Tony Chukwunyem 
The International Monetary Fund (IMF) has said that even as central banks set their policy stance to tackle inflation, they should consider how this will impact financial stability.
The Fund, which stated this in a new blog on Thursday, noted that while most banks are largely insulated from shifts in inflation, as the exposure of income and expenses tend to offset each other, “some have significant inflation exposures, which may lead to financial instability if concentrated losses lead to wider panics in the banking sector.”
According to the Bretton Woods institution, “some banks are particularly susceptible to inflation due to different risk management and business models.”
Specifically, the IMF said: “Most lenders appear largely hedged against inflation with both bank income and expenses rising with inflation to similar degrees. Income and expenses tied to borrowing and lending are exposed indirectly to inflation, because they primarily react to policy rates that fluctuate in response to inflation.
In contrast, other income and expenses—revenues from nontraditional banking activities, services, salaries, and rent— are exposed directly to price changes.
“At the country level, the impact of inflation on bank income and expenses individually varies widely across banking systems. Shifts in inflation are reflected in income and expenses much more rapidly in some countries than in others. But, again, since both income and expenses rise with inflation to similar degrees in most countries, most banking systems appear largely hedged to inflation.
“Our research identifies specific vulnerabilities: some banks are particularly susceptible to inflation due to different risk management and business models. Outliers in both advanced and emerging market and developing economies stand to see large losses when inflation and interest rates spike.
” While noting that banks in emerging economies appear more exposed to inflation directly, “possibly due to more widespread price indexation,” the IMF stated that, “amid high inflation, tightening monetary policy, while necessary, could lead to meaningful losses for banks with large exposures”, adding that, “customers and investors may then reassess risks across all banks, which could lead to panics and financial instability.”
It further recommended that “if losses at individual banks leave room for wider contagion, central banks may need to balance raising rates to contain inflation against the potential for financial instability.”
