IMF Warns Banks Against Taking Too Many Risks Amid Low Rates

(Bloomberg) -- A prolonged period of low interest rates would squeeze financial institutions, forcing big banks to take more risks as they hunt for higher returns, the International Monetary Fund warned.

Advanced economies have experienced unusually low growth and interest rates since the financial crisis -- a situation that would present a “considerable challenge” to financial institutions if it continues, the IMF said in an analytical chapter of its semi-annual Global Financial Stability Report. The full report will be released April 19 at the fund's spring meetings in Washington.

“Over the long term, the scenario would entail significant changes to the business models of banks, insurers, and pension funds,” the IMF said.

While the U.S. Federal Reserve has raised rates three time since late 2015 and it forecasts more tightening, central banks in most other developed countries continue to keep rates near or even below zero. In countries such as Japan and Germany, five-year government bonds still have negative yields.

Small deposit-taking banks that aren't geographically diversified would hurt the most under a scenario where rates stay low for long, putting pressure on them to merge, the IMF said. Big banks could suffer too, as the search for higher yields leads them to increase their risk exposure abroad, especially in emerging markets.

In such a situation, life insurers and pension funds would face a long-term challenge to remain profitable and even solvent, a process that will likely require them to seek additional capital, according to the Washington-based fund. Insurers would likely cede part of their business of providing savings products to asset managers and banks, it said.

Countries should develop laws and regulations that enable financial institutions to merge smoothly, while putting in place rules that limit risk taking in an environment of lower returns, the fund recommended.

To contact the reporter on this story: Andrew Mayeda in Washington at amayeda@bloomberg.net.

To contact the editors responsible for this story: Brendan Murray at brmurray@bloomberg.net, Sarah McGregor, Randall Woods