## Rising Rates May Trigger Financial Instability, Complicating Fight Against Inflation

_IMF Blog, February 13, 2025_

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## Bibliographic details
- Authors: Katharina Bergant, Mai Hakamada, Divya Kirti, Rui-Mano
- Published: February 13, 2025

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### Inflation matters
- Research combines balance sheet and income data for more than 6,600 banks in advanced and emerging economies with nearly three decades of IMF economic data.
- Most lenders are largely hedged against inflation: income and expenses tend to rise with inflation to similar degrees.
- Distinction in exposures:
  - Income and expenses tied to borrowing and lending are exposed indirectly to inflation because they primarily react to policy rates that fluctuate in response to inflation.
  - Other income and expenses—revenues from non-traditional banking activities, services, salaries, and rent—are exposed directly to price changes.
- Cross-country variation:
  - At the country level, the impact of inflation on bank income and expenses individually varies widely across banking systems.
  - Shifts in inflation are reflected in income and expenses much more rapidly in some countries than in others.
  - Nevertheless, since both income and expenses rise with inflation to similar degrees in most countries, most banking systems appear largely hedged to inflation.

### Concentrated exposures
- Some banks are particularly susceptible to inflation due to different risk management and business models.
- Outliers in both advanced and emerging market and developing economies stand to see large losses when inflation and interest rates spike.
- Key statistics:
  - 3 percent of banks in advanced economies are at least as exposed to elevated interest rates as Silicon Valley Bank at the onset of its failure.
  - 6 percent of banks in emerging economies are at least as exposed to elevated interest rates as Silicon Valley Bank at the onset of its failure.
- Banks in emerging economies appear more exposed to inflation directly, possibly due to more widespread price indexation.

### Policy implications
- Tradeoffs:
  - Amid high inflation, tightening monetary policy, while necessary, could lead to meaningful losses for banks with large exposures.
  - Customers and investors may then reassess risks across all banks, which could lead to panics and financial instability.
- Recommended measures to contain inflation exposures and reduce systemic risk:
  - Strengthen prudential regulation and supervision.
  - Heighten required risk management at banks.
  - Improve transparency.
  - Use granular risk assessments accounting for the key factors highlighted in the research for a broad set of banks.
- If losses at individual banks leave room for wider contagion, central banks may need to balance raising rates to contain inflation against the potential for financial instability.

*Katharina Bergant, Mai Hakamada, Divya Kirti, Rui C. Mano, February 13, 2025.*

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## References

- [Our new research](https://www.imf.org/en/Publications/Staff-Discussion-Notes/Issues/2025/02/10/Inflation-and-Bank-Profits-Monetary-Policy-Trade-offs-557542)

_Source: https://www.imf.org/en/blogs/articles/2025/02/13/rising-rates-may-trigger-financial-instability-complicating-fight-against-inflation_