The global financial system is coming under increasing strain as Donald Trump’s trade war rocks markets, the International Monetary Fund has warned.
“Global financial stability risks have increased significantly,” the IMF said in its regular snapshot of the system, urging regulators to be on the alert for potential crises.
It pointed to the “sharp repricing of risk assets” that has followed the US president’s tariff announcements since February – in particular his 2 April “liberation day” statement – and warned that there may be more to come.
Published as finance ministers and central bankers gather in Washington for the IMF’s spring meetings – and as the IMF downgraded its forecasts for global growth amid tariff concerns – the Global Financial Stability Report identified what it called “forward-looking vulnerabilities” in markets.
These include what it said were overstretched valuations for stocks and bonds in some areas, even after recent sell-offs; the highly leveraged state of some financial institutions, including hedge funds; and the vulnerability of some governments to volatility in sovereign bond markets.
The IMF also warned economic policy and trade uncertainty were at an all-time high, “foreboding further shocks, corrections of asset prices, and tightening of financial conditions”.
Governments in emerging economies could be hit especially hard by sudden increases in borrowing costs, the IMF warned, suggesting “investor concerns about public debt sustainability and other fragilities in the financial sector can worsen in a mutually reinforcing fashion”.
Meanwhile, companies may find it more expensive to borrow, if volatile corporate bond markets drive up the cost of debt, it suggested – while households will be hit via “wealth effects”, if the value of their pensions and other investments continues to slide.
The Washington-based lender expressed particular concern about the growing role of “nonbank” lenders, which are much less heavily regulated than banks, but can still pose risks to the wider financial system.
The role of these lenders, which include pension and investment funds, has grown rapidly in recent years, after rules on banks were toughened up after the 2008 global financial crisis.
The IMF warned of a “deepening nexus” between these nonbank lenders and traditional banks. It suggested they could be forced to divulge more information to regulators, which could then identify and rein in “poorly governed and excessive risk-taking institutions”.
High levels of borrowing by these nonbank lenders also “imperils market functioning”, the IMF said, noting these investors had amplified a recent sell-off in US government bonds due to pressure to meet margin calls. This is when an investor must provide collateral to cover losses quickly.
Borrowing by hedge funds could also “exacerbate losses” during periods of market turmoil, the IMF said. At the hedge funds that make big macroeconomic bets, leverage can be as high as 40 times the value of their assets, the report found.
The institution also suggested big global banks could be underestimating the “true level of risk” attached to their business.
Banks use the “average risk-weight”, or “RWA density”, as a metric to reflect the level of risk connected to its business. However, the IMF found that data from international banks, even those with similar models and overall risk profiles, showed “wide variation” by this measure.
The IMF also urged governments to ensure there is sufficient capital and liquidity in the banking system to cope with a crisis – including by the “full, timely and consistent implementation” of the so-called Basel 3 rules, devised after the 2008 crisis.
The Bank of England recently delayed the implementation of the final stage of these rules, known as Basel 3.1, by a year in the UK, as the chancellor, Rachel Reeves, pressed regulators to take a more pro-growth approach.
The report also flagged potential contagion risk in the private credit fund system, which it said could “spread credit shocks across institutions and countries”.
More companies are borrowing from private credit funds, it said, and big investors such as pension funds are increasingly backing foreign direct-lending funds.
As the market becomes more complex and global, “the risk that credit shocks will propagate from one jurisdiction to others intensifies”, the report said.
Separately on Tuesday, a member of the Bank’s rate-setting panel, Megan Greene, said US trade tariffs were more likely to push down UK inflation than to drive it up, but that there were risks on both sides.
Greene told Bloomberg: “The tariffs represent more of a disinflationary risk than an inflationary risk.” However, she added: “There’s a ton of uncertainty around this, but there are both inflationary and disinflationary forces.”
On Monday, Trump renewed his attack against the Federal Reserve chair, Jerome Powell, and the independence of the US central bank.
Greene said that “credibility is the currency of central banks and I think independence is quite an important piece of that”. She said the Bank could credibly try to hit its targets because it was free to make its own decisions.
