Financial stability refers to a situation in which the global financial system is capable of performing its functions simultaneously (International Monetary Fund, 2012). It encompasses the ability of the financial system to be able to facilitate and enhance economic process, absorb shocks and manage risks. In addition, financial stability is usually changeable with time, and it is always consistent with various combinations of all the elements of finance. Financial stability, as a concept, is wide as it comprises of various parts of the financial systems markets, institutions and infrastructure. There is a significant among the three components. This implies that any disorder in any of them would affect the whole financial system.
Financial stability plays a significant role in enhancing financial system to accomplish its responsibility of allocating resources, transforming and managing risks and mobilizing reforms. In addition, it also plays a substantial role in sustaining the payment flow across private and official, whole sale and retail, and formal and informal mechanism of payment (International Monetary Fund, 2012). This is for the purpose of enhancing smooth functioning of the economy.
In order to maintain global financial stability, it is necessary to diminish financial crisis as well as lessen the possibilities which limit the emergence of various financial imbalances before they cause a threat to financial instability. When there is financial stability, this is possible through self corrective and market disciplinary mechanisms which create resilience.
There are various challenges encountered in an attempt to achieve, preserve and maintain global financial stability. In order to achieve financial stability, it is crucial to have effective mechanisms designed to prevent financial challenges or threats which compromise the financial, as well as the economic system (International Monetary Fund, 2012). One of the most vital aspects of the financial stability challenge is to maintain the ability of the economy for the purpose of sustaining growth, while performing other vital functions.
Issues Increasing risks to Financial Stability
According to the IMF report, it is true that the report indicates increased risks to the financial system globally. The report continues to state that the euro area is the key source of concern. There are several significant issues that are increasing risks to global financial stability. These are banking crisis, speculative bubbles and crashes, international financial crises, and wider economic crises (International Monetary Fund, 2012).
Banking crisis occurs when the banks suffers sudden rushes of withdrawals by the depositors. Since banks usually lend most of the money that they receive as deposits, it becomes difficult for them to pay all the deposits at once, in case all the clients demand all their money. In case this happens, it leaves the bank in bankruptcy and clients may also lose all their savings. Through this, the bank can accelerate financial crisis leading to financial instability (International Monetary Fund, 2012).
On speculative bubbles and crashes, economist indicates that a financial asset exhibits a bubble in case its price becomes more than the present value (International Monetary Fund, 2012). Most of the participants in the market always buy assets mainly hoping that they will sell them later at a higher price, instead of buying them for the income that they will generate. This implies that there is a bubble, hence creating a risk of increased prices of assets. These speculative bubbles and crashes are leading to financial instability in many parts of the world, resulting to global financial crisis.
International financial crises occur when a country which maintains a fixed exchange rate is forced to devalue its currency due to a speculative attack. This results to disruption in the flow of capital in the country which in turn leads to increased risk to global financial stability (International Monetary Fund, 2012).
Lastly, wider economic crises, as a key issue which is fueling increased risk in financial stability is primarily as a result of a recession, which is a negative Gross Domestic Product (GDP) growth, lasting two or more quarters (International Monetary Fund, 2012). A prolonged recession is a depression. Both recession and depression are significantly contributing to the global financial instability. This is because they cause economic stagnation in the entire globe.
The IMF report of October 2012 urges and recommends the policy makers to act immediately for the purpose of…