Klaas Knot: High debt and financial stress - implications for Asian
financial stability
Speech (online) by Mr Klaas Knot, President of the Netherlands Bank and chair of
Financial Stability Board, at the ASEAN+3 Economic Cooperation and Financial
Stability Forum, Kanazawa, 5 December 2023.
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Thank you for inviting me to speak today. I am sorry that I cannot be there in person
with you, as I was unable to travel from the COP28 proceedings , where I am today, to
Kanazawa in time. Nevertheless, I am grateful to be able to share a few words with you
on a theme that aligns so closely with the mandate of the FSB: Safeguarding Growth
and Stability in a Complex World.
A resilient and stable financial system is indispensable to sustaining economic growth,
particularly in the current environment. This is at the core of the FSB's mandate. As the
global financial stability watchdog, the FSB is responsible for assessing vulnerabilities
affecting the global financial system. In addition, the FSB identifies and reviews the
regulatory and supervisory actions needed to address these vulnerabilities.
So how do we go about that? To start with, our surveillance framework aims to
proactively identify vulnerabilities and provides a global, cross-border, and
crosssectoral perspective on existing vulnerabilities. This framework draws on the collective
perspective of the broader FSB membership. But that perspective can only take us so
far in understanding and responding to global vulnerabilities. Indeed, the global issues
of today require coordinated responses, but this does not necessarily mean one size fits
all. Regional perspectives matter. To gain a truly global perspective, it is important for
us to incorporate the experience and intelligence of emerging market economies
(EMEs) and also look beyond our G20 membership.
Our Regional Consultative Groups are one way we do this. They provide us with a
richer and more detailed regional perspective. One which we appreciate ever more
during times like the present when financial and macroeconomic uncertainty are
elevated.
Last week our Regional Consultative Group for Asia met in Hong Kong. Members
discussed global and regional financial market developments and their impact on Asian
economies. A key theme was rising government indebtedness and financial stability
risks linked to the sovereign-bank nexus. I note that AMRO's Financial Stability Report
raises many of the themes discussed by our regional group, including elevated private
and public nonfinancial debt and the expanded role of NBFIs in the region.
Let me talk about these vulnerabilities from an FSB perspective, with a focus on EMEs
and the Asian region.
The global financial system is transitioning to a higher interest rate environment.
Financial institutions and market participants have not experienced sharply rising
interest rates for a long time, making this adjustment to a world of higher rates
challenging.
Earlier this year, amid shifting financial conditions, we witnessed the first failure of a
global systemically important bank since the 2008 global financial crisis. In addition, a
few medium-sized bank failures also rang alarm bells. Contagion from these individual
bank failures was limited, thanks to the swift and coordinated actions of authorities
across the globe and to the confidence in the resilience of the broader financial system.
This resilience is underpinned by the G20 reforms introduced following the global
financial crisis. Still, further strains in financial markets cannot be ruled out, as the
dynamics associated with the transition to higher interest rates play out over time.
Market conditions for the larger EMEs have been fairly stable. But, the recent slowdown
in economic growth - and rising interest rates in some jurisdictions - could make it
more challenging for some economies to service high debt levels. At the same time,
increasing government debt and the withdrawals of foreign investors in the wake of the
pandemic have strengthened the "sovereign-bank nexus". This may lead to speedier
transmission of shocks between sovereigns and banks and threaten bank
macrofinancial stability.
One particular issue that could arise relates to the interaction of US dollar funding and
external vulnerabilities in EMEs. For most of the decade prior to the COVID-19
pandemic, capital flows to EMEs were supported by abundant global liquidity and a
hunt for yield among investors to boost their returns. These inflows provided EMEs with
the benefits of greater access to international capital markets, but also contributed to
the build-up of vulnerabilities. Non-bank financial intermediaries (NBFIs) have played an
increasing role in funding EME external debt. While this development added to the
diversity of EME funding sources, it also created new challenges. As the global financial
system continues to digest higher interest rates, there is the possibility that this could
affect capital flows to EMEs. In a more extreme scenario, NBFIs and others might
withdraw their investments in certain economies.
This has been an important area of work for the FSB. In 2022, we published a report
looking at trends in the structure of EMEs' external borrowing, focusing on the shift
towards non-bank financing. The report examined how these developments contributed
to the build-up of vulnerabilities in EMEs and to the March 2020 turmoil. It discussed
policy issues that could be considered when thinking about measures to limit these
vulnerabilities. This included measures to tackle the build-up of foreign exchange
mismatches; enhance crisis management tools; and address data gaps to facilitate risk
monitoring and the timely adoption of policies. The FSB also stressed the importance of
ongoing work to address vulnerabilities from liquidity mismatches in open-ended funds,
which would also help bolster the resilience of EMEs' financial systems. I am therefore
happy to report that the FSB is finalising its policy recommendations to address
structural vulnerabilities from liquidity mismatch in open-ended funds, working in close
coordination with IOSCO.
Enhancing the resilience of the NBFI remains a key priority for the FSB in 2024. The
FSB will also continue to build on the lessons from the March 2023 turmoil and to
monitor macro-financial vulnerabilities in a higher interest rate environment.
Let me conclude.
Vulnerabilities in the global financial system remain elevated. Tightening financial
conditions and high levels of debt create challenges for both bank and non-bank
lenders. In tackling the challenges ahead, formulating policy responses and building
resilience, it is essential that there is global coordination and that we pay attention to
potential cross-border spill-overs.
Gatherings like today's forum are an important way of exchanging views and identifying
the different ways in which governments and international organisations can work to
enhance the resilience of our global financial system. As I mentioned earlier, regional
perspectives matter a great deal, and AMRO's financial stability report is therefore a
welcome contribution to the global dialogue on vulnerabilities. For our part, the FSB will
remain focused on building resilience, so that the financial system can continue to play
its part in building strong, sustainable, inclusive, and balanced growth.
Thank you.