Financial System Survey Highlights — Spring 2022

The three main categories of risk are:

  1. External risks— mainly the risk of a cyber incident. Banks and insurers cited cyber incidents as the most significant risks. Responders manage the risk of a cyber incident through:
    • continued investment in cybersecurity
    • employee training
    • outsource certain IT processes

    In addition to threats against their organizations, some respondents expressed concerns about a successful Russian cyberattack on critical infrastructure in retaliation for economic sanctions.

  2. International economic and political risks— these are mainly geopolitical tensions. Asset managers and pension funds cited geopolitical tensions as the biggest risks. The most frequently mentioned geopolitical tensions were related to the Russian invasion of Ukraine. Respondents reported no or minimal direct exposure to Russia, but expressed concerns about geopolitical fallout, such as China:
    • support Russia and face economic sanctions
    • invade taiwan

    Some also feared that greater uncertainty around geopolitical tensions would increase the risk of a correction in high-yield debt and emerging market prices. Respondents have intensified their monitoring of their exposures to high yield debt and emerging markets; however, they did not change their asset allocation.

  3. Domestic macroeconomic risks— high inflation and weak economic growth were the most frequently mentioned domestic macroeconomic risks. Some sponsors manage these risks by:
    • increased protection against inflation, including through their exposure to private assets
    • diversify asset exposures to reduce market risk

    Some respondents feared that tensions between Russia and Ukraine could further increase inflation and slow growth. This echoes the April 2022 discussion Monetary Policy Report on how Russia’s invasion of Ukraine has:

    • reduced global growth
    • increase in inflation by rising commodity prices
    • even more disrupted supply chains

The top three risks facing organizations are also relevant to the wider financial system:

  • As discussed in the 2021 Financial System Reviewa successful cyberattack on a large financial institution or financial market infrastructure could lead to system-wide disruptions because the financial system is interconnected.
  • Geopolitical tensions could trigger a deterioration in financial conditions and a repricing of risky assets globally. For example, the month of April 2022 Monetary Policy Report explains how the war in Ukraine initially led to:
    • corporate credit spreads are widening
    • equity indices down sharply

  • A sharp rise in expected inflation could trigger a revaluation of risky assets and, potentially, a recession. For more details, see the section on potential risks associated with the normalization of monetary policy.

New developments

Respondents also reported new developments that their organizations have begun to monitor over the past year. Many of them were similar to their top three risks, such as geopolitical risks and high inflation. Other new developments included:

  • Fintech or open banking—Some respondents expressed concern about losing market share if they cannot compete with or partner with fintech companies.
  • Digital and crypto assets—Some respondents cited banking sector disintermediation as well as cyber threats and fraud as a concern. Others have referred to the volatility of crypto-assets.
  • Talent retention and attraction—Some respondents reported having difficulty attracting and retaining employees.

Potential risks related to the normalization of monetary policy

We invited market participants to share their views on the potential risks associated with the normalization of monetary policy. We offered respondents two scenarios that differed from their expected path. We then asked them to select the one that would most negatively affect their organization and tell us how:

  • the scenario would affect the financial markets
  • they prepared the script
  • they would adjust their strategies if the scenario happened

Impact of an unexpected monetary policy normalization scenario

Among respondents, 92% said that an unexpected monetary policy normalization scenario would negatively affect their organization (Chart 4).

  • Among respondents, 61% believed that a faster-than-expected normalization would lead to the most severe negative impact. They thought this scenario could lead to:
    • reduced demand for goods and services
    • higher unemployment
    • a possible recession

  • Among respondents, 31% believed that a slower-than-expected normalization would be the most serious. They feared that this scenario would initially lead to higher inflation, which could reduce the credibility of central banks and result in unanchored inflation expectations. This could then be followed by aggressive policy tightening to contain inflation, which could trigger an even deeper recession in the future.

In both scenarios, respondents were primarily concerned about the effects of a rapid tightening of monetary policy. However, respondents’ opinions diverged on the timing of the tightening and the associated economic impacts.

Of the respondents, 8% believed that neither scenario would have a negative impact on their organization. These respondents were primarily exchanges and clearinghouses, trading platforms and other financial market infrastructures that reported no direct exposure to risky assets. Some even believed that higher volatility following these scenarios would benefit their organization through increased trading volumes.

Source link

Don F. Davis