The International Monetary Fund (IMF) has urged countries to adopt regular stress tests for central banks to better determine how much capital they need to maintain financial resilience and institutional credibility.
In a new policy blog titled “Stress Tests Can Help Determine How Much Capital Central Banks Need”, IMF economist Romain Veyrune said the approach would help clarify appropriate capitalization levels for central banks—institutions that, while they cannot go bankrupt, still face risks that can erode their independence and credibility.
“Unlike commercial banks, central banks do not have prescribed minimum capital requirements.
They can issue currency to meet their payment obligations, but weak capital positions can undermine confidence and independence,” the IMF noted.
According to the IMF, balance sheet risks at central banks were once minimal but have grown substantially since the global financial crisis (GFC) and the COVID-19 pandemic, when many banks expanded their balance sheets through large-scale asset purchases to stabilise economies.
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Those actions helped avert deeper recessions, but they also exposed central banks to interest rate, credit, and foreign exchange risks.
As interest rates later rose sharply, many central banks recorded significant valuation losses on long-term bonds purchased during low-yield periods.
“These losses are not a measure of policy failure,” the IMF said, “but they underscore the need to strengthen frameworks for managing balance sheet risks,”he said.
The IMF observed that most central banks’ laws and bylaws offer little guidance on how capital should evolve in response to inflation or economic growth. Many institutions maintain fixed authorised capital, which becomes outdated over time, while rules for profit distribution are often rigid or arbitrary.
Some central banks are legally required to retain profits until they reach a minimum capital threshold—typically between 8% and 20% of base money—but the IMF noted that these limits are not based on clear risk assessments.
Others have no formal capital rules, leaving such decisions to their governing boards.
“Existing legal provisions can lead to either excessive or inadequate capital buffers,” Veyrune explained, adding that greater transparency and consistency are needed to ensure that capital levels align with the evolving risk environment.
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To address these gaps, the IMF proposes using stress-testing frameworks—similar to those applied to commercial banks—to simulate how a central bank’s capital would behave under different economic shocks.
The Fund’s new quantitative model, building on earlier research by economists Robert E. Hall and Ricardo Reis, evaluates how capital could evolve under stress scenarios involving changes in interest rates, credit risk, and exchange rate movements.
The model also incorporates inflation dynamics and macroeconomic variables to determine the capital levels needed to absorb “large but plausible shocks” without compromising institutional credibility.
The IMF said that stress testing could serve multiple purposes; helping central banks decide when to retain profits to build capital buffers; clarifying when and how profits can be distributed without undermining solvency.
While some central banks may view weak capital positions as a threat to their independence, others may see limited risk.
Even so, the IMF argued that stress testing enhances public accountability by providing a clearer picture of how monetary policies affect financial resilience.
To support implementation, the IMF has published a Guidance Note on Central Bank Stress Testing and is providing technical assistance to member countries, including South Africa, to strengthen their institutional frameworks.
“Ultimately, stress testing offers a forward-looking approach to safeguarding central banks’ balance sheets,” the IMF concluded, “ensuring they remain strong enough to pursue their mandates effectively, even in an era of heightened financial and economic uncertainty.”
