MAS' Financial Stability Review 2021

December 2021

The Monetary Authority of Singapore (“MAS”) has published its Financial Stability Review (“FSR”) which sets out its assessment of risks and vulnerabilities arising from developments in Singapore and the global economy, and their implications for the soundness and stability of Singapore’s financial system. The analyses and results contained in the FSR aim to contribute to a greater understanding among market participants, analysts and the public on issues affecting Singapore's financial system.

Emerging sources of financial stability risks identified by the FSR include (i) a more pronounced manifestation of climate-related physical and transition risks, and (ii) the growing prominence of crypto-assets in financial activity. While these risks may be less pronounced at this juncture, they warrant close monitoring and an active assessment of options due to their potential to rapidly develop and materialise into significant stability risks over the next 3 to 5 years. We set out below a summary of these emerging vulnerabilities and the MAS’ strategy to managing them:

Climate risks 

  • Climate-related extreme events have been increasing in frequency with global warming. As the urgency to combat climate change comes to the fore, global efforts to transition to a low-carbon economy have also gained much traction. Accordingly, the manifestation of physical and transition risks is likely to become more pronounced over time.
  • There has also been growing recognition of the effects that these climate risks could pose to financial stability. For example, increasing awareness could trigger an abrupt reassessment of physical and transition risks, leading to a sharp increase in risk premia across a wide range of assets that are perceived to be incompatible with a low-carbon economy.
  • Further, there remain significant challenges in estimating the impact of physical risk at this juncture, given data limitations as well as the complexity and uncertainty associated with extreme weather events. For instance, the prevailing lack of data on the physical risk scores of financial institutions’ counterparties’ production sites along the entire value chain makes it difficult to comprehensively assess counterparty-level vulnerabilities to physical risk as well as the corresponding financial impact.
  • It is thus imperative for financial institutions and authorities to build up capabilities to better assess, manage and mitigate the impact of these climate risks on their assets. The MAS is working with other government agencies and is also looking to engage with research and educational institutes in Singapore and the region, to better understand the implications of physical risk that would be relevant for our financial institutions’ exposures.
  • In addition, to provide a more forward-looking view of the impact of climate risk on the financial sector, MAS will incorporate a range of thematic climate scenarios as part of the 2022 Industry-wide Stress Test. These exploratory scenarios will feature both physical and transition risks over a 30-year horizon, and will take reference from the long-term climate scenarios developed by the Network for Greening the Financial System as well as feedback obtained from financial institutions in MAS’ earlier engagements. MAS will continue to work in partnership with industry, academia, other regulators as well as international organisations to assess the resilience of the financial system to climate risks.

Increased prominence of crypto-assets

  • Crypto-assets have gained increasing prominence with the rapid rise in crypto-asset market capitalisations and trading volumes over the past two years. 
  • As an asset class, crypto-assets have also seen rising interest from investors. For example, in a recent survey by Fidelity Digital Assets, a cryptocurrency custody and trading firm, 52% of institutional investors surveyed globally had investments in financial digital assets, and 71% of institutional investors in the US and Europe were keen to purchase such assets, compared to 59% in 2020. The range of derivative products linked to crypto-assets on established international derivatives exchanges has also been growing.
  • Despite rapid growth, crypto-assets remain only a small proportion of overall financial system assets and have not been widely used in critical financial services. For example, the peak daily trading volume of crypto-assets against the SGD year-to-date has been less than 1% of the average daily turnover on the Singapore Exchange. However, the continued growth in activity and deepening of interconnections between financial institutions in such assets are likely to continue, with crypto-assets and their markets becoming systemically significant for financial stability considerations in the future. The wealth effect could also be more pronounced if crypto-assets account for a larger share of investor portfolios. In particular, consumption could be subject to considerable shocks arising from the inherent heightened volatility of such assets.
  • Importantly, stablecoins could be subject to a surge in redemptions that lead to liquidity stresses during market stress scenarios, similar to that of money-market funds, which could in turn propagate instability to the wider financial system. If widely used for payments, operational disruptions to stablecoin arrangements may disrupt financial system functioning and real economic activity. Stablecoins could also increase the likelihood of systemic bank runs in a banking crisis given the ease of bank deposit withdrawals if such tokens become widely accepted as a common store of value and as a digital substitute for bank money and cash.
  • The growth of decentralised finance or DeFi also has the potential to create a shadow financial system without the regulatory safeguards designed to mitigate financial stability risks across the entire range of financial services. As such, close monitoring of the crypto-asset market will be increasingly important going forward.