High Inflation, Interest Rates Pressure Global Financnail System
The International Monetary Fund (IMF) warns that increased inflation and interest rates are putting the world financial system to the test and implores banks to keep more capital and liquid assets to help them withstand shocks.
In order to assist assure system resilience, the IMF encouraged banks to perform stress tests, which it mentioned in its April 2022 Global Financial Stability Report.
To control inflation, central banks all around the world have been raising their monetary policy rates (MPR).
According to the IMF, financial stability risks had increased rapidly since October 2022 as the resilience of the global financial system faced a number of tests.
“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.
“If financial strains intensify significantly and threaten the health of the financial system amid high inflation, trade-offs between inflation and financial stability objectives may emerge,” the Fund stated.
It expressed that while the banking turmoil had raised financial stability risks, its roots were fundamentally different from those of the global financial crisis of 2008.
“The recent turmoil is different. The banking system has much more capital and funding to weather adverse shocks; off balance sheet entities have been unwound, and credit risks have been curbed by more stringent post-crisis regulations,” IMF said.
It identified a meeting between the steep and rapid rise in interest rates and fast-growing financial institutions as unprepared for the rise.
The IMF also trimmed its 2023 global growth outlook slightly as higher interest rates cooled activity, but warned that a severe flare-up of financial system turmoil could slash output to near recessionary levels.
“Our growth-at-risk metric, a measure of risks to global economic growth from financial instability, indicates about a 1-in-20 chance that world output could contract by 1.3 per cent over the next year.
There’s an equal probability that gross domestic product could shrink by 2.8 per cent in a severe tightening of financial conditions in which corporate and sovereign spreads widen, stock prices fall, and currencies weaken in most emerging economies.
“Faced with heightened risks to financial stability, policy makers must act resolutely to maintain trust,” the Fund added.“Faced with heightened risks to financial stability, policy makers must act resolutely to maintain trust,” the Fund added.“Faced with heightened risks to financial stability, policy makers must act resolutely to maintain trust,” the Fund added.