IMF: Risks to financial stability have ‘increased rapidly’ but won’t threaten fight against inflation
Risks to financial stability have “increased rapidly” since October last year but they were unlikely to be big enough to distract central banks from fighting inflation, the International Monetary Fund (IMF) said today.
The global economic watchdog’s biannual financial stability report pointed to a range of different threats to financial stability following the turmoil in the banking sector last month.
“The failures of Silicon Valley Bank and Signature Bank of New York and the loss of confidence in Credit Suisse are powerful reminders of the challenges posed by the interaction between tighter monetary and financial conditions and the build up in vulnerabilities since the global financial crisis,” it said.
However, the report also suggested that government intervention in the US and Europe in the wake of banking collapses has helped to stem the uncertainty.
These interventions included the temporary backstop of uninsured deposits in the US and the emergency takeover of Credit Suisse by UBS.
As a result of the targeted interventions, the IMF was hopeful that central banks could continue their battle against inflation without causing widespread financial instability.
“I don’t think monetary policy will be any different due to financial stability concerns,” IMF Financial Counsellor Tobias Adrian said in a press briefing today. “Central banks could continue to tighten monetary policy because they had the tools to contain financial instability.”
However, the report did say that regulators needed to tighten some banking rules, in particular the “adequacy of capital and liquidity stress tests”.
Regulators around the world have suggested that liquidity rules need to be adjusted to reflect the speed at which funds can now be transferred.
Shadow banks
The IMF also highlighted challenges in the non-bank financial sector, often known as shadow banking.
Many shadow banks built up leverage over the past few years to boost returns during an era of low interest rates. However, vulnerabilities from this leverage can be difficult to track because it is often hidden.
Hidden leverage was a key problem for so-called liability driven investment funds in the UK when soaring interest rates nearly sparked a financial meltdown.
The report argued policymakers need appropriate tools to tackle the consequences of stress in the shadow banking sector. This could include providing central bank liquidity to non-banks, which normally are not able to receive central bank support.
It highlighted that while non-banks help to diversify the financial sector, this “increased interconnectedness makes the financial system more complex and can be a source of vulnerability if it becomes a shock amplifier”.
Geopolitical fragmentation was also raised as a possible risk to financial stability too. Increasing tension restricts the flow of capital as financial institutions tend to allocate less in countries with dissimilar foreign policy outlooks.
“This could pose macro-financial stability risks through an increase in banks’ funding costs, a decline in their profitability, and lower credit provision to the private sector. These impacts are likely to be disproportionately larger for banks with lower capitalization ratios,” the report said.