The world’s finance ministers and heads of central banks are increasingly concerned about the possibility of a new financial crisis.
As the financial elite prepare to gather in Washington for the fall meeting of the International Monetary Fund (IMF) this week, they will be confronted with a series of warning signals pointing to a new tremor in the markets.
Extremely lax monetary policies in the euro zone and Japan, and the resulting very low interest rates around the world, are enticing investors and banks to embark on a “search for yield” once again. This is in turn leading to the types of excesses that existed before the 2008 financial crisis.
“A dangerous cocktail has developed,” warned one central banker.
Risk factors that include unbridled growth in the junk bond market are also a cause for concern among conservative central bankers. According to the Bank for International Settlements, or BIS, a global association of central banks, about 35 percent of all corporate bonds issued in Europe in the second quarter came from companies with poor credit ratings.
This is yet another echo of the boom phase that preceded the 2008 financial crisis.
The BIS noted that this brought the number of junk bonds issued to a record level, an observation that quickly attracted the attention of the heads of national central banks.
A few real estate markets in Europe are also showing signs of becoming overheated, while some banks have recently been requiring only minimal collateral for the financing of corporate takeovers – yet another echo of the boom phase that preceded the 2008 financial crisis.
The situation has been exacerbated by the Federal Reserve in the United States. The central bank is in the process of abandoning its policy of low interest rates, causing turmoil in markets that had long relied on the central bank’s easy money to drive their own investments.
Banks themselves are also a concern. Central bankers and financial policy experts warn of significant fluctuations in the capital markets, and they wonder whether all banks are adequately prepared to weather new storms.
The toxic cocktail has made it painfully clear that one of the biggest problems of the financial crisis has not yet been solved.
Only recently, the Financial Stability Board, or FSB, an international body that monitors the global financial system, warned that lenders should not become complacent as a result of the prolonged phase of relative calm in the markets.
The toxic cocktail has made it painfully clear that one of the biggest problems of the financial crisis – how to safely liquidate banks that might threaten the global financial system if they collapsed – has not yet been solved. While many countries -and the European Union as a bloc – have adopted new plans to restructure banks that are in trouble, there are no globally-agreed common rules for winding down multinational financial firms.
“It’s a disgrace that a breakthrough hasn’t been achieved in this area yet,” says one prominent central banker.
Regulators at the IMF meeting hope to take an important step forward in tackling the problem of banks that are considered “too big to fail.” Andreas Dombret, a member of the executive board of Germany’s central bank, the Bundesbank, says that resolving this dilemma remains one of the “cornerstones of the regulation of financial markets.”
In the future, banks with such a strong impact on the global financial system will have to get used to the idea of having an “adequate supply of available capital to absorb losses,” Mr. Dombret said.
Regulators at the IMF meeting hope to take an important step forward in tackling the problem of banks that are considered "too big to fail."
This, he explained, would add credibility to the recapitalization and liquidation plans of major banks in a worst-case scenario. The problem could be tackled at the November G20 summit of world leaders in Brisbane, Australia, Mr. Dombret added, allowing a new program to be implemented in 2015.
In Germany, the bank most affected by new global rules would be Deutsche Bank, the country’s largest.
Observers believe that regulators aim to create a system that goes well beyond previous efforts, which have in recent years been limited primarily to bolstering equity capital.
This time the entire capital structure is involved, including debt capital, which can be converted into equity in the event of an acute crisis. According to financial insiders, the FSB has already agreed on minimum requirements, which could provide for banks to hold loss-absorbing capital worth up to 25 percent of risky assets.
A lack of details currently makes it impossible to precisely estimate the exact amount banks hold of of this capital reserve, dubbed “total loss absorbency capital” (TLAC).
Observers believe that regulators aim to create a system that goes well beyond previous efforts.
“The devil is in the details,” warns an insider. In the end, the roughly 30 systemically important banks – including, for example, JP Morgan and HSBC – will have to get used to rising overall capital costs, even though additional equity capital would not be necessary.
“Investors will demand a higher return for securities that are at risk of default in the event of insolvency. They need to take a close look at the fine print on subordinated bonds,” explains a banking expert.
Mark Carney, chairman of the FSB and head of the Bank of England, believes the measure is necessary, so that taxpayers won’t be asked pay for the next bank bailout. In addition to the capital measures, minimum liquidity requirements for banks are also planned to avert new crises.
Regulators will speed up the pace of implementing the new rules. This is because increasing the equity capital cushion – the method applied in recent years – has unwanted side effects. This capital is expensive for banks to raise on the open market, and there are fears that keeping higher levels of capital will reduce the availability of credit, especially in the crisis-ridden countries of the European Union, to levels lower than those desired by politicians and central bankers.
The author is head of the banks desk at Handelsblatt’s bureau in Frankfurt. To contact the author: email@example.com