On Sep. 27, WRLD BK discussed financial system trends in six charts.
WRLD BK discussed financial sector vulnerabilities in emerging market and developing economies (EMDEs), finding that they are largely divided along income lines.
Overview
While vulnerabilities are low to moderate in higher-income EMDEs, half of lower-income countries face much higher risks; additionally, progress on financial development goals, such as local capital market deepening, stalled in many countries.
But advances made on financial inclusion for individuals and greening financial sector.
EMDE banks substantially increased their holdings of government debt.
These exposures are at decade high; subject financial sector to extra risks, particularly in countries with weaker macroeconomic policies, public debt sustainability challenges.
Climate change is also challenging for EMDEs as they face higher risks from it than advanced economies, plus bigger climate financing gaps; despite being largest source of finance, the banking sector in EMDEs supplies only limited climate finance.
EMDE banking authorities are beginning to adopt tools and innovate in approaches to address climate-related financial sector vulnerabilities and climate finance gaps.
But will need to avoid compromising on key financial stability and inclusion objectives.
Dealing with Financial Sector Stress
Pointed out most countries facing high financial sector risks are currently not prepared to handle financial sector stress; face important weaknesses in regulatory, supervisory frameworks and essential components of crisis management frameworks.
As well as financial sector safety nets that are often missing or inadequate.
Vulnerable countries should urgently act to remedy critical policy, institutional gaps.
While banks in debt-distressed countries have higher exposure to government debt.
EMDE banks substantially their holdings of government debt in recent years, known as sovereign-bank nexus; bank exposure to government debt in EMDEs rose by +35% from 2012-2023 as governments borrowed more, partly due to Covid pandemic.
That exposure rose even more - by over 50 percent - in debt-distressed countries.
Excessive government debt exposures among EMDE banks mean government debt distress could be contagious, trigger banking crises, which were damaging in past.
They have left GDP per capita significantly lower than it otherwise would be.
New analysis found countries with high sovereign-bank nexus can be less prepared to deal with financial stress; while broader policies that preserve public debt sustainability and macroeconomic stability are necessary, EMDE banking authorities should shore up financial crisis management, safety net frameworks, consider disclosure requirements for banks’ exposures to the government to encourage more prudent bank risk taking.
Climate Change
Central banks and prudential authorities are starting to implement approaches to address climate-related financial sector risks and mobilize climate finance.
Although guidance for applying them is lacking and their potential effectiveness is both mixed and unproven in some cases; banking authorities must therefore take care to prioritize financial stability and continue to promote financial inclusion and efficiency.
Based on experience to date, tools can broadly be divided into three categories.
Win-win; jury’s still out; and not recommended; sheer size of climate financing gap will require support from beyond the banking sector, namely from central governments.
As well as from deeper capital markets and national development financial institutions.
