The International Monetary Fund (IMF) said on Tuesday that financial stability risks have increased rapidly since the release of its last ‘Global Financial Stability Report’ in October last year, as the resilience of the global financial system has faced several tests.
“We have all witnessed the recent events in the banking sector. These are powerful reminders of the challenges now being faced as we see tighter monetary policy and tighter financial conditions, at the same time, as financial sector vulnerabilities are building up,” said Tobias Adrian, Director of the Monetary and Capital Markets Department at the IMF at a media briefing.
“The immediate and forceful policy response reduced market anxiety, but sentiment remains fragile,” he said.
Adrian said strains are still evident across other institutions as investors reassess the health of the financial system.
“The emergence of stress in financial markets also complicates the task of central banks as they seek to maintain the path towards higher interest rates in the face of stubbornly high inflation,” the IMF executive said.
The impact of tighter monetary and financial conditions could be amplified because of financial leverage, mismatches in asset and liability liquidity, and a high degree of interconnectedness within the nonbank financial intermediation sector and with the traditional banking institutions, IMF said.
“Looking beyond financial institutions, buffers built by households and corporations during the pandemic have given them more room to absorb financial shocks. But these buffers are deteriorating, leaving them vulnerable to defaulting on their debt.
“When we look at large emerging markets, we see that they have so far avoided adverse spillovers from the recent turmoil. However, financial stresses intensify and the sizable pull back from global risk taking could trigger capital outflows across emerging markets,” Adrian said.
He said for smaller and riskier emerging market economies, the IMF sees that they continue to face debt sustainability strains and funding challenges.
The IMF senior executive said the emergence of stress in financial markets complicates the task of central banks at a time when inflationary pressures are proving to be more persistent than anticipated.
“Clear communication by central banks about the objectives and policy functions is crucial to minimize economic and financial uncertainty,” Adian said.
Central banks should use available tools to address financial stability risks which should help them to separate monetary policy objectives from financial stability goals and this should allow them to continue to tighten policy to address inflationary pressures, he added.
The recent bank failures brought to light weaknesses in bank supervision and regulation, as well as failures in the bank’s internal risk management practices, in particular with respect to interest rate and liquidity risk.
Supervisors should ensure banks have risk management and corporate governance that matches their risk profile, IMF said.
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