Financial Stability Board of the G20: Emerging Vulnerabilities to Global Financial Stability

Set up by the G20 in 2009, the Financial Stability board (FSB) is venerable institution with a responsibility to assess the vulnerabilities in the global financial system and suggest measures to deal with them. It coordinates the actions of the central banks and international standards setting bodies and develops effective regulatory, supervisory, and other financial sector policies that promote financial stability. The FSB brings together a variety of national financial authorities from 24 countries and jurisdictions as well as international financial institutions, sector-specific international groupings of regulators and supervisors and central bank experts. It maintains outreach to nearly 70 other jurisdictions through its six Regional Consultative Groups.

Its work spans climate-related risks, economic recovery from COVID-19, risks from crypto assets, cyber resilience, emerging markets and developing economies, non-bank financial intermediation and vulnerabilities assessments

Ahead of the G20 summit on Bali, Indonesia, FSB has submitted its report on the global financial health. Its head Klaas Knot, the President of De Nederlandsche Bank has spoken publicly about the emerging challenges. The FSB has also developed an action plan on financial stability.

Fragile Economic Recovery

Speaking on 11 May 2022 at a public forum, Klaas Knot had warned that the economic recovery from the covid crisis had been uneven and weak. The Russia-Ukraine war that began in the end of Feb 2022 had exposed the fragile nature of economic recovery.

While observing that the war had not created any notable financial crisis, the FSB has highlighted that the impending global economic downturn could trigger a financial crisis. The world is seeing a return to the period of high inflation. The Russia Ukraine war has led to high oil, food and energy prices worldwide. This will inevitably lead to tighter monetary conditions and high interest rates crimping the economic growth further. Even though oil prices have come down from their peaks, they still remain uncomfortably high. Many counties are facing high indebtedness. Low economic growth will further shrink their fiscal space. High volatility in commodity prices could disturb macroeconomic fundamentals of counties which in turn may have knock-on effects on the broader financial system.

Growing Climate Risks

The FSB has underscored several other risks to global financial health. It has warned that climate change represents a structural risk to global financial health. It strongly recommends that the financial institutions should henceforth incorporate climate risks into their lending methodologies. It may be noted that international financial institutions are beginning to prioritise climate in their lending programmes. For instance, the World Bank Group’s Climate Change Action Plan for 2021–2025 has recommended that an average of 35 percent of the World Bank’s financing over the next five years must be dedicated to climate action with at least half of Bank financing supporting adaptation and resilience efforts. This represents a big change in the thinking of the international financial institutions.

The FSB acknowledges that the present understanding of climate risks to financial systems is still at a rudimentary stage. It recommends a standardized system of firm level disclosures to climate risks, collection of relevant data, vulnerability analysis and preemptive action.

Mitigating climate risks requires transition to clean and green energy which is going to be expensive. As the Russia-Ukraine war has shown, even developed economies in Europe, who have all along championed transition to clean energy, are unable to wean themselves from fossil fuels. The transition will be particularly difficult for the developing countries in the absence of sumptuous funding from the lending institutions.

Crypto Assets are a Threat to Financial Stability

Besides climate, the FSB describes crypto assets as a major risk to global financial stability. It notes that crypto assets are not backed by physical asset. They are highly volatile, unregulated and work outside the traditional banking system. Although crypto assets constitute a relatively small share of overall financial assets today, their value is growing rapidly. What is worrying is that crypto assets are connected with traditional financial systems in various ways. Any failure in crypto markets can contaminate the traditional financial system and trigger a huge crisis.

‘Stablecoins’ have been invented to mitigate the risk of volatility in crypto currency. Stablecoins are crypto currencies pegged to the dollar, gold or some algorithms. US Tether (UST) with a market value of about USD 83 billion is one such stable coin cryptocurrency. But it turns out that even stablecoins are after all not that stable. UST became volatile in May and unpegged itself from the dollar. The FSB has highlighted the need for the regulation, supervision and oversight of global stable-coins and unbacked crypto-assets.

Technology is threatening the traditional banking system. Decentralised Finance (DeFi) is an umbrella term used to describe a clutch of cryptocurrency and blockchain based peer-to-peer financial services that remove banks and intermediaries from the traditional loop and create an alternative financial system that is not in the control of the banks and financial regulators. The Financial Stability Board highlights the risk of decentralized financial services and its impact on global financial stability.(DeFi can be compared to a blockchain and crypto-currency based Havala system)

In the era of growing digitalization and technological innovation, cyber risks cannot be ignored. Cybercrime which includes financial cybercrime results in trillions of dollars of damages to global economy annually. The FSB highlights the cyber risk to the global financial system and emphasises the need for cyber incident reporting and the enhancement of cyber response and recovery capabilities of the financial institutions.

India has a Stake in the Work of the FSB

India has a huge stake in global financial stability. As it takes over the presidency of G20 later this year, it will have the opportunity to shape the G20 agenda and give ideas for reforming the global financial architecture. India is an active Member of the FSB. It has three seats in its plenary, represented by Secretary (EA) in the Department of Economic Affairs, Deputy Governor, RBI and Chairman, SEBI. India has been implementing the measures and reforms suggested by the FSB in the past and India has been assessed to be largely ‘compliant’ on Basel III reforms for the banking sector. It remains to be seen how India responds to the new suggestionsof the FSB concerning climate, cryptoassets and cyber resilience. India will have to be ensured that its own developmental agenda, which requires economic growth as well as financial stability, is not impacted. The FSB cannot ignore the developmental needs of the emerging economies.

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