ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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The New Thrust of Fiscal Conservatism

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In a new turn to its advocacy of a conservative fiscal stance amidst a recession, the International Monetary Fund in the April 2022 edition of its Global Financial Stability Report has called for reining in bank credit to governments as a way of weakening the sovereignbank nexus that was strengthened during the pandemic and ostensibly threatens bank stability. What is side-stepped is the real possibility that this additional thrust to limit government borrowing would only contribute to an intensification of the recession, adversely affecting bank profitability and increasing rather than reducing bank fragility. The IMFs case seems to be driven by its ideological adherence to fiscal conservatism rather than any effort to address the vulnerabilities that have heightened bank fragility during the prolonged crisis affecting the world economy.

In the April 2022 edition of its Global Financial Stability Report (Chapter 2), the International Monetary Fund (IMF) has made a case for reducing or capping bank lending to governments on the grounds that excess lending by banks to governments, driven by a sovereignbank nexus strengthened during the COVID-19 pandemic, threatens banking stability. In the IMFs view, this incipient fragility requires governments to not only better target spending and implement tighter medium-term fiscal frameworks but also curtail bank lending to sovereigns. To that end, the IMF argues, governments in emerging markets should intervene to implement (i) prudential measures that discourage excess holding of sovereign bonds by banks; and (ii) measures such as capital surcharges on banks holdings of sovereign bonds above certain thresholds, which would restrain bank lending to sovereigns. In addition, the report suggests that, though there is no consensus on changes to the regulatory capital treatment of risks from sovereign exposures, the Basel Committee should consider initiating a discussion on the issue to possibly prescribe higher risk weights for bank holding of sovereign debt. If these recommendations from the IMF are accepted by governments and central banks, they would narrow access to what is an important source of financing of government expenditures in many countries.

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Published On : 20th Jan, 2024

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