Financial stability faces high risks, with asset prices strained and value accumulating in private, less regulated institutions, the International Monetary Fund has warned.
“While financial conditions are easy, macrofinancial risks remain somewhat elevated,” said Tobias Adrian, financial counsellor and director of the IMF’s monetary and capital markets department. “Asset prices are stretched.”
After falling steeply in April when the US imposed swingeing tariffs, global stockmarkets have rebounded strongly, while corporate credit spreads have tightened.
The IMF’s Global Financial Stability Report warned that valuation models indicated risk asset prices were “well above” fundamentals, “increasing the probability of disorderly corrections when adverse shocks occur”.
The IMF expressed concern about the rapid growth of non-bank financial institutions.
“While helpful in facilitating capital market activities and channelling credit to borrowers, their expansion raises the spectre of risk-taking and interconnectedness in the financial system,” the report said.
Several banks in the US and eurozone have exposures to NBFIs greater than their tier 1 capital. This increases the risk of contagion to the banking system if NBFI assets face downgrades or falling collateral values.
Julia Symon, head of research and advocacy at Finance Watch, told GlobalMarkets the IMF’s warnings on NBFIs had “important policy implications”.
“While systemic risk in the banking sector has been recognised as a risk to financial stability and the real economy since the global financial crisis, the scale and potential impact of the NBFI sector remain largely unaddressed,” she said. “There is still a strong belief, particularly evident within the EU Savings and Investments Union agenda, that financial risks can simply be spread across the financial sector and absorbed by the capital markets.” Yet for Symon, “the inherent complexity and opacity of the NBFI sector are the fundamental cause of regulatory and supervisory gaps”.
The IMF said effective supervision of NBFIs required “improved data collection, coordination and analysis, including across borders”. Symon argued this “raises the possibility of new, unidentified concentrations of systemic risk”.
“This calls for adequate macroprudential and regulatory policies, which would go beyond a narrow sectoral view and adopt a comprehensive, system-wide perspective,” she added.
Fiscal concerns
The IMF also highlighted potential interactions between rising longer term bond yields and the financial system. “It’s important to look at the fiscal side,” said Adrian.
While the IMF’s report said bond market functioning had been “stable to date”, it warned “abrupt yield increases” could put strain on bank balance sheets and open-ended funds.
However, Adrian made a clear distinction between rising yields in France and the euro crisis of the 2010s.
“At that time, you saw spillovers across European countries,” he said. “That was one of the key features of that sovereign debt crisis. That is quite different to the situation today. Spreads have been widening to some degree, but it’s fairly contained and we haven’t seen a spread to other countries. There’s some repricing, but at the same time a fairly contained price action.”