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FINANCIAL vulnerabilities are building up in the wake of accommodative monetary policies in the G3 economies, the Monetary Authority of Singapore (MAS) said in its annual Financial Stability Review on Thursday.
According to the report by the central bank's Macroeconomic Surveillance Department, financial risks posed by unconventional monetary policies in the eurozone and the United Kingdom, Japan and the United States have become increasingly stark and bear close monitoring.
"The prolonged low interest rate environment and the search for yield have contributed to instances of heightened financial risk-taking and elevated asset valuations, especially in less liquid assets and markets," MAS said.
Divergent G3 monetary policies could have financial stability spill-overs. Uncertainties over the timing and trajectory of interest rate normalisation in some G3 countries as well as the strength of the growth stimulus in other G3 countries could lead to disorderly adjustments in global financial markets and volatility in capital flows to Asia. These could in turn adversely impact some financial institutions and particularly highly-leveraged corporates and households.
"While banking systems have strengthened over the past year, risks have continued to build up in asset valuations and market liquidity. Faster-than-expected rate rises, volatility spikes or geopolitical tensions could trigger market adjustments in the G3 that may spill over to other regions," MAS said.
It said while strong global liquidity has underpinned buoyant financial conditions in Asia, this can quickly reverse amidst normalising monetary conditions in the US.
A turn in investor sentiment and a potential disorderly exit from accommodative monetary policies could fuel liquidity and funding risks. Shocks from markets in the advanced economies could lead to capital outflows and greater volatility in some Asian markets, particularly if uncertainty over the timing and course of US policy normalisation persists.
Disorderly corrections in some asset classes, including property, could add to financial stability risks. Highly-leveraged corporates and households in Asia would also be vulnerable to interest rate shocks, and potential foreign currency mismatch risks. Bank asset quality could decline as borrowers' debt servicing capacity weakens.
"Nonetheless, Asian economies are expected to remain resilient due to improved fundamentals and active reforms. Efforts to strengthen public finances and build up international reserves have helped anchor investor confidence and should provide some buffer against external risks," MAS said.