Global financial stability report (GFSR) is a semi annual publication by Monetary and Capital Markets department of IMF. The report “seeks to assess key vulnerabilities the global financial system is exposed to”, “plays a role in preventing crises by highlighting policies that may mitigate systemic risks”.
Crypto in GFSR was covered for the first time in April 2018, with limited sentiment for the technology promise and many doubts about sustainability. In the second coverage, in September 2021 issue, chapter one of three was devoted to Crypto. The key points were that crypto asset transactions had reached macro critical levels in some emerging markets, about risks of poorly managed exchanges and stablecoins, traditional regulation issues. Stable coins were discussed in detail with policy recommendations to align their rules with those of similar tools of traditional finance. An interesting point was raised that cryptoization in emerging markets can lead to wider dollarization, as residents use crypto to bypass domestic monetary restrictions and get hold of the foreign currency.
2022 April’s issue is expected to be all about the unprecedented conditions caused by Ukraine and Russia conflict. While uncertainty dominates the text, authors highlighted the following: the exposure of financial institutions to Russia is not significant, there are implications on commodity and energy markets and, following from it, emerging and frontier markets will be suffering the most, while exporters are in better position. Inflation and other post COVID recovery trends, that seemed to be the major agenda in this issue are out of focus now.
Fintech development review took one full chapter out of total three in IMF April’s report. Co-authored with experts from BIS and FCA, IMF experts covered Neobanks and DeFi. Neobanks here are defined as digital banks performing the core banking functions, branchless, through digital touchpoints such as websites or mobile apps. Unlike other categories of fintechs that complement and extend banking services either on the lending or deposit side, neobanks are often fully licensed banks. They seek to compete with traditional banks utilizing Cloud Computing, API, AI, Big Data and mobility. Brazil, UK, Korea, Russia, Kazakhstan and Germany, in this order, are home to neobanks with largest capitalization. High valuation does not always reflect the balance sheet of the neobanks, but still an important indicator of market expectations. Other features of neobanks: higher risk customers — but operating with less loan loss reserves, lower liquidity ratios that are balanced by greater interconnection with traditional banks and other neobanks, weak profit margins (counterintuitive!) due to high marketing (CAC), less cross-selling. A case study about US mortgage market did not reveal full-scale disintermediation of traditional banks.
The DeFi section of the report describes common DeFi terms for depositing, borrowing, collateral, repayment and liquidation. The most typical position is to borrow stable coins against volatile crypto and use them to buy volatile crypto again (leveraged long). More than 90% of the DeFi lending is denominated in stablecoins, while more than 75% of collateral is volatile crypto, IMF staff calculations show. Obviously, automatic liquidations are frequent during sharp declines in crypto prices.
Liquidity is a business challenge for DeFi, and liquidity providers (depositors) are incentivized. However, the report mentions that liquidity sources are still very concentrated: half of the funds are provided as few as 10 accounts. The “utilization rate” metric, an equivalent of “loan-to-deposit” ratio is part of smart contract algorithms managing a safe corridor, but steep market price fluctuations and bank runs still push it to extremes.
Cyperattacks in DeFi cause large and often irrecoverable losses. Most of them, as we also mentioned in our articles exploit code inefficiencies, not only technical but also logical. In some cases, entire platforms can collapse in the aftermath of the attack. Due to early stage of development and lack of proper history, these risk factors are not built into the margins of DeFi products. Combined with high level of automation, DeFi provides substantially lower margins compared to similar financial activities.
Finally, a direct quote from the report summary: “the absence of centralized entities governing DeFi is a challenge for effective regulation and supervision” concludes the overall sceptical approach to the developments so far.