IMF's new working paper highlights risks to financial stability

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IMF's new working paper highlights risks to financial stability

According to a new working paper released by the International Monetary Fund, the rapid growth of the crypto asset industry has generatedheightened concerns about potential risks to financial stability.

The study by the IMF follows multiple failures in the crypto industry, including the collapse of TerraUSD and FTX, which have led to calls for enhancing regulatory frameworks related to crypto assets. The authors stress the crypto sector as a rapidly expanding shadow financial system, noting that while crypto assets provide benefits like more efficient payments, their integration into the broader economy still poses financial stability risks that existing policy frameworks do not yet have sufficient tools to assess.

It's important to note that the paper is the work of an internal working group and that it does not represent formal IMF policy. As policymakers worldwide grapple with the oversight of decentralized digital markets, the ideas are aimed at eliciting feedback.

Among the proposed policy proposals is introducing a Crypto-Risk Assessment Matrix that would sum up each country's crypto-related vulnerabilities, track key indicators, identify potential triggers of instability, and match risks to tailored policy responses. The paper suggests incorporating crypto factors into existing systemsic risk management conducted by the IMF and others.

The working group stressed the need for heightened international cooperation in crypto regulation, given cross-border spillovers. This could result in information sharing between national supervisors. Addressing data gaps through reporting rules is viewed as a second priority.

While risks may concentrate in certain players like stablecoin issuers, the paper argues for the development of macroprudential tools to focus on crypto-specific risks. Some institutions are labeled as systemically important, including requirements such as capital buffers, liquidity requirements, and defining certain institutions as systemically important. Specialized oversight bodies, adapted models, and novel policy responses like cyber risks were among the recommendations put forward.

The paper notes that crypto assets are susceptible to mispricing and shock transmission due to their propensity for mispricing and shock transmission. Automation and decentralization, both of which bring new complexities to regulation, are among their distinctive features. Crypto assets may weaken monetary policy transmission, enable volatile cross-border capital flows, and suffer from data gaps.

The aim of the paper is to expand macroprudential policy tools to cover crypto-specific risks. The initiative calls for international collaboration to overcome data limitations that hinder effective oversight. The paper contends that crypto assets should be incorporated into systemsic risk assessment, tailored to each nation's vulnerabilities.

The IMF and the Federal Reserve are tasked with preserving financial and economic stability, which each will always be at the forefront of their decisions. With the popularity of crypto growing, however, regulators are facing the complex task of balancing innovation against stability as market demand for crypto products gradually takes hold.