30% of developing countries face high financial-sector risks – Report

A new report by the World Bank says 30 percent of emerging markets and developing economies (EMDEs) are facing high financial sector risks in the next 12 months.

The Finance and Prosperity 2024 report, an annual World Bank publication that examines financial sector developments and vulnerabilities in low- and middle-income countries, notes that the majority of these countries do not have an adequate policy framework and institutional capacity to deal with financial stability challenges.

According to the report, an analysis of 50 emerging markets and developing economies (EMDEs), which represent 93 percent of total bank assets in EMDEs, found that 30 percent of these countries face high financial-sector risks in the next 12 months. The report details measures that banking authorities in these countries can take to fortify vulnerable financial sectors.

According to the report, “In many of these countries, domestic risks are compounded by global risks related to monetary policy and economic growth outlooks in advanced economies (AEs), as well as geopolitical conflicts.”

The bank advises that the countries will benefit greatly by strengthening their financial sectors as they strive to support job creation, attract private capital, address climate change, and tackle other development challenges.

It said the financial sector risk outlook for emerging markets and developing economies (EMDEs) is largely divided along income lines, with lower-income countries facing much higher risks than higher-income countries. The report said most banks in EMDEs weathered the pandemic shock well and appear relatively sound and resilient, but pockets of weakness exist.

“Most EMDE banks have sufficient buffers to withstand sizable credit and sovereign risk shocks,” the report said, adding, “Yet some sample banks in lower-income EMDEs would be undercapitalized if confronted with a significant but plausible increase in the non-performing loan ratio. Several banks—mostly in the Middle East and North Africa, Sub-Saharan Africa, and South Asia regions—face elevated risks of ‘haircuts’ on sovereign bonds should there be a domestic debt restructuring, a situation that could trigger an adverse feedback loop between the sovereign and domestic banks.”

It said a majority of the countries facing high financial sector risks (including many lower-income African countries) are currently not well-prepared to handle financial stress. It noted that important weaknesses in regulatory and supervisory frameworks hamper the ability of some high-risk EMDEs to ensure the soundness of the financial sector, and essential components of crisis management frameworks and financial sector safety nets are often missing or inadequate.

The report advises that these vulnerable countries should take urgent steps to remedy critical policy and institutional gaps in order to improve the resilience of their financial sectors. It adds that liquidity assistance, robust resolution frameworks, and credible deposit insurance systems are examples of essential tools that can reduce the impact and likelihood of financial stress and mitigate spillovers to the real economy.

“In addition, it is important to bolster the operational independence and powers of banking sector authorities, clarify that their financial stability mandate takes precedence over financial sector development objectives, and ensure effective supervision of financial institutions and strong financial sector safety nets.

“Although progress has been slow for many financial sector development priorities, there have been improvements in financial inclusion for individuals and in efforts to green the financial sector. Developing the financial sector is critical to promoting sustainable economic growth and ending poverty,” the report said.