IMF says financial stability risks increased significantly amid trade turmoil

By Pete Schroeder

WASHINGTON (Reuters) -Global financial stability risks have increased significantly since the fall, driven largely by heightened economic uncertainty around trade policy and other geopolitical factors, the International Monetary Fund cautioned Tuesday.

In its semiannual Global Financial Stability Report, the IMF cautioned tightening financial conditions, coupled with heightened uncertainty, is driving up financial risks worldwide.

"The overall level of policy uncertainty has increased...the forecast of economic activity going forward is slightly lower," said Tobias Adrian, director of the IMF's monetary and capital markets department.

The warning of higher financial risks comes as the IMF cut growth forecasts for most countries, citing the impact of U.S. tariffs.

Specifically, the IMF flagged three vulnerabilities that could weigh on financial stability going forward. One, valuations still remain high in some equity and corporate debt markets despite recent selloffs, leaving room for further declines. Second, some highly leveraged financial institutions, such as hedge funds, could come under strain in volatile markets and exacerbate any selloffs.

And lastly, more turmoil could weigh on sovereign debt markets, particularly for countries with high debt levels.

The IMF's latest update to its gauge of financial risks comes after the election of President Donald Trump, and his efforts to impose sweeping tariffs with trading partners across the globe. The report comes as the IMF and World Bank kick off their semiannual meeting in Washington.

Specifically, the IMF warned that tariff turmoil could weigh heavily on banks, as a trade shock could force banks to park more funds against potential losses, reduce noninterest income if there is a slowdown in capital markets, or disrupt trade finance, a driver of $18 billion in bank revenue worldwide.

"Trade finance depends on stable cash flows, supply chains, and regulatory frameworks, all of which might be disrupted by abrupt tariff changes," the report stated.

In response to these risks, the IMF reiterated its call for regulators globally to ensure banks have sufficient capital and liquidity, including by implementing the global "Basel III" accord on higher capital standards.

Specifically, the IMF called for "full, timely and consistent implementation" of those new capital standards, which comes as U.S. regulators have abandoned prior attempts to impose those rules and instead are likely to try and craft a new standard with minimal new capital burden on banks.

The IMF also called for "independent and intensive" supervision of banks, with a heightened focus on how banks and nonbanks, which do not face similar scrutiny, interact.

"The growing interconnectedness across jurisdictions means that stress emanating from specific jurisdictions can have a global impact, calling for other regions to be prepared. This highlights the crucial role of both multilateral surveillance and the global financial safety net for swift and effective mitigation of financial risks," the IMF said in its report.

The IMF also warned in the report that internationally active non-U.S. banks could face U.S. dollar funding pressures stemming from heightened volatility and geopolitical events. Reuters previously reported that some European central banking and supervisory officials are questioning whether they can still rely on the U.S. Federal Reserve to provide dollar funding in times of market stress.

(Reporting by Pete Schroeder; Editing by Chizu Nomiyama)