Financial Stability Risks April 2025

Combined Summary: Financial Stability Risks from Trade Uncertainty and Geopolitical Shocks (Chapters 1 & 2) Both Chapter 1 ("Enhancing Resilience amid Global Trade Uncertainty") and Chapter 2 ("Geopolitical Risks: Implications for Asset Prices and Financial Stability") highlight a significant increase in risks to global financial stability. This heightened risk stems from a confluence of factors, primarily driven by:

1. Elevated Geopolitical Risks and Trade Uncertainty: Geopolitical risks, encompassing conflicts, sanctions, and diplomatic tensions, have risen notably, contributing to an all-time high in economic and trade policy uncertainty. The surprise magnitude of US tariff announcements in April 2025 and subsequent retaliatory measures are a prime example of how such policy uncertainty can trigger financial market turmoil.
2. Tightening Global Financial Conditions: Amid this uncertainty, global financial conditions have tightened, marked by abrupt movements in asset prices and increased volatility.

The report identifies several key findings and vulnerabilities:

• Market Volatility and Asset Price Corrections: While market reactions to geopolitical events are often modest on average, major events (especially military conflicts) trigger significant, persistent adverse impacts on asset prices. The April 2025 tariff announcement caused swift and widespread market volatility. Despite recent sell-offs, valuations remain stretched in some segments (US tech, corporate bonds) relative to the grimmer outlook and elevated uncertainty, foreboding further potential corrections. Tail risks in markets have also increased, particularly after major shocks.
• Strains on Financial Institutions: High leverage in the financial system, particularly among Nonbank Financial Intermediaries (NBFIs) like hedge funds and asset managers, poses a significant risk. Growing interconnectedness with banks means that strains at highly leveraged NBFIs (e.g., due to margin calls or forced deleveraging following asset price drops) can amplify market turmoil and spread stress to the broader banking system. Private credit funds' reliance on bank financing and increasing cross-border links are also vulnerabilities. Banks, while profitable recently, face headwinds from trade impacts and potentially understated risks from internal capital models (RWA density). Major geopolitical events can adversely affect bank capital (especially in EM) and weigh on lending.
• Sovereign Bond Market Turbulence: High government debt levels and increased financing needs (for both advanced economies and emerging markets) come at a time of challenged bond market functioning. Central bank quantitative tightening means more debt must be absorbed by price-sensitive private investors. Dealer intermediation capacity is constrained, making markets fragile. Geopolitical events, especially military conflicts, significantly increase sovereign risk premiums, particularly for emerging markets and commodity importers with weaker buffers (fiscal and reserve) or institutional quality.
• Vulnerabilities in Emerging Markets and Frontier Economies: These economies face significant headwinds from trade tensions (weighing on growth/stocks) and tighter global conditions. High financing needs, increased interest expenses, depressed currencies, and higher capital outflow risks are concerns. Nonresident interest in local currency bond markets remains subdued. Frontier economies face high yields and market access risks. Investment funds with exposure to affected countries face lower returns and outflows.
• Risks in Specific Sectors and Countries: China faces exacerbated deflationary pressures from tariffs, bond market risks from declining yields and concentrated institutional holdings, and leverage risks from NBFI repo activity. Corporate sectors globally face widening spreads, rising bankruptcies, and refinancing challenges; EM firms are especially vulnerable to FX volatility and USD debt burdens. Households face increased vulnerability from high equity/real estate exposure and rising delinquencies for certain debt types. The commercial real estate sector shows uneven signs of stabilization with persistent stress in office properties and large refinancing needs.

Policy Recommendations: To enhance resilience amid this uncertain backdrop, the report recommends a comprehensive set of policies:

1. Strengthen Preparedness and Crisis Management: Authorities must be prepared for financial instability, ensuring financial institutions have tested access to central bank liquidity facilities (including for nonbanks with guardrails) and being ready for early intervention in core markets. Robust recovery and resolution frameworks are essential for dealing with weak or failing institutions.
2. Calibrate Macroeconomic Policies: Central banks should carefully assess price dynamics and calibrate monetary policy appropriately (easing where growth/inflation momentum is slowing, remaining restrictive where inflation is stubborn). Fiscal adjustments should focus on credible, growth-friendly rebuilding of buffers to manage high financing needs and contain borrowing costs.
3. Enhance Prudential Supervision and Regulation: Implement Basel III and other international standards fully and consistently to address bank risk-weight variability. Conduct intensive, independent supervision, including stress testing bank exposures (e.g., to CRE). Enhance the assessment and management of risks stemming from bank-NBFI linkages. Strengthen policies to mitigate risks from nonbank leverage, including better reporting requirements and cross-sectoral coordination.
4. Utilize Macroprudential Tools: Calibrate macroprudential buffers to increase resilience against shocks where buffers are insufficient, or release them to support credit provision during a downturn.
5. Manage Sovereign Debt Proactively: Explore liability management operations to manage refinancing risks. For countries with unsustainable debt, prompt engagement with creditors is crucial for orderly debt treatment.
6. Tailor Policies for Emerging Markets: Implement policy responses consistent with the IMF's Integrated Policy Framework, including appropriate use of exchange rate flexibility, FX intervention, or capital flow management based on country-specific circumstances. Deepen financial markets and improve regulatory frameworks to support hedging. Maintain adequate macroeconomic policy space and international reserve buffers. Policymakers and financial institutions in these countries should specifically consider country-specific geopolitical risks in their oversight and risk management.
7. Address Crypto Asset Risks: Implement the IMF/FSB road map and relevant standards consistently and coordinately to safeguard monetary sovereignty, manage capital flow volatility, ensure clear tax treatment, and monitor/supervise activities falling under existing regulations.
8. Enhance International Cooperation: Strengthen multilateral surveillance to monitor global shocks and spillovers. Reinforce the global financial safety net to enable swift and effective mitigation of systemic risks. Financial institutions themselves should devote adequate resources to identifying, quantifying, and managing geopolitical risks in their own operations.