The global financial system is confronting the ongoing war in the Middle East, potential inflationary pressures, rising risks of further tightening in financial conditions, and several channels through which market turmoil could escalate into financial instability, said the International Monetary Fund (IMF).
In its “April 2026 Global Financial Stability Report”, the IMF added that while markets have corrected in an orderly manner so far, risks are asymmetric. The longer the conflict continues, the greater the risk that global financial conditions—which had been very accommodative before the war—could tighten further and more abruptly.
The financial system’s resilience could be tested as several channels could amplify such tightening, leading to financial stability risks, the IMF warned. These channels include:
First, rising debt-to-GDP levels, combined with an increased presence of price-sensitive investors, has led to larger bond yield gyrations on auction days. Greater bond market volatility could tighten funding markets, which has been a locus of past financial turmoil.
Second, emerging markets may face currency and capital outflow pressures as carry trades unwind and terms of trade worsen.
Third, an abrupt tightening of financial conditions can lead to forced selling by hedge funds, option sellers, leveraged exchange-traded funds, and other nonbank financial intermediaries (NBFIs) that have expanded through leverage.
Fourth, signs of more borrower defaults in private credit could cascade into broader concerns about corporate credit, particularly for highly leveraged borrowers subject to the artificial intelligence (AI) disruption.
Fifth, booming investments in AI may slow significantly if the conflict in the Middle East were to persist. This could weigh on the enterprise value of firms along the AI value chain that have increasingly relied on circular financing arrangements, with hyperscalers in the center, although its impact on financial stability appears modest currently.
Finally, simultaneous and larger sell-offs of equities and bonds occur during market downturns, reflecting more frequent supply shocks in recent years. Further shocks raises the risk of forced deleveraging in both asset classes.
Policy recommendations
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Policymakers should act decisively to bolster resilience. They should be prepared for market dysfunction by ensuring that liquidity and funding facilities are accessible and operationally ready.
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Monetary policy should preserve price stability and be attuned to spillovers from actual inflation to inflation expectations, while remaining data dependent.
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Strong governance frameworks for central banks and financial sector supervisors are vital to ensuring operational independence and accountability.
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Emerging market authorities should continue to strengthen policy frameworks.
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The shock absorption capacity of exchange rates should be complemented with tools within the IMF’s Integrated Policy Framework.
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Fiscal stances should shift toward appropriately tight settings to place public debt on a stable path, with new spending focused on protecting vulnerable groups from the inflation shock.
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The potential for strains in short-term funding markets call for strengthening market infrastructure, for example, by central clearing repo transactions.
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Completing the Basel framework implementation is essential, alongside avoiding regulatory arbitrage and weakening prudential standards.
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As NBFIs grow more leveraged and more connected to banks, closing data gaps, improving cross-jurisdictional data sharing, and enhancing oversight are critical.
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Stress tests or scenario analyses should be applied to banks and, where possible, to NBFIs, to assess the impacts of a potential rise in illiquidity and corporate credit distress.