Massive stimulus measures could have “unintended consequences” as stock markets becomes increasingly disconnected from reality, and insolvencies among small businesses could test the resilience of the financial system, the IMF warned on Tuesday.
In its annual global financial stability report (GFSR), the IMF said that the unprecedented fiscal and monetary response had contained near-term risks to financial stability, boosting investor sentiment and maintaining the flow of credit. Yet the Fund said there were “significant downside risks”, with a still 5% chance of global growth remaining below zero in 2021.
“If I think back to March, when there were some horrible expectations, I would not have expected markets to come back so much,” said Tobias Adrian, financial counsellor and director of the monetary and capital markets department at the IMF, told Global Markets. “Capital has returned to emerging markets and we’re in a pretty good place where credit is available despite being in the worst recession since the Great Depression.”
March provided a frightening example of what an unwinding of risk sentiment can look like, with even the US Treasury market turning dysfunctional. Though the IMF is confident in the ability of monetary authorities to ease disruption as they did then, the risks of a sharp downturn in financial markets are increasing, with stock market valuations reaching historically high levels in some countries, despite the pandemic.
“Though asset valuations themselves are not so much of a risk to financial stability, the risk is a combination of a market sell-off with the vulnerabilities we’ve already seen in the non-bank financial sector,” Adrian said . “Central bank stimulus worked well before and I would expect central banks to step up again.”
Corporate defaults
Policy stimulus has also restricted corporate defaults, protecting the damage on banks’ balance sheets. But though Adrian said the bank system was in good shape, the IMF does “see weak banking systems in some countries”. Even in countries with strong banking systems, “there is typically a weak tail of banks”, he said.
Even though continued policy stimulus and economic recovery should “keep insolvencies at bay”, said the IMF, small and medium-sized enterprises (SMEs) — which tend to dominate contact-intensive sectors, such as hotels and restaurants — are vulnerable.
“Because SMEs rely almost entirely on bank financing, they could be a source of vulnerability, especially for regional and small banks,” said the GFSR.