The wholesale revolution in the financial services industry in recent years could trigger an outbreak of instability "with macroeconomic consequences" unless it is adequately monitored, the International Monetary Fund has warned.
The world's premier financial watchdog told a seminar at the Bank of England that technological changes and financial deregulation had changed the way that banks and other players operated.
It said the increase in competition and the number of new players such as hedge funds in the financial systems would force central banks and regulators to change the way they set interest rates and regulated markets.
It told senior City figures and economists at a briefing in London on Friday that the greater speed and flexibility of financial markets such as Britain and the United States could leave them more exposed to booms and busts in asset prices.
Its warning come just a few weeks after the Bank of International Settlements urged central banks to target asset prices such as property as well as inflation when setting interest rates.
The IMF, led by managing director Rodrigo Rato, said the liberalisation of financial markets had been particularly noticeable in Anglo-Saxon economies such as the UK, the US and Australia which has moved to what it called an "arm's length" system.
In contrast to continental countries such as Germany and France that relied on long-term relationships, the UK and US have moved to more openly competitive markets where lenders competed for customers without seeking to develop any long-term trust.
The IMF said it was pioneering research into the links between different forms of financial systems and the wider economy to understand how different countries might react to a major shock or slowdown.
In a report it said: "The greater speed and flexibility with which transactions can be executed and the higher degree of leverage in the household sector in more arm's lengths systems could become sources of financial instability with macroeconomic consequences."
In an echo of the warning from the BIS, it said: "The effect of interest rate changes on asset prices will likely become an increasingly relevant channel of monetary policy transmission through the impact on consumption and residential investment."
It said the impact on wealth on people's behaviour might have been larger than central bankers had expected. "Monetary policymakers will need to remain flexible," it said.
This was an issue in the UK at the end of 2004 when a slowdown in house prices coincided with a similar weakness on the high street, when rising interest rates and utility bills dented retail sales. Since then a robust rebound in house prices has been accompanied by strong retail sales, at least until the latest month.Reuse content