WASHINGTON – A long-term shift to low interest rates in major economies will heighten challenges to global financial stability by stressing banks and other financial companies, according to an International Monetary Fund paper released Thursday.
Part of the IMF’s twice-annual review of financial stability, the report follows moves by the U.S. Federal Reserve to lift benchmark rates in the last two quarters after a period of extraordinary accommodation following the 2008 financial crisis.
Nevertheless, rates in the U.S. remain historically low, while other major central banks still maintain ultra-low interest rates.
Persistently low interest rates “would present a considerable challenge to financial institutions,” requiring “significant” changes to business models, the paper said.
“In such an environment, yield curves would likely flatten, lowering bank earnings and presenting long-lasting challenges for life insurers and defined-benefit pension funds.”
Although the IMF paper did not predict a permanent shift to low rates, it said the implications of such an outcome must be considered. Low interest rates could become a feature of low growth in advanced economies with aging populations and stagnant productivity.
The example of Japan suggests “an imminent and permanent exit from a low-interest rate environment need not be guaranteed,” the paper said.
Perpetually low rates pose challenges for banks by cutting into profits that traditionally come from the gap generated by their ability to borrow money at low rates for short periods while lending for long periods at higher rates.
That condition could force smaller banks to merge with each other or larger banks that may be less stressed because of greater regional diversification.
Low interest rates will also pose difficulties to the insurance and pension sectors, which could no longer rely on interest rate-based returns to meet future liabilities and may be forced to raise additional capital, the paper said. They may also need to shift to different product lines as consumers live longer, demanding fewer savings products and more health insurance.
The paper urges policymakers to work to ensure long-term stability “instead of falling prey to demands for deregulation.”
Key policy changes could include not hindering consolidation among banks that need to merge, tightening requirements on insurers and pension funds to evaluate their assets and liabilities based on economic value, and stepping up oversight of passive index-linked funds that could attract more investors in a low-rate era, but are also more risky, the report said.
“Surveillance and regulation of asset management activities will become even more important if this industry’s share of the financial system continues to grow,” the report said.
Separate from the report, the IMF said the same day bailout talks to help resolve Greece’s pressing debt burden have made some progress but important matters remain unresolved.
Greece is awaiting the next installment of an €86 billion ($91.6 billion) aid package agreed in 2015 that it needs for debt repayments in July.
But talks between Athens and its eurozone and IMF creditors have been stalled for months.
Disagreements have focused on debt relief and budget targets for the austerity-hit country.
Greece is hoping a meeting Friday of eurozone finance ministers in Malta will yield a breakthrough on debt relief.
“There has been progress in the discussions but important issues remain outstanding. Discussions are continuing,” IMF spokesman Gerry Rice told reporters Thursday, adding that the fund hopes to send a mission to Athens soon.
“We need to see progress on the reform package on behalf of the Greek authorities and credible debt relief commitment in order for the IMF to go forward. That position has not changed,” Rice said.