Digital Zeitgeist – IMF Warns Geopolitical Fragmentation Could Raise Financial Stability Risks

Washington (Reuters) – The International Monetary Fund warned on Wednesday that escalating geopolitical tensions and the fragmentation of the world economy they have caused might magnify financial stability risks by lowering cross-border investments, asset prices, payment systems, and banks’ capacity to lend.

The global economy is already fragmenting into geopolitical blocs, with China and other authoritarian governments on one side and U.S.-led democracies on the other, and the IMF has long warned of rising costs, economic friction, and GDP production losses as a result. Reduced commerce and rival, competing technological platforms are the looming danger.

Yet, a recent working paper from the IMF underlined the possibility that escalating tensions might lead to outflows of cross-border capital, including direct investment, from nations, with particularly significant risks for developing and emerging market economies.

According to IMF analysts in a study prepared for the IMF and World Bank spring conference next week as part of the Global Financial Stability Report. Unfortunately,  such stability concerns are pushed through financial, and banking channels.

With recent upheaval in the banking sector, including the bankruptcies of Silicon Valley Bank and Signature Bank in the United States and the forced sale of Credit Suisse to competitor UBS in Switzerland, financial stability is anticipated to be a significant issue during the meetings.

The paper cited research using the U.S.-China divergence in UN Security Council voting since 2016 as a proxy for rising geopolitical tension between an investing and a recipient country. Such tension reduces cross-border portfolio investment and banking claims by 15% in the recipient, it said.

“Imposition of financial restrictions, increased uncertainty, and cross-border credit and investment outflows triggered by an escalation of tensions could increase banks’ debt rollover risks and funding costs,” the IMF researchers said in an accompanying blog post.

“It could also drive up interest rates on government bonds, reducing the values of banks’ assets and adding to their funding costs.”

According to the fund, this might prompt banks to reduce lending, which would slow real economic development and contribute to further financial instability.

The IMF advised bank supervisors, regulators, and financial institutions to utilise stress testing and scenario analysis to better understand how escalating tensions may affect the financial system and reduce the risk of potentially disruptive consequences from geopolitical events.

It advised policymakers to make sure that regional and national agencies work together to develop crisis management systems. Using currency exchange lines or preventative loan lines from international financial organisations like the IMF, countries could develop regional safety nets.

The study recommended strengthening foreign reserves, capital, and liquidity buffers at financial institutions for economies that also depend on external finance.

online sources: reuters.com, imf.org