Economies in the financial spotlight in 2021

Throughout 2020 and into 2021, the global financial system withstood the effects of the global pandemic and economic lockdowns due to unprecedented policy support. Strong financial systems that are well regulated and well supervised help maintain financial stability. But like a well calibrated engine on a car, maintenance is key. Each year the IMF takes a look under the hood of select economies, which helps to unmask vulnerabilities that could present bigger problems down the road.

The Financial Sector Assessment Program, or "FSAP" as it's widely known, helps to assess financial vulnerabilities and make financial systems stronger and better able to withstand adverse events. The IMF considers country-specific features of financial systems and tailors its analysis to the needs of each member participating in the program. Assessments for advanced economies are done by the IMF alone, while those for other economies are typically carried out jointly with the World Bank. The IMF's Executive Board will soon conduct a periodic review of the FSAP.

In 2021, the IMF plans to assess the stability of six financial systems. Two assessments cover economies with large financial systems (United Kingdom, Hong Kong SAR). The remaining four focus on the emerging market (Chile, Philippines, South Africa) and frontier (Georgia) economies. For economies with large, systemically important financial systems it is mandatory to undergo financial stability assessments every five years. For others, assessments are carried out at the request of their governments.

The 2021 FSAP assessments include the following:

Chile features very large and deep local markets compared to other economies of similar size and level of development. The assessment will focus on the resiliency of the financial system, which exhibits a high level of interconnectedness between banks, mutual funds, pension funds, and insurance companies, particularly in light of the economic shocks that were experienced in the fourth quarter of 2019 and during the pandemic. It will also examine the effectiveness of banking, insurance, and financial market supervision following the reorganization and consolidation of the regulatory structure, with an emphasis on macroprudential policy coordination, the closing of regulatory gaps, and Covid-related forbearance measures.

Hong Kong SAR is a small, open economy, and a major international financial center. The FSAP will assess the financial sector's cross-sectoral and cross-border linkages, in view of extensive linkages to mainland China, stretched real estate valuations, and exposure to shifts in global market and domestic risk sentiment. The assessment will review the regulatory and supervisory frameworks for fintech developments, in addition to regular risk and regulatory assessments of banking, securities and insurance markets, as well as a review of crisis management arrangements and macroprudential frameworks. In addition, there will be a detailed assessment of payments and financial market infrastructures.

Georgia is a small, open economy with a moderately-sized financial sector comprised almost entirely of banks. The banking system is relatively concentrated and highly dollarized in both deposits and lending—the latter leading to higher credit risks from unhedged borrowers of banks' loans in foreign currency in case of currency depreciation. Against this backdrop, the FSAP will focus on banks' solvency and liquidity risks, and carry out assessments of banking supervisory oversight, macroprudential policy (especially with regards to risks from financial dollarization), and financial safety nets, including bank resolution and deposit insurance. The World Bank will also examine financial sector competition, assess oversight of markets and payments systems, and provide guidance for development of capital markets and access to finance for small and medium enterprises.

The Philippines' assessment was just concluded in March 2021. The country is now recovering from the impact of Covid-19. Banks dominate the financial system and entered the pandemic with solid capital and liquidity buffers. However, they are closely interconnected with nonfinancial corporations where market analysts forecast significant earning shocks, especially in retail, tourism, transportation, and construction industries. While recovering, the economy is also vulnerable to physical risks from climate change owing to its geographical position. The risk assessment examined bank resilience against Covid-19 shocks and physical risks (typhoon) and their interconnectedness with nonfinancial corporations. The assessment also evaluated bank oversight, macroprudential policy, and safety-net arrangements. The World Bank investigated oversight and developmental issues of insurers, payment systems, capital markets, and credit reporting, as well as climate change and environment risks supervision and deepening markets for green growth.

South Africa is home to Africa's largest financial sector, with large cross-border banking groups and a well-developed investment fund and insurance sector. The assessment will examine the strength of the financial sector in a difficult environment of subdued growth and large fiscal deficits (exacerbated by a weak financial position of state-owned enterprises and the ongoing health and economic impact of Covid). The importance of capital flows to the financial sector will underpin the "capital-flows-at-risk" analysis, as well as the assessment of systemic liquidity management and macroprudential policy. The assessment will also examine banking, insurance, and securities markets; pension and cyber risk supervision; crisis management and resolution; fintech; financial inclusion; climate risk; and capital markets development.

The United Kingdom is one of the world's most complex and open financial systems, hosting several globally systemic entities, and a large domestic financial sector. The 2021 FSAP will take place during a challenging macrofinancial period: While UK institutions have proven resilient to the pandemic's sharp economic contraction, there could be scars that challenge the profitability prospects of the financial system. The United Kingdom's exit from the European Union will lead to structural changes. And there are new developments—such as the growing share of market-based finance, adoption of new technologies, and the increasing importance of climate change and cyber risks—that deserve attention. The FSAP will examine risks in these areas and assess the adequacy of the oversight framework to safeguard financial stability.

Disclaimer: This article first appeared on IMF Blog and is published by special syndication arrangement