Policymakers Should Encourage Economic Risk Taking, Keep Financial Excess Under Control
Six years after the start of the financial crisis, the global recovery continues to rely heavily on accommodative monetary policies in advanced economies. This has helped economic risk-taking in the form of higher investment and employment by firms, and higher consumption by households. But the impact has been too limited and uneven. Things look better in the United States and Japan, but less so in Europe and in emerging markets.
At the same time, a prolonged period of low interest rates and other central bank policies has encouraged the buildup of excesses in financial risk-taking. This has resulted in elevated prices across a range of financial assets, credit spreads too narrow to compensate for default risks in some segments, and, until recently, record-low volatility, suggesting that investors are complacent. What is unprecedented is that these developments have occurred across a broad range of asset classes and across many countries at the same time.
“The best way to address the new global imbalance between economic and financial risk-taking is to adopt policies that transmit the benefits of monetary policy to the real economy, and to address financial excesses through well-designed micro- and macroprudential measures,” said José Viñals, Financial Counsellor and head of the IMF’s Monetary and Capital Markets Department.
Banks need a new fitness regime
Banks hold significantly more capital than before the crisis, but many institutions do not have a sustainable business model that can support the recovery.
The report analyzed 300 large banks in advanced economies—which comprise the bulk of their banking system—and found that banks representing almost 40 percent of total assets are not strong enough to supply adequate credit in support of the recovery. In the euro area, this proportion rises to about 70 percent.
These banks will need a more fundamental overhaul of their business models, including a combination of repricing existing business lines, reallocating capital across activities, consolidation, or retrenchment. In Europe, the comprehensive review of bank balance sheets by the European Central Bank provides a strong starting point for these much-needed changes in bank business models.
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