‘Devote resources’ to financial stability risks, warns IMF

Financial stability risks have risen “significantly”, the International Monetary Fund (IMF) has warned in its recent Global Financial Stability Report.

The IMF — which works to achieve sustainable growth and prosperity in financial markets across the 190 member countries — noted that the global financial market had changed since its last report, released just six months ago (in October 2022).

Indeed, the forecast is projecting the worst five years of growth in more than three decades, according to Treasurer Jim Chalmers.

The conclusion was drawn after assessing the collapse of several banks in the United States, high inflation, rising costs and “rising geopolitical tensions [such as the ongoing impacts of the war in Ukraine] among major economies” which may “cause capital flows to suddenly reverse and could threaten macro-financial stability by increasing banks’ funding costs”.

In the report, the body writes: “The sudden failures of Silicon Valley Bank and Signature Bank in the United States, and the loss of market confidence in Credit Suisse, a global systemically important bank (GSIB) in Europe, have been a powerful reminder of the challenges posed by the interaction between tighter monetary and financial conditions and the build-up in vulnerabilities.”

While the IMF noted that bank regulators in the US have been stepping in, it added that market sentiment “remains fragile, and strains are still evident across a number of institutions and markets, as investors reassess the fundamental health of the financial system”. 

“The fundamental question confronting market participants and policymakers is whether these recent events are a harbinger of more systemic stress that will test the resilience of the global financial system — a canary in the coal mine — or simply the isolated manifestation of challenges from tighter monetary and financial conditions after more than a decade of ample liquidity,” the report reads.

As such, the report authors noted that the emergence of stress in financial markets is “complicating the task of central banks at a time when inflationary pressures are proving more persistent than anticipated”, and other concerns, such as conditions in the commercial real estate (CRE) market (particularly in the US), which has been under pressure from a worsening of fundamentals and tighter funding cost.

It has therefore suggested a range of policy measures that could be taken to mitigate global financial stress. These include:

• Central banks’ liquidity support measures should aim to address liquidity, not solvency issues;
• Supervisors should ensure that banks have corporate governance and risk management commensurate with their risk profile, including in the areas of risk monitoring by bank boards and the capacity and adequacy of capital and liquidity stress tests;
• Prudential rules should ensure that banks hold capital for interest rate risk and guard against hidden losses that could materialise abruptly in the event of liquidity shock;
• Providing non-bank financial institutions with direct access to central bank liquidity could prove necessary in times of stress, but implementing appropriate guardrails is paramount; and
• Policymakers should devote resources to assessing, managing, and mitigating financial stability risks caused by geopolitical tensions rising

Noting the report, Federal Treasurer Jim Chalmers commented: “In the view of the International Monetary Fund, the global economy is on an increasingly perilous path. 

“The situation in the world has become more complex and more challenging even over the course of the last few months, and so we won’t be completely immune from that. We do expect — or the Treasury does expect — our own economy to slow considerably later this year because of that combination of a slowing global economy and the impact of higher interest rates here at home as well.

“So we’ve got a lot coming at us from around the world but we’ve got a lot going for us as well. We’ve got low unemployment, we’re getting good prices for our exports, we’re seeing the beginnings of wages growth, which is really important. So we’ve got some advantages, we’re optimistic about the future, but we need to be realistic about these global conditions and what it means for us, particularly when we see these gloomy forecasts from the International Monetary Fund.”

However, Mr Chalmers added that it’s still the expectation of the Treasury and the Reserve Bank that Australia may avoid a recession — even if “the economy will slow”.

“That’s why this budget is so important in a little under four weeks’ time, because what we need to do is provide some responsible cost‑of‑living relief without adding to inflation; we need to lay the foundations for future growth in our economy, at the same time as we try and make ourselves more resilient to these sorts of international shocks,” he said.

The Treasurer suggested that Australian banks were “well regulated, well capitalised and well placed to deal with some of this market turbulence”.

Mr Chalmers is this week travelling for the G20 Finance Ministers’ and Central Bank Governors’ Meeting and IMF – World Bank 2023 Spring Meetings in Washington DC.

He said: “There is no more important time to engage with international authorities and take the temperature of global conditions, as we carefully calibrate the settings of the May budget.”

[Related: Australian economy on ‘narrow path to a soft landing’: IMF]