IMF warns on financial stability

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The risks to global financial stability in the immediate future have declined, according to a new assessment from the International Monetary Fund.

But at the same time, vulnerabilities over the longer term are building, the IMF warns.

The very low interest rate policies of the rich countries have led investors to search for higher returns.

But that, in turn, has led them to be increasingly willing to accept higher risks.

There is some good news in this assessment. The strengthening global recovery – which was the focus on the IMF’s World Economic Outlook – has helped reduce financial risks in the near term.

Stronger growth means that borrowers, whether business or households, are more likely to get the income needed to maintain their debt payments. It also boosts confidence in the financial markets.

QE, too

But one of the key factors the IMF identifies as supporting the post-financial crisis economic recovery also contributes to risks over the longer term.

That’s the ultra-low interest rate and quantitative easing (QE) policies pursued by rich country central banks. QE has added to the downward pressure on interest rates paid by borrowers.

Those lower rates have meant poor returns for investors who buy assets such as bonds that are essentially debts.

So many have sought to find other investments that generate better returns, a process that has been called a “search for yield”.

In one respect, they have no choice but to seek alternatives. The QE policy of major central banks involves purchasing financial assets that are usually regarded as safe investments, mainly government debt. That means there has been less of this safe type of asset for the private sector to buy.

As a result, many have had to buy more of assets where there is a greater chance of making a loss – such as shares, the debts of less creditworthy borrowers or assets in emerging markets.

All this, the IMF says, helps to support the economic recovery, but “there are risks if these trends extend too far”.

Rate rises

There are also potential pitfalls in the gradual return to more normal central bank policy that has begun in the United States and will, presumably, take place eventually in the other developed economies, notably the eurozone, Japan and the UK.

That involves higher interest rates, which would make debt payments challenging for some borrowers, increasing the danger that lenders will make large losses.

The report raises some specific concerns about the build-up of credit in China. It says the authorities there have already taken “welcome steps” to address risks, but it says there is still work to do.

There is no suggestion from the IMF that another financial crisis is imminent. But the agency is clearly keeping a very wary eye on the risks that may be building as a result of the response to the crisis of a decade ago – risks which plenty of independent observers have also warned about, often suggesting there is much greater urgency.

Source: BBC

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