CGFS - Activities

The CGFS monitors financial sector developments and analyses their implications for financial stability and central bank policy.

Global financial vulnerabilities

In 2022-23, the CGFS focused its attention on the consequences of forceful monetary tightening for financial stability. In 2022, the global financial system proved largely resilient to a sharp tightening of financial conditions, a large appreciation of the US dollar and volatile commodity prices. The resilience of many EMEs was underpinned by past improvements in fundamentals and institutional frameworks. In early 2023, business models that relied on low-for-long interest rates felt the strain and individual banks in some countries came under stress.

Looking forward, members cautioned that the financial system's continued stability was likely to be tested by a sustained global tightening of monetary policy. To bring inflation back to target, monetary policy might need to remain tighter for longer than markets had priced in. Also, owing to differences in inflationary pressures, the stance of monetary policy might diverge across countries in the future, increasing the likelihood of disruptive moves in exchange rates.

Members shared perspectives on the specific risks that a downturn in property markets might pose to the financial system and macroeconomy. In many markets, valuations remained stretched, which increased their vulnerability to a large, prolonged correction. The high level of household debt in some countries exacerbated the sensitivity of residential property prices and consumer demand to changes in interest rates. Non-bank financial institutions (NBFIs) and foreign investors had become prominent players in commercial property markets, resulting in closer links between these markets and many parts of the financial system. As a result, any troubles could quickly spread.

During the Covid-19 crisis, the simultaneous easing of monetary, fiscal and prudential policies had reinforced their stimulative effect on demand. In the light of this experience, the CGFS exchanged views about complementarities between prudential and monetary policies during periods of monetary tightening. Members concurred that the main role of macroprudential policies was to support the resilience of the financial system, and that a resilient financial system gave central banks more room to tighten monetary policy.

Vulnerability of NBFIs to rising interest rates

When interest rates were near historical lows, a "snapback" had been seen as a salient threat to financial stability. Although the rise in interest rates worldwide in 2022 did not cause widespread financial strains among NBFIs, members remained wary that higher rates might reveal vulnerabilities at NBFIs that had built up during the period of low rates and lead to systemic stress. Also, the growing presence of NBFIs in the financial system heightened concerns about how their vulnerabilities might exacerbate cross-border spillovers, through channels outlined in a paper prepared for the CGFS. Meaningful improvements in the liquidity management practices of money market and other open-ended funds were seen as particularly urgent to mitigate potential systemic risks.

Central bank asset purchases in response to the Covid-19 crisis

Following the outbreak of the Covid-19 pandemic in early 2020, central banks moved quickly and forcefully to limit the economic and financial fallout from the health crisis. In addition to cutting rates, they engaged in large-scale asset purchases. In a report published in March 2023, the CGFS found that asset purchases were broadly successful in addressing disruptions in monetary policy transmission and providing additional stimulus when the policy rate was constrained by the effective lower bound.

The impact of asset purchases and relative importance of various transmission channels differed across time and economies. The liquidity channel, whereby purchases improved financial market liquidity, was particularly important during the early weeks of the Covid-19 crisis, when markets were stressed. The signalling channel, whereby purchases foreshadowed the future stance of monetary policy, was less important than the portfolio rebalancing channel, through which purchases altered the duration and credit risk in private investors' portfolios. The contribution of the signalling channel to the easing of financial conditions was weak in countries where policy rates remained above the effective lower bound.

Climate risks and asset prices

To what extent are climate risks priced in financial markets? The CGFS brought together central banks, market participants and academics to explore this question and identify ways to enhance the incorporation of information about climate risks into asset prices. Drawing on a review of the academic literature, climate risks were seen as underpriced. Steps that could be taken towards better pricing included improving disclosures and strengthening the credibility of energy transition paths. Financial stability risks arising from climate change might be severely underestimated if they did not take account of indirect effects, such as the macroeconomic consequences of underinvestment in fossil fuels during the energy transition. These risks would increase the longer that it took to improve the pricing of climate risks.