The International Monetary Fund has warned that increasing levels of domestic borrowing from banks in Nigeria and other emerging markets could threaten the country’s financial stability.
According to the IMF, the pandemic has increased the amount of debt emerging-market banks are holding, which could increase the pressures on public-sector finances, and threatening financial stability in the process.
The Washington-based lender disclosed this in a report titled, ‘Emerging-Market Banks’ Government Debt Holdings Pose Financial Stability Risks.’ It added that authorities should act to minimise the risk.
It said, “Governments around the world have spent aggressively to help households and employers to weather the economic impact of the pandemic. Public debt has mounted as have issued bonds to cover their budget deficits.
“The average ratio of public debt to the gross domestic product—a key measure of a country’s fiscal health—rose to a record 67 per cent last year in emerging market countries, according to Chapter 2 of the IMF’s April 2022 Global Financial Stability Report.”
It added, “Emerging-market banks have provided most of that credit, driving holdings of debt as a percentage of their assets to a record 17 per cent in 2021. In some economies, debt amounts to a quarter of bank assets. The result: emerging-market rely heavily on their banks for credit, and these banks rely heavily on bonds as an investment that they can use as collateral for securing funding from the central bank.
“Economists have a name for this interdependence between banks and . They call it the ‘sovereign-bank nexus,’ because debt is also known as sovereign debt—a vestige of the Middle Ages when kings and queens did the borrowing.”
According to the IMF, the large holding of sovereign debt could expose banks to losses if finances come under pressure and the market value of debt declines which could force banks, especially those with less capital, to reduce their lending to companies and households, weighing on economic activity.
It added that as the economy slows and tax revenues reduce, finances will come under pressure, further threatening banks.
It stated that this could eventually lead to a default.
The IMF said, “Now, emerging-market economies are at greater risk than advanced economies for two reasons. For one, their growth prospects are weaker relative to the pre-pandemic trend compared with advanced economies, and have less fiscal firepower to support the economy.
“For another, external financing costs have generally risen, so will have to pay more to borrow. What could trigger the doom loop in a country? A sharp tightening of global financial conditions—resulting in higher interest rates and weaker currencies on the back of monetary policy normalization in advanced economies and intensifying geopolitical tensions caused by the war in Ukraine—could undermine investor confidence in the ability of emerging-market to repay debts.
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