IMF Issues a Warning. How Funds, Insurers, Could Trip Up Banks.

Signage during the International Monetary Fund and World Bank fall meetings at the IMF headquarters in Washington, D.C., on Monday. (Aaron Schwartz/Bloomberg)

The International Monetary Fund warned that trouble in the growing world of nonbank financial institutions, such as pension funds, insurance companies, and investment funds, could create problems for banks and complicate managing financial crises.

In its Global Financial Stability Report, released Tuesday, IMF officials said risks to the system were high because of stretched valuations for stocks and selling pressure on sovereign bonds. But they highlighted one longstanding area of concern: The lightly regulated and less transparent world of nonbanks.

As money has poured into private markets and financing has moved outside of the traditional banking sector, risk watchers like the IMF have been raising flags for years about nonbank institutions. The IMF said they could imperil the financial system through various paths, including popular private-credit funds, real estate, and cryptocurrencies.

These institutions now hold about half of the world’s financial assets and account for half of the daily turnover in the foreign-exchange market, according to the IMF. When trouble hits the nonbank universe—think credit downgrades or falling values for collateral—it can have significant effects on banks’ capital and liquidity ratios, according to the IMF.

For example, if nonbanks fully draw their credit lines from banks, about 10% of U.S. banks and 30% of European banks, by assets, would see their regulatory capital ratios fall by more than a full percentage point, according to the IMF’s stress tests. These ratios, which regulators monitor to ensure banks have enough leeway to stay solvent if crisis hits, compare capital to risk-weighted assets. Such a decline would mean they have less ability to absorb trouble such as losses on loans.

The bond market and liquidity mismatches in mutual funds can also be a vehicle for spreading trouble. For example, if investors sell shares quickly, but fund companies can’t rapidly unload the assets needed to pay them, the funds could be forced to sell their most liquid assets, including Treasuries, to meet redemptions. Margin calls could put additional pressure on funds to raise cash.

That could create volatility in an asset widely held for safety, exacerbating concerns about financial stability.

The IMF recommends enhanced supervision, ensuring mutual funds have adequate liquidity-management tools to reduce the risk of forced sales, and greater attention to private credit.

Write to Reshma Kapadia at reshma.kapadia@barrons.com