$80 trillion in hidden debt

Dhe financial system remains vulnerable, and the central banks dissuade from their meanwhile aggressive anti-inflation course. The Bank for International Settlements (BIS) warned of this in its quarterly report published on Monday. As an example, the economists at the BIS, which is considered the bank of central banks, refer to the turmoil in the British government bond market in September.

Back then, plans by the UK government to cut taxes and subsidize energy had sparked budgetary concerns and a sell-off in currency and bond markets. This put UK pension funds in a quandary from which they Bank of England by buying British bonds, which pushed yields down again. For Claudio Borio, chief economist at the Basel-based BIS, the persistently high level of debt poses a challenge for the central banks, which have to curb inflation by raising interest rates.

Vulnerable Shadow Banks

Overall, he sees the financial system in stable condition due to the regulatory reforms after the major financial crisis of 2008/2009. Financial regulators regularly point to the robust capital buffers that banks should have to weather tough times.

But Borio is concerned about the unregulated or hardly regulated financial market participants. These are referred to by the BIS as non-bank financial intermediaries, for which the casual term “shadow banks” is also used. The BIS counts among these financial intermediaries not only hedge funds, some of which have risky investment strategies, but also large pools of capital such as insurers or pension funds.

In their quarterly report, the economists point out that the risks to financial stability due to a high level of debt being used in illiquid markets in which trading only works to a limited extent are not limited to pension funds.

Corona crash as another warning signal

The example from the Corona crash in March 2020, when hedge funds ran into a bottleneck in the market for American government bonds, serves to do this. Larger upheavals that endangered financial stability could only be prevented on the world’s largest securities market by the intervention of the American Federal Reserve.

The long phase of extremely low interest rates has intensified the search for yield, with the result that high levels of debt have piled up across the entire spectrum of financial market participants, the BIS notes. A rapid rise in interest rates coupled with low liquidity could limit the ability of the markets to function.

That could put pressure on the central banks to take measures such as broad-based bond purchases and thus counteract their currently restrictive monetary policy. In addition, the BIS economists see the danger that market participants’ willingness to take risks could then increase in the long term.

In a follow-up analysis of the 2022 Triennial Central Bank Survey, released at the end of October, BIS economists point to risks posed by changes in trading patterns and market structures. The BIS analysts point to hidden dollar risks of 80 trillion dollars. These originate from currency exchange transactions (swaps) and are not included in the balance sheets of the respective institutes or companies.

Of these risks, non-banks outside the United States account for $26 trillion and non-US banks with limited access to the Federal Reserve account for $39 trillion. That number more than doubles the $15 trillion in dollar debt shown on the balance sheets.

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