IMF warning over credit bubble risks

 
Tim Wallace
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PREVENTING severe disruption to financial services that could spill over and damage the “real” economy should be the focus of macroprudential policies, the International Monetary Fund (IMF) said yesterday in its global stability report.

Policymakers need to understand the series of shocks that can lead to a build-up of systemic risk, the report said.

Regulators are advised to keep a particularly close eye on credit conditions and the other factors affecting them.

“The increase and persistence of credit and the decline in bank capitalisation ratios are significantly higher in the case of bad shocks than good shocks,” the report explained.

It also pointed to other signals accompanying credit growth. For example, when credit grows at over five percentage points of GDP at the same time as equity prices rise at over 15 per cent, “this pushes the probability of a crisis to 20 per cent within two years.”

The IMF believes that the experiences of one country in this field can broadly be applied to any other, though the country’s scale, and that of its financial services industry, does make a difference.

In separate chapter of its report, the IMF warns that the prolonged low-interest rate environment could promote the development of risky investment strategies.

The warning particularly applies to long-term investors like pension funds and insurance companies, who are receiving exceptionally poor returns on their money.

“So far most long-term institutional investors are choosing to accept lower returns rather than take on more risk,” it reported. “Given their fixed future payments or liabilities, with guaranteed returns, pressure will build for them to move into riskier assets the longer the low interest rate environment lasts.”

Although experiences of the financial crisis have made investors more risk conscious, low rates may push investors into emerging markets rather than riskier assets in developed countries, with the accompanying risk that there will be turnaround in the countries’ fortunes, the report warned.