Global Financial Stability Report

Chapter 1: Shifting Ground beneath the Calm: Stability Challenges amid Changes in Financial Markets

Recent months have seen elevated trade and geopolitical tensions, rising government debt, and continued growth of nonbank financial intermediaries (NBFIs) and stablecoins. Markets appear complacent to this shifting ground: valuations have returned to stretched levels since the April 2025 Global Financial Stability Report, and financial conditions have eased.

Financial stability risks remain elevated. Valuation models show risk asset prices well above fundamentals, raising the risk of sharp corrections. Sovereign bond markets face pressure from widening fiscal deficits, while stress tests reveal greater interconnectedness and maturity mismatches among banks and NBFIs that could amplify shocks. These vulnerabilities reinforce each other. An abrupt decline in asset prices or sharp rise in yields could strain banks’ balance sheets and pressure open-ended funds. Greater interconnectedness between banks and NBFIs would intensify the transmission of shocks across the financial system.

Policymakers should remain vigilant. Priorities include preserving central bank operational independence in addressing inflation, curbing government deficits, and advancing internationally agreed prudential standards such as Basel 3. Strengthening financial safety nets, enhancing oversight of NBFIs, and regulating stablecoins effectively are also essential to safeguard global financial stability.

Chapter 2: Risk and Resilience in the Global Foreign Exchange Market

The foreign exchange (FX) market has evolved into the world’s largest and most liquid financial market, driven largely by rising participation of nonbank financial institutions and increased use of derivatives. This growth may have enhanced market liquidity and expanded risk diversification opportunities, it has also introduced greater complexity and interconnections—leaving the market susceptible to more stress. This chapter examines how episodes of heightened macrofinancial uncertainty affect FX market functioning and its potential implications for financial stability. During periods of uncertainty, flight-to-quality dynamics and stronger demand for hedging tend to raise foreign currency funding costs, widen bid-ask spreads, and amplify excess exchange rate return volatility. These strains are exacerbated by structural vulnerabilities such as significant currency mismatches on balance sheets, concentrated dealer activity, and elevated participation by nonbank financial institutions. Stress in the FX market can spill over into other asset classes, tightening overall financial conditions, especially in economies with significant currency mismatches or weaker fiscal positions. The continued expansion of FX trading has heightened settlement risks—the possibility that one party will deliver currency without receiving the countervalue—and exposed the market to operational risks, including technical failures and cyberattacks. Policymakers can mitigate these risks by enhancing surveillance, ensuring adequate buffers at financial institutions, and strengthening the global financial safety net and operational resilience.

Chapter 3: Global Shocks, Local Markets: The Changing Landscape of Emerging Market Sovereign Debt

The chapter examines the evolution of emerging market and developing economies’ sovereign debt markets against a backdrop of rising debt levels, heightened vulnerabilities to global shocks, and reduced interest from global investors given lagging performance of emerging market debt. It contrasts major emerging markets that have largely been able to expand borrowing through increased local issuance to local investors, with other emerging and frontier markets that have needed to rely on shorter maturity financing from domestic banks and the central bank, as well as foreign currency debt. This could deepen the divergence between more resilient and more vulnerable economies if shocks appear. New empirical analysis shows that countries with deeper local investor bases have indeed experienced greater resilience to global shocks over the last 15 years. However, more domestic buyers are not always better; the chapter also examines risks that may stem from an overreliance on a narrow group of domestic investors, especially if driven by financial repression. The chapter concludes with policy recommendations to develop strong and resilient local currency bond markets. While improving macroeconomic fundamentals remains essential, a strong policy frameworks and robust financial market systems are also critical. Foundational market infrastructure must be developed, legal certainty provided, and sovereign debt management practices strengthened.