Tracking Global Financial Stability Risks From Higher Interest Rates
IMF Blog, August 8, 2023
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- Authors: Tobias Adrian, Hiroko Oura
- Published: August 8, 2023
Context and recent events
- Global central banks raised interest rates to contain the biggest inflation outbreak in four decades.
- Rate increases generated strains for banks in the United States and Europe in 2023.
- Some banks lost money on bond holdings, including US Treasuries, prompting customer withdrawals amplified by technology and social media; a number of banks failed.
- The value of safe US Treasury securities can drop by as much as 30 percent when yields go up by 400 basis points—the actual shock to 10-year Treasury note yields since 2020.
- Events in March 2023 (including the failure of Silicon Valley Bank) illustrated that:
- Bond-holding valuation losses hit earnings, capital, and cash buffers.
- Depositor withdrawals exposed banks that could not access central bank liquidity in time.
FSAP role and methodological evolution
- The Financial Sector Assessment Program (FSAP) is a central pillar of IMF surveillance that:
- Closely tracks financial stability risks for individual countries.
- Gauges financial sector resilience.
- Assesses whether financial sector supervision, regulation, crisis management tools, and safety nets (emergency liquidity support and deposit insurance) follow international best practices.
- Conducts stress tests of potential risks to banks and increasingly to nonbank financial intermediaries (pension managers, insurers, asset managers).
- Three important evolutions for FSAP risk assessments:
- Increased attention to potentially vulnerable smaller financial companies, assessing business models and risk management issues. Example: US authorities relaxed stress testing for small- and medium-sized banks in 2019; the 2020 US FSAP recommendations criticized this relaxation. The Federal Reserve’s annual stress test and the 2020 US FSAP omitted Silicon Valley Bank and other regional banks.
- Closer investigation of interlinkages among asset market stress, financial companies’ earnings, and run risk—especially for banks. Standard FSAP stress tests consider bank capital stress and run risks separately but do not fully account for their interaction.
- Continued development of understanding funding risk spillovers across financial companies (systemwide liquidity risks). Bond market turbulence can trigger liquidity stress in some companies and then spill over as asset sell-offs reduce prices and funding withdrawals occur.
Market volatility, runs, and nonbank risks
- Rapid monetary policy tightening could make bond and interest-rate derivatives markets volatile.
- Before March 2023, FSAP work emphasized risks from bond market shifts to nonbank financial companies, which often hold large bond investments and suffer valuation losses.
- Investment funds are vulnerable to rapid redemptions—runs—because customers can quickly exit unprofitable funds.
- Runs are rarer for pension and life insurance companies due to early withdrawal penalties, but entities using derivatives to boost returns may face margin calls and liquidity stress (example: some UK pension funds last year).
- Several FSAPs applied a simple, new systemwide liquidity stress testing tool, including Türkiye, Jordan, Chile, and the Philippines.
- The 2022 Mexico FSAP examined capital outflow impacts as global policy rates and financial conditions tightened.
- The 2020 US FSAP examined how corporate bond market turmoil is amplified or mitigated by investment funds, banks, and insurers.
FSAP and regulatory/supervisory lessons
- FSAPs will continue to incorporate evolving international standards on regulation, supervision, and crisis management.
- Prior FSAPs for the United States and Switzerland highlighted supervisory and regulatory shortcomings revealed by the 2023 bank failures, noting:
- The principles underlying post-global financial crisis reforms remain appropriate.
- Financial supervisors may have lacked the willingness, legal backing, and resources to put problematic banks back on track.
FSAP coverage in 2023 and preparations for 2024
- In 2023, FSAP covers four economies with systemically important financial sectors that must be assessed every five years: Belgium, Finland, Sweden, and Türkiye.
- Additional voluntary participants in 2023: Botswana, Ecuador, Kazakhstan, Iceland, Jordan, Maldives, and Panama.
- Preparation for 2024 FSAPs is underway, including mandatory cases such as China, Indonesia, Japan, Luxembourg, the Netherlands, Saudi Arabia, and Spain.
- The program emphasizes that in-depth and comprehensive financial sector surveillance is particularly valuable amid a major global monetary tightening cycle.
Source: Tracking Global Financial Stability Risks From Higher Interest Rates, IMF blog, August 8, 2023.
Content in this bundle
- Chapter 2