NAIROBI, Kenya, April 17 – The International Monetary Fund(IMF) has urged central banks across the world to develop tools aimed at addressing financial stability risks so as to be able to tackle uncertainty in the markets when issues such as high inflation arise.
The Bretton Woods Institution noted that the tools will help central banks separate monetary policy objectives from financial stability goals, allowing them to continue to tighten policy to address inflationary pressures.
The recommendations come after the latest IMF Global Financial Stability noted an increase in financial stability risks since October 2022 which exposed many market participants to liquidity, duration, and credit risks.
“The sudden failures of Silicon Valley Bank and Signature Bank in the United States, and the loss of market confidence in Credit Suisse have been a powerful reminder of the challenges posed by the interaction between tighter monetary and financial conditions and the buildup in vulnerabilities” the report reads.
The report noted that when financial strains for countries intensify and threaten the health of the financial system amid high inflation, trade-offs between inflation and financial stability objectives may emerge.
“Clear communication about central banks’ objectives and policy functions will be crucial to avoid unnecessary uncertainty,” the report noted.
The IMF recommended policymakers to act swiftly, in the event of financial stability risks, to prevent any systemic event that may adversely affect market confidence in the resilience of the global financial system.
“Should policymakers need to adjust the stance of monetary policy to support financial stability, they should clearly communicate their continued resolve to bring inflation back to target as soon as possible once financial stress lessens,” the IMF said.
IMF noted that the recent turmoil experienced in the banking sector also highlighted failures in internal risk management practices with respect to interest rate and liquidity risks at banks, as well as supervisory lapses.
“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,” the report noted.
Further, the report notes that adequate minimum capital and liquidity requirements including for smaller institutions are essential to contain financial stability risks.
“In the current environment of persistent inflation and high interest rates, authorities should pay specific attention to bank asset classification and provisions as well as to exposures to interest rate and liquidity risks,” it says.
IMF also recommended that central banks’ liquidity support measures should aim to address liquidity, not solvency issues.
It said that solvency issues, which is where a bank’s liabilities and equity are greater than its assets, should be left for relevant fiscal authorities such as the Treasury.
