Top IMF official warns of ‘acute’ risks in global financial system

A top official at the IMF has warned of “acute” risks to the global financial system and said weaker banks face further pressure if central banks continue ratcheting up rates to squash inflation.

In an interview with the Financial Times, Tobias Adrian, director of the fund’s monetary and capital markets department, struck a downbeat tone in the wake of the worst bout of banking turmoil since the global financial crisis. Last month, three US banks failed while Credit Suisse was forced to sell to UBS.

The IMF is worried that inflation will not decline as rapidly as expected this year, forcing central banks to tighten monetary policy even further and unmasking new weaknesses in the financial system.

“The financial system is being tested by the stresses that are being triggered by monetary policy tightening,” Adrian said. “The risk going forward is that the situation could create more stressors for the financial system.”

Adrian’s comments came as the IMF released its latest Global Financial Stability Report, which warned financial risks had “increased rapidly” since its last update in October. Adrian described those risks as “acute at the moment”.

In the report, the IMF said regulatory changes implemented since the 2008 crisis had “made the financial system generally more resilient” but said there was a “fundamental question” over whether the recent banking turmoil was a “harbinger of more systemic stress”.

Asked if that turmoil had been contained, Adrian said it had “ended well so far, but there are significant vulnerabilities that remain”.

Adrian listed several risks for banks, including paper losses on bondholdings that have increased in line with rate rises, as well as higher funding costs. These costs would increase further in the event of “upside surprises” for inflation and interest rates, he said.

“When you look at the cross section of banks, there are some very, very strong players but there are also some weak ones [that are] vulnerable to further shocks.”

Per the IMF’s estimates, nearly 9 per cent of US banks with assets between $10bn and $300bn would fail to meet capital requirements if they were to fully account for unrealised losses on securities they intend to hold to maturity in addition to those they plan to sell before then.

“This suggests that interest rate risks could intensify for some small banks should interest rates stay higher for longer and were they forced to sell these securities to raise liquidity,” wrote the IMF report’s authors.

In the report, the IMF also flagged vulnerabilities in the non-bank financial sector, which includes hedge funds, pension funds, insurers and other asset managers.

Adrian pointed to the turmoil that gripped the UK pensions industry in the autumn following the government’s botched release of its budget as one example of a danger lurking in the non-bank sector.

The Bank of England was forced to intervene to stem contagion, a development that the Adrian described as a “wake-up call”. He also noted that the meltdown of family office Archegos Capital Management in 2021 had generated losses in excess of $10bn for some of the world’s biggest banks.

“There’s a lot of opacity in the non-banks. The total magnitude of risk is sometimes difficult to understand.”

Central banks that have been mostly focused on fighting inflation must now also consider the effects of tighter monetary policy on the broader financial system.

Adrian said monetary authorities had been “quite successful in separating financial stability goals from price stability goals.

“However, there are scenarios of severe financial crisis [and] severe systemic distress where this clean separation is much more tenuous.”