IMF Warns of Increased Financial Stability Risks and Highlights Perilous Combination of Vulnerabilities in Markets

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The International Monetary Fund (IMF) has raised concerns over the state of financial stability in global markets. According to the IMF's latest Global Financial Stability Report, the financial system is facing a "perilous combination of vulnerabilities," with participants' failure to prepare for interest rate increases leading to significant uncertainty. In particular, the report warns that US regional banks may warrant closer scrutiny, given the largest bank collapses since the 2007-2009 financial crisis, which exposed weaknesses in a sector responsible for a sizeable share of consumer and business credit in the world's largest economy. The IMF also cautioned that risks had increased rapidly in the six months since its previous assessment.

Even before the recent turmoil in the banking sector, there were maturity mismatches and financial leverage that have existed quietly under the surface for years, according to the report. While risks are obvious in hindsight, the systemic implications of the existing weaknesses were largely unanticipated by policymakers and investors alike. The underlying issues exploded last month when shares of Silicon Valley Bank plunged and depositors fled after it surprised the market with plans to raise capital to fill a nearly $2 billion hole from the sale of securities. Regulators closed the bank just two days later, and Signature Bank was shut two days after that.

Going forward, regional banks could face greater scrutiny with respect to their holdings and funding structures, the IMF cautioned. "Because regional and smaller banks in the United States account for more than one-third of total bank lending, a retrenchment from credit provision could have a material impact on economic growth and financial stability," the report said. The IMF recommended that authorities should be more prepared to deal with financial instability, including by strengthening their bank resolution regimes.

In conclusion, while households and businesses accumulated buffers during the pandemic that boosted their shock-absorbing capacity, those cushions have deteriorated as interest rates have risen, leaving them more vulnerable to default risk. A decline in revenues and tighter funding conditions from banks could expose large firms to downgrade risks, particularly for large firms in emerging markets, the report said. The IMF will be watching very closely to see whether the central banks have the tools to make sure that trust remains in the system.

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