Chile's financial system has enough liquidity, central bank says

May 18 (Reuters) - Chile's banking system has adequate levels of liquidity and solvency despite more restrictive financial conditions that are expected to lead to an economic contraction, the country's central bank said on Wednesday.

"The banks present limited risks and adequate levels of solvency and liquidity," the central bank said in its Financial Stability Report (IEF). "This has been the result of prudent behavior and the extraordinary measures implemented by the financial authorities during the pandemic.

In the report, the bank said that the greatest external threats to local stability are a deterioration in liquidity and increases in long-term interest rates. Other threats include risk premiums for emerging economies due to faster rate adjustments in the United States, a possible escalation of the Ukraine conflict, or a deterioration in the Chinese economy.

In Chile, the reduction of stimulus is essential to mitigate the cost of inflationary control and prevent a deepening of the macroeconomic imbalances from 2021, the report said.

"Initiatives that deepen the accumulated imbalances or that affect an adequate evaluation of credit risk would make it difficult for this normalization to continue," the central bank said.

It also noted that early pension withdrawals that were used to help households deal with the economic impact of the COVID-19 pandemic reduced the depth of the local capital market.

The negative effects of withdrawals have been visible in both mortgage lending and corporate sector financing, according to the report.

"The loss of depth already experienced by the local capital market, together with a more challenging environment, highlight the importance of not further weakening stable sources of long-term savings," the central bank said.

It pointed out that the economy is expected to contract for several quarters as more restrictive financial conditions and greater uncertainty lead to a drop in private consumption and investment. (Report by Fabian Andres Cambero; Writing by Alexander Villegas; Editing by Paul Simao)