Global financial stability risks are rising: How emerging markets can find balance amid new shifts in capital flows

The Fragility of Global Financial Stability Is Being Repriced

In its *Financial Stability Review* published in November 2025, the European Central Bank explicitly noted that financial stability vulnerabilities in the euro area remain elevated, stemming not only from regional structural problems but also from profound changes in the global geopolitical and economic landscape. For emerging markets, this report effectively provides a mirror: changes in global financial conditions—especially the repricing of US asset risks, trade policy uncertainty, and the vulnerabilities of non-bank financial institutions—will have far-reaching effects on economies in the Global South through channels such as capital flows, exchange rate fluctuations, and trade demand.

The report noted that global stock markets rebounded quickly after the sharp volatility in April 2025 and repeatedly hit record highs, but elevated valuations and rising market concentration have allowed adjustment risks to accumulate. In particular, the growing weight of "hyperscalers"—dominated by a few large US technology companies—in both public and private markets means that if their earnings expectations fail to materialize, a sharp reversal in global risk appetite could be triggered. For emerging markets, this implies that while they can enjoy capital inflows from ample global liquidity, they also face the potential threat of sudden capital flight.

Trade Policy Uncertainty: A Double-Edged Sword for Emerging Markets

Since May 2025, a series of trade agreements reached between the United States and major trading partners (including the EU) has brought global trade policy uncertainty down from its April peak. However, the ECB warned that tariff announcements, suspensions, and reversals remain a structural feature of the global environment, and re-escalation is still possible in the future. For Asian and Latin American economies deeply integrated into global supply chains, such uncertainty not only affects export orders but also weakens long-term growth potential by influencing corporate investment decisions and supply chain configurations.

Notably, the report mentioned that a weaker US dollar could amplify the impact of US tariffs on euro area exporters. This logic applies equally to emerging markets: if the US dollar continues to weaken, economies with currencies pegged to the dollar or with large dollar-denominated debt may see their debt burdens lightened, but their export competitiveness could suffer from currency appreciation. Countries in the Global South need to strike a difficult balance between exchange rate flexibility and export stability.

The Spillover Effects of US Fiscal Risks

The report placed particular emphasis on concerns about US fiscal credibility. Persistently high fiscal deficits, massive debt service costs, and current account deficits have led to a steepening of the US Treasury yield curve and have weakened the traditional safe-haven properties of US Treasuries and the US dollar. The ECB is concerned that market worries about public finances could trigger pressure in global bond markets and transmit to the euro area through international capital flows and exchange rate fluctuations.For emerging markets, the spillover of U.S. fiscal risks is more direct. A rise in U.S. Treasury yields typically means higher global financing costs, and emerging market governments and companies face higher borrowing costs. At the same time, dollar depreciation may prompt international investors to reallocate assets, shifting from dollar-denominated assets to assets denominated in other currencies, which to some extent may bring capital inflows to emerging markets, but may also trigger disorderly exchange rate fluctuations. Countries with large current account deficits and high dependence on external debt will be especially more vulnerable to the tightening of global financial conditions.

Vulnerability of non-bank financial institutions and its linkage with emerging markets

The ECB report points out that euro area non-bank financial intermediaries (NBFIs) have relatively large and concentrated exposures to U.S. assets. Once markets undergo a sharp adjustment, these institutions may suffer losses and trigger a vicious cycle of liquidity mismatches and deleveraging. This risk also crosses borders: global asset managers, hedge funds, and private equity funds also hold large positions in emerging markets, and their behavior is often highly procyclical.

When global risk sentiment shifts, fund redemptions and deleveraging pressures may lead to large-scale sell-offs of emerging market assets, while liquidity mismatches in open-ended funds may exacerbate price declines. The report specifically mentions that the opacity of private markets may amplify market downturns, and alternative investments and private credit in emerging markets are also growing rapidly, which brings new challenges for regulators.

Credit risks hidden behind banking resilience

Although the ECB believes that the banking sector has shown resilience in recent shocks, it also warns that corporate credit risks in tariff-sensitive industries are rising, which may weaken bank lending performance. At the same time, the increasingly close links between banks and non-bank financial institutions may expose bank funding vulnerabilities during periods of stress. Emerging market banking systems face similar risks: the global trade slowdown has led to declining revenues for export enterprises, while local currency depreciation and rising interest rates may push up non-performing loan ratios. In addition, emerging market banks' reliance on international dollar funding exposes them to greater pressure when global liquidity tightens.

Emerging markets need to build their own stability mechanisms

Although the ECB's financial stability review focuses on the euro area, its analysis of global financial risks offers important policy implications for emerging markets. In the face of trade policy uncertainty, the spillover of U.S. fiscal risks, and the vulnerability of non-bank financial institutions, emerging market economies should strengthen macroprudential regulation, raise capital buffers in the banking system, and develop local currency bond markets to reduce currency mismatches. At the same time, regional financial cooperation and the flexible use of foreign exchange reserves can provide a line of defense against external shocks.

More importantly, emerging markets must realize that global financial stability is an integrated whole, and policy mistakes in advanced economies are often borne disproportionately by the Global South. Therefore, in the reform of global financial governance, the voices and interests of emerging markets should be more fully reflected, and efforts should be made to promote a more inclusive and robust international financial architecture.Against the backdrop of the continued southward shift of global growth centers, emerging markets are no longer just passive recipients of global financial stability, but are increasingly becoming active shapers. However, the precondition is that they must deeply understand the transmission mechanisms of global financial risks and make forward-looking arrangements, so as to grasp certainty in an uncertain world.