The near collapse of Britain’s pension funds during Liz Truss’s brief premiership highlights the risk that higher global interest rates will trigger more financial crises in the coming months, the International Monetary Fund (IMF) has warned.
In a report, the agency based in Washington DC said the rescues of Silicon Valley Bank and Credit Suisse may not have been isolated incidents and that there was a chance that problems could stretch beyond the traditional banking sector to pension funds, insurers and hedge funds.
The warning came in a chapter from the IMF’s half-yearly global financial stability report, released before its official publication next week, which stressed the need for regulation of non-banks to be tightened.
A blog by three IMF officials – Fabio Natalucci, Antonio Garcia Pascual and Thomas Piontek – accompanying the report said weaknesses had emerged after a period of more than a decade in which interest rates had been low and cheap money had been readily available.
“Recent strains at some banks in the US and Europe are a powerful reminder of pockets of elevated financial vulnerabilities built over years of low rates, compressed volatility and ample liquidity.
“Such risks could intensify in coming months amid the continued tightening of monetary policy globally, making it especially important to understand and safeguard this broad swath of the financial sector that comprises an array of institutions beyond banks.”
The IMF said the growth of non-bank financial intermediaries (NBFIs) had accelerated after the 2008 global financial crisis and that they now accounted for almost 50% of global financial assets. “As such, the smooth functioning of the non-bank sector is vital for financial stability.”
The report said stress tended to emerge when NBFIs borrowed money to finance investments or boost returns through the use of financial instruments such as derivatives, and when an institution was unable to generate enough cash through the sale of assets to satisfy redemption requests by investors. The connections between NBFIs and traditional banks amplified problems at times of stress.
“Last year’s UK pension fund and liability-driven investment strategies episode underscores the perilous interplay of leverage, liquidity risk and interconnectedness,” the IMF added.
“Concerns about the country’s fiscal outlook led to a sharp rise in UK sovereign bond yields that, in turn, led to large losses in defined-benefit pension fund investments that borrowed against such collateral, causing margin and collateral calls. To meet these calls, pension funds were forced to sell government bonds, pushing their yields even higher.”
The Bank of England intervened to help pension funds by promising to buy up to £65bn of government bonds but the IMF said such moves had drawbacks at a time when central banks were trying to ease cost of living pressures.
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“With the fastest inflation in decades, and with price stability at the core of most central bank mandates, injecting central bank liquidity for financial stability purposes could complicate the fight against inflation”, the blog said.
The IMF said robust supervision, regulation and surveillance were vital if governments were to prevent turmoil in the NBFI sector affecting financial stability.
“Policymakers must also narrow or eliminate gaps in regulatory reporting of key data, including how much risk firms are taking with their borrowing or use of derivatives. Policies are also needed to ensure NBFIs better manage risks, and this might be accomplished through timely and granular public data disclosures and governance requirements.”
