Global economic recovery ‘losing momentum’ as higher rates kick in

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The world’s most powerful financial watchdog has warned global leaders that financial markets could face “further strains” in the coming months, as high interest rates undermine economic recoveries and threaten key sectors including real estate.

The Financial Stability Board, a Basel-based body made up of central bank governors, finance ministers and regulators, gave its sobering assessment of the global outlook in a letter to Group of 20 leaders who are gathering in New Delhi this week to search for consensus on divisive issues such as the Ukraine war and climate change.

Financial markets have been relatively stable in recent months, a welcome respite after a spate of crises this year that claimed midsized US lenders such as Silicon Valley Bank and Signature and brought about the demise of Europe’s Credit Suisse, which was folded into its Swiss rival UBS.

But Klaas Knot, FSB chair and Dutch central bank governor, said risks in the financial system were still evident even though contagion from the events of February and March had been limited.

“Further strains in financial markets cannot be ruled out in the months ahead as higher debt servicing costs continue to permeate the economy,” he said in his regular update to G20 leaders.

“The global economic recovery is losing momentum and the effects of the rise in interest rates in major economies are increasingly being felt,” said Knot. He highlighted real estate as one area that authorities should “closely monitor” for signs of stress given its vulnerability to rate rises, and urged “financial providers to those sectors to manage their risks properly”.

Higher interest rates take time to fully pass through to the real economy because some borrowers are on fixed-rate loans set before central banks such as the US Federal Reserve, European Central Bank and Bank of England began tightening monetary policy to tackle soaring inflation in the wake of Russia’s invasion of Ukraine.

Knot said the potential for further market stresses underscored the case for “fully and consistently” implementing global bank capital rules agreed by regulators in 2017 and due to come into force by 2023.

He also pointed to the need for tighter regulation of non-bank financial institutions — which span everything from private credit to hedge funds and insurers — and said it was “critical” to implement agreed reforms to address risks in those markets. Regions have moved at different speeds on measures to regulate NBFIs, including provisions around money market funds, open-ended funds, margins, leverage and bond market liquidity.

The US announced in July that it would not implement the bank capital regime until mid-2025, some six months later than the EU and UK which had themselves already announced delays, to give banks more time to adjust to the new regime.

Even though the package was widely described as the “endgame” for post-global financial crisis regulation, policymakers are already considering another set of refinements to address some of the vulnerabilities that were exposed this year. The FT reported that these measures included tightening capital and liquidity rules and forcing the US to apply globally-agreed measures to a broader range of banks.

Knot said the FSB would soon publish a report on the “lessons learned” from this year’s banking crises and the “policy priorities going forward”.