IMF Warns Risks to Global Financial Stability Have Risen ‘Rapidly’

International Monetary Fund logo outside the headquarters building during the IMF/World Bank spring meeting in Washington, on April 20, 2018. (Yuri Gripas/Reuters)

The risks to global financial stability have risen “rapidly” since the International Monetary Fund’s (IMF) previous assessment in October, the organization wrote in a new report.

In the latest Global Financial Stability report, IMF economists wrote that there is a “perilous combination of vulnerabilities” in financial markets as institutions failed to properly prepare for a rising interest-rate environment, producing substantial uncertainty regarding the financial system’s health. Moreover, the formation of stress in worldwide financial markets has resulted in a complex situation for inflation-fighting central banks, especially as price pressures prove “to be more persistent than anticipated.”

Despite the financial system being tested by higher inflation and interest rates, the IMF recommends that central banks utilize their suite of tools to separate their monetary-policy objectives, such as restoring price stability and accomplishing financial stability goals. At the same time, should financial pressures intensify and potentially threaten the financial system while inflation remains elevated, monetary policymakers must “act swiftly to prevent any systemic events.”

With the IMF warning in its World Economic Outlook of “stickier” and “persistent” inflation levels, this could produce “a reassessment of the path of policy for monetary policy.” If so, Tobias Adrian, director of the IMF’s Monetary and Capital Markets Department, thinks this could “trigger certain financial sector instabilities.”

“So, vulnerabilities are suddenly elevated both in the banks and in the non-bank financial sector,” Adrian told reporters during a press briefing.

While Adrian does not believe there will be a sudden shift in monetary policymaking, he and his colleagues purported that if policymakers must adjust their policy stances, they will need to clearly communicate their continued resolve to reduce inflation to target as financial stress subsides.

Meanwhile, the collapse of both Silicon Valley Bank and Signature Bank and the situation involving Credit Suisse highlighted “supervisory lapses” and “internal risk management failures.”

“Supervisors should focus on interest rate and liquidity risks in banks and work to strengthen regulation and close data gaps in nonbank financial intermediaries,” the IMF economists wrote. “Resolution regimes should be enhanced to better facilitate resolution of systemic banks without risking public funds.”

According to IMF officials, authorities and regulators must focus on bank asset classification, provisions, and exposure to interest rate and liquidity risks.

By incorporating these suggestions into their regulatory endeavors, governments and central banks will be better equipped to handle financial instability.

“The international community will need to take stock of these experiences and draw policy conclusions on the effectiveness of resolution reforms after the global financial crisis,” the report said.

Post-Crisis Interest Rates

In the early days of the COVID-19 pandemic, central banks worldwide slashed interest rates to zero.

Today, many economies are seeing benchmark rates at their highest levels since before the Great Recession. In the United States, for example, the federal funds rate is in the target range of 4.75–5.00 percent, the highest since late 2007.

With inflation easing and economic growth slowing, Adrian alluded to IMF research that suggests the world economy will eventually return to “relatively low interest rates.” But when this happens is uncertain, he noted.

In the United States, the futures market is already penciling in rate cuts heading into 2024 in response to lackluster economic growth rates, according to the CME FedWatch Tool.

The WEO report forecast that global headline inflation will tumble to 7 percent and world output will be less than 3 percent. The U.S. economy’s real GDP growth rate is forecast to slow to 1.6 percent in 2023 and 1.1 percent in 2024, down from 2.1 percent in 2022.

Threats to Commercial Real Estate

Is the commercial real estate (CRE) market the subsequent big weakness in the global economy?

The CRE industry has contended with the consequential shift to hybrid and remote work since the work-from-home era during COVID-19 public health crisis began, causing office vacancy levels to rise across North America.

But now, the CRE market will face headwinds from refinancing “more than half of its mortgage debt in the next two years,” Morgan Stanley says.

A commercial retail space is advertised for lease along King Street West in Toronto, Canada, on March 9, 2021. (The Canadian Press/Tijana Martin)

“Commercial real estate ... has to refinance more than half of its mortgage debt in the next two years,” wrote Lisa Shalett, Morgan Stanley Wealth Management’s chief investment officer, in a note (pdf). “More than 50 percent of the $2.9 trillion in commercial mortgages will need to be renegotiated in the next 24 months when new lending rates are likely to be up by 350 to 450 basis points.”

Shalett projects that CRE prices could crash as much as 40 percent from their peak.

The IMF reported that U.S. commercial real estate investment trusts (REITs) had slumped 14 percent year over year in the first quarter of 2023. In Europe and Asia-Pacific, commercial REITs have tumbled 13 percent and 20 percent, respectively. Overall, global transaction activity in this sphere is down 17 percent from a year ago, the IMF noted.

“As central banks continue to tighten their monetary policy stance, the CRE market is facing significant pressures,” the organization stated. “Similar to what takes place in residential markets, a key driver of the repricing in CRE markets is the sharp rise in market interest rates. This in turn raises the required return for real estate, as rising interest rates are not accompanied by either higher expectations for growth or lower perceptions of risk.”

Historically, low interest rates boosted CRE market valuations over the past decade, Global Financial Stability report authors explained.