Safeguarding Financial Stability amid High Inflation and Geopolitical Risks: A Financial System Tested by Higher Inflation and Interest Rates
May 1, 2023, IMF Official Report: Financial stability risks have risen significantly as the resilience of the global financial system has faced a number of severe tests since the October 2022 Global Financial Stability Report. In the aftermath of the global financial crisis, amid extremely low interest rates, compressed volatility, and ample liquidity, market participants increased their exposures to liquidity, duration, and credit risk, often employing financial leverage to boost returns— vulnerabilities repeatedly flagged in previous issues of the Global Financial Stability Report. 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 buildup in vulnerabilities. Amplified by new technologies and the rapid spread of information through social media, what initially appeared to be isolated events in the US banking sector quickly spread to banks and financial markets across the world, causing a sell-off of risk assets (Figure ES.1).
It also led to a significant repricing of monetary policy rate expectations, with magnitude and scale comparable to that of Black Monday in 1987 (Figure ES.2).
The forceful response by policymakers to stem systemic
risks reduced market anxiety. In the United States, bank regulators took steps to guarantee uninsured deposits at the two failed institutions and to provide liquidity through a new Bank Term Funding Program to prevent further bank runs. In Switzerland, the Swiss National Bank provided emergency liquidity support to Credit Suisse, which was then taken over by UBS in a state supported acquisition.
But 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.
While there is little doubt that the regulatory changes implemented since the global financial crisis, especially at the largest banks, have made the financial system generally more resilient, concerns remain about vulnerabilities that may be hidden, not just at banks but also at nonbank financial intermediaries (NBFIs). In the United States, investors’ fears about losses on interest rate–sensitive assets led to the banking sell-off, especially for banks with concentrated deposit bases and large mark-to-market losses (Figure ES.3).
In Europe, the impact was greatest on banks that trade at significant discounts to their book values, in which there are long-term concerns regarding profitability and their ability to raise capital. Emerging market banks appear to have avoided significant losses in their securities portfolios so far, while deposit funding has
been stable. IMF staff estimates that the impact on regulatory ratios of unrealized losses in held-to-maturity portfolios for the median bank in Europe, Japan, and emerging markets would likely be modest, although the
That said, many countries have low levels of deposit insurance coverage, and emerging market banks generally have assets with lower credit quality than in advanced economies. In addition, emerging market banks generally play a larger role in the financial system than in advanced economies, so the consequences of banking sector distress could be more severe. These events have been a reminder that funding can disappear rapidly amid widespread loss of confidence. Shifting patterns of deposits across different institutions could raise funding costs for banks which could restrict their ability to provide credit to the economy. These concerns are particularly pertinent for US regional banks. With the recent fall in bank equity prices, lending capacity of US banks could decline by almost 1 percent in the coming year, reducing real GDP by 44 basis points, all else being equal.