabilities from liquidity mismatches in open-ended funds and to ensure better preparedness of market participants for sudden spikes in demand for liquidity. Another key element of the NBFI work programme is to assess and address vulnerabilities associated with leverage in NBFI. Taken together, these initiatives hold the promise of making large, destabilising liquidity imbalances in stress periods much less likely.

While having to cope with a challenging conjuncture, the financial system is also confronted with secular trends, one of which is digitalisation. This trend brings both opportunities and risks. Digitalisation offers the prospect of fundamentally changing the way finance works and how the financial industry is organised. Harnessing the opportunities of this trend while containing associated risks is critical for financial stability and economic prosperity.

One key development in the area of digitalisation has been the rise of crypto assets. The bankruptcy of FTX and other high-profile failures in crypto asset markets served as a reminder that existing crypto assets, including so-called stablecoins, suffer from important structural vulnerabilities. Developing a global regulatory framework to address these vulnerabilities has been a key priority of the FSB. To this end, the FSB’s finalised recommendations for the regulation, supervision and oversight of crypto-assets and markets and of global stablecoin arrangements seek to promote comprehensive and consistent global regulatory and supervisory approaches to both types of assets. They are built on the principle of ‘same activity, same risk, same regulation’ to support a level playing field and ensure a technology-neutral approach. The publication of these recommendations is an important milestone. Attention must now turn to their full and effective implementation globally.

Trend watching

Another secular trend comes from climate change, including the need to manage climate transition risk. Two years ago, the FSB developed a roadmap to address climate-related financial risks. Since then, progress has been steady across all four blocks of the roadmap: data, disclosures, vulnerabilities analysis, and supervisory and regulatory approaches. The recent publication of the International Sustainability Standards Board’s final standards is an important milestone. It will serve as a global framework for sustainability disclosures and, when implemented, will enable disclosures by different companies around the world to be made on a common basis. Further work is needed to support forward-looking climate risk assessments and to embed climate scenario analysis into the monitoring of financial vulnerabilities. We are also working to develop our understanding of the cross-border and cross-sectoral transmission of climate shocks.

The macro-financial environment has changed a lot in recent months. At the same time, the financial system remains in the midst of a structural evolution. For these structural changes to deliver benefits to society, it is crucial that associated financial risks are addressed. The FSB will continue to facilitate global cooperation in assessing vulnerabilities and designing and implementing policy reforms in the interest of enhancing global financial stability.