**4.2 Impact of the war in Ukraine on global financial vulnerabilities12**

Russia's invasion of Ukraine is causing an intense humanitarian crisis. More than 12 million people are estimated to have been displaced and more than 13 million require urgent humanitarian assistance. Ukraine's economy is being devastated and the acute trauma suffered by the population will have enduring consequences. The

<sup>11</sup> This subsection draws on chapter 3 of the Global Financial Stability Report 2022 [12].

<sup>12</sup> This subsection draws freely on Ref. [15].

### *Current Challenges to World Financial Stability: To What Extent is the Past a Guide for the… DOI: http://dx.doi.org/10.5772/intechopen.107432*

war in Ukraine has set back the global response to—and the recovery of the global economy from—the COVID-19 pandemic.

Prior to the invasion, the world was focused on the health and economic challenges caused by the pandemic. In particular, supporting the global economy amid an uneven recovery characterized by lingering supply bottlenecks; the withdrawal of policy support; and rising inflation, including for food and energy. The war has added a global adverse impact, especially through the prices of commodity markets. Russia is the world's largest exporter of wheat, accounting for 18% of global exports. Ukraine accounts for a further 7%. Russia is also the largest exporter of natural gas (25%), palladium (23%), nickel (22%), and fertilizers (14%). It also accounts for 18% of global exports of coal, 14% of platinum, 11% of crude oil, and 10% of refined aluminum.13

Europe's dependence on Russia for energy renders its economy vulnerable. Russian exports account for more than 35% of the euro area's imports of natural gas, more than 20% of oil, and 40% of coal (Figure 3.E in Ref. [16]). Russia is also dependent on the euro area for its exports, with around 40% of its crude oil and natural gas going to the euro area. While Russia may eventually be able to redirect some of its exports of gas and oil to others, this will be constrained by the existing pipeline infrastructure. Some emerging markets and developing economies (EMDEs) rely heavily on Russia and Ukraine for food and fertilizer. Russia and Ukraine account for more than 75% of imports of wheat in many countries. Logistics relating to transporting crops also remain a challenge; about 90% of Ukraine's grain trade flows through Black Sea ports that are currently blocked by the Russian navy. Russia has recommended that fertilizer manufacturers halt exports of fertilizer, which will hinder food production in parts of the world, since Russia is the largest exporter of fertilizers, accounting for 14% of global exports.

Although no global systemic event affecting financial institutions or markets has materialized so far, the war raised financial stability risks along several dimensions. Equity market volatility has risen markedly, especially in Europe. The European VSTOXX index shot up briefly in early March and remains unusually elevated. Equity volatility in the United States (as proxied by the VIX Index) also increased substantially in the month following the start of the war, though has since declined somewhat. Sovereign borrowing costs have increased since the start of the war. U.S. 10-year government bond yields have risen considerably, reflecting a range of factors including higher expected inflation.

Spreads on EMDE bonds have not widened significantly on average, although bond issuance by EMDEs across February–March was weaker than in the same period of any year since 2016. For some financial institutions, a recession in Russia is likely to result in substantial losses. Some European banks have material linkages with Russian entities facing severe losses, such as Sberbank. The majority of European banking exposures to Russia are through the claims of Russia-based subsidiaries, however, which are primarily funded by local creditors and depositors. Combined with the healthy capitalization of European banks prior to the war, this should reduce the probability of losses being amplified into European bank funding markets.

Nonetheless, large equity losses for exposed banks seem probable, as implied by drops in the equity prices of European banks perceived to be exposed to Russia following the introduction of sanctions. The profits and liquidity positions of

<sup>13</sup> Ukraine is the largest exporter of seed oils primarily used in cooking, accounting for two-fifths of global production, and is also the fourth largest exporter of corn, accounting for 13% of global exports. Ukraine also produces up to 50% of global neon gas, which is a critical element used in chip making.

institutional investors will also be impacted by write-downs on Russian assets with encumbered liquidity and by the need to hold additional margin against implicated exposures.
