By: Benjamin Nii Nai Anyetei
The International Monetary Fund (IMF) has proposed a new approach for central banks to maintain strong capital buffers, recommending the use of stress-testing frameworks to better manage risks and protect institutional credibility.
While central banks differ fundamentally from commercial banks—they cannot technically go bankrupt since they can issue currency—the IMF cautions that a weak capital position can still undermine independence and public confidence.
“Stress-testing can help a central bank gauge the level of capital that would allow it to absorb large but plausible shocks without pushing capital to levels that could weaken its credibility and independence,” the IMF explained in its new policy guidance.
Historically, balance sheet risk was not a major concern for central banks, as they typically held small balance sheets and generated consistent profits, largely from investing in government bonds while their liabilities—currency in circulation—carried no interest. But in the wake of the global financial crisis and the pandemic, central banks significantly expanded their balance sheets through large-scale asset purchases. This has exposed them to new vulnerabilities, especially as interest rates have risen, leading to sizable losses.
The IMF argues that these losses, while not necessarily reflecting the social value of central bank actions, highlight the need for a systematic approach to risk management. Its proposed stress-testing model incorporates factors such as interest rate shifts, credit exposures, and foreign exchange risks, alongside inflation and other macroeconomic dynamics.
Currently, many central banks’ bylaws set fixed capital levels, which erode over time with inflation. Others rely on rigid rules for profit distribution that may result in either excessive or insufficient capital retention. A few institutions leave the matter entirely to their boards, often without adequate transparency to the public.
By adopting stress-testing, the IMF says central banks could align their capital buffers more closely with “policy solvency”—the ability to fulfill mandates in times of heightened balance sheet risk. The framework would also help determine when to retain profits to bolster capital, and when it is safe to distribute them to governments without jeopardizing financial stability.
Beyond risk management, the IMF believes stress-testing would enhance transparency and public accountability, particularly in an era where central banks’ expanded roles in crisis response are under scrutiny.
