The IMF said accommodative measures adopted by the Bank of England and other central banks, such as low interest rates and quantitative easing, had helped to stabilise the financial system, reports The Telegraph.
However, it warned that the longer these policies – dubbed “MP-plus” – were in place, the greater the risk that negative effects could spill over to other parts of the economy.
“Financial stability risks may be shifting to other parts of the financial system, such as shadow banks, pension funds, and insurance companies,” the IMF said in a chapter of its Global Financial Stability Report.
“Despite their positive short-term effects for banks, these central bank policies are associated with financial risks that are likely to increase the longer the policies are maintained.”
The IMF found evidence that loose monetary policy “may be supporting a delay in balance sheet cleanup in some banks”, and could encourage them to “evergreen”, or roll over bad loans instead of recognising losses on their books.
It said that keeping so-called ‘zombie’ firms afloat could have an adverse effect on banks. “It is difficult to identify weak but ultimately viable borrowers, and such evergreening may be keeping non-viable firms alive,” the IMF said. “Their demise when rates rise could affect the quality of the loan portfolio over the medium term.”
Large increases in bank liquidity associated with QE could make financial institutions “addicted to central bank financing”, the IMF said. Asset purchases could also lead to a “sharp” jump in sovereign borrowing costs once conditions improve, it added.
“Once economic conditions warrant the withdrawal of monetary stimulus, markets may anticipate that central banks will switch from buying government bonds to actively selling them, and political pressure may be exerted to move the monetary authorities in that direction.”
According to research by Bank of America, financial asset purchases by the US Federal Reserve, European Central Bank and Bank of Japan will equate to between 30 and 60pc of their gross domestic product by the end of 2014. Almost $20 trillion (£13 trillion) of the global government bond market now trades below 1pc.
The IMF said that sharp interest rate rises could demolish bank capital buffers in countries like Japan where almost a quarter of government debt is held domestically. An interest rate rise from 2pc to 4pc would generate losses of 16pc on the market value of a 10-year bond, the IMF said.
It urged countries to “vigorously pursue” bank restructuring, rebuild capital buffers and stressed the importance of communicating clear monetary policy “exit strategies” and explain circumstances under which a tightening may occur to avoid market disorder.
Christine Lagarde, the Fund’s managing director, warned yesterday that the threat from world’s biggest lenders was “more dangerous than ever” and said that Europe needed to restructure or wind down its banks as part of a vital clean-up of the industry,
A separate chapter released by the IMF on Thursday found that sovereign credit default swaps – a form of insurance against default – did not destabilise markets or push up countries’ borrowing costs.
The IMF said that there was “little evidence overall that such excessive increases in countries’ SCDS spreads cause higher sovereign funding costs.”