The International Monetary Fund (IMF) has cautioned that financial institutions active in the world’s largest $9.6 trillion currency (forex) market must maintain adequate liquidity and capital levels and conduct robust stress testing to prevent potential disruptions in the financial system. In its Global Financial Stability Report, the IMF noted that although progress has been made in risk assessments and stress testing, the forex market’s role in risk transfer and cross-border effects remains underappreciated. The report highlighted the significant presence of US dollars on global banks’ balance sheets, making them vulnerable to financial shocks. Additionally, the growing participation of non-bank financial institutions and increased derivatives trading could further weaken the market. Tensions in the forex market may impact other asset classes, potentially tightening financial conditions, especially in countries facing currency imbalances and financial vulnerabilities. The IMF emphasized the need for financial regulators and banks to effectively monitor and manage liquidity risks in major currencies. Strengthening and expanding swap lines between the Federal Reserve and other central banks was deemed essential to support global forex liquidity and prevent the spread of financial crises. These swap lines serve as financial backstops that help stabilize markets during periods of stress. The IMF also underscored the stabilizing role of international reserves during times of pressure, as they can be deployed when private financing diminishes. Given that the forex market is the largest and most active globally, with daily transactions amounting to trillions of dollars, its stability is crucial for the health of the global financial system since abrupt currency fluctuations can adversely affect international trade and investment.
IMF Warns of Liquidity Risks in $9.6 Trillion Forex Market
