Central banks may need to provide further emergency support to the non-bank financial system, the Bank for International Settlements (BIS) warned in an article published in the Financial Times on Sunday 29 March.
The BIS acts as a policy-making advisory body for the world’s central banking community.
In the article, the BIS general manager, Agustín Carstens, said that a focus on channelling financial support to individuals and small and medium-sized enterprise through the banking system may not work.
“This time, the banking sector is a smaller part of the financial system”
This is because businesses are now often more reliant on other market-based finance providers–intermediaries like institutional investors and asset managers—than on banks to supply critical finance, the BIS said.
The BIS general manager contrasted the current recession with 2008, when central banks had been able to support economic activity by supporting banks and buying assets through quantitative easing (QE) programmes.
“One key difference between the current crisis and 2008 is the set of players involved. That event was a global banking crisis with over-leveraged lenders at its centre. Central banks had direct levers to address banking stress by providing funding to distressed banks or by purchasing assets,” Carstens said.
“This time, the formal banking sector is a smaller part of the financial system, while market-based finance has become more important.”
According to the Bank of England, market-based finance, measured by the assets of non-bank financial institutions, grew to $150 trillion in 2015, or about half the total assets of the global financial system. This is an increase of about 50 percent since 2008.
“This has brought the liquidity risks from market-based finance into sharp focus”
Within the market-finance total, the asset management industry manages around $80trn, half of which is in investment funds.
Last summer outgoing Bank of England governor Mark Carney warned of the new vulnerabilities created by this trend, saying that investment funds promising daily liquidity to clients while investing in less liquid underlying assets, like corporate bonds, risk amplifying any downturn in the global economy.
“Investment funds have more than doubled [their assets since 2008],” Carney said.
“Within that, debt-focussed funds make up nearly a quarter of the assets under management as investor flows into fixed income funds since the crisis have materially outpaced those into equity funds. This has brought the potential liquidity risks from market-based finance into sharp focus.”
“$30trn of global assets are held in investment funds that are particularly flighty, reflecting their promise of daily liquidity to investors despite investing in potentially illiquid underlying assets,” Carney warned at the time.
Last Monday, in an aim to quell market panic, the US Federal Reserve enlisted BlackRock, the world’s largest asset manager, in a bond-buying exercise worth tens of billions of dollars.
The Fed’s move was called “truly outrageous” by one asset management executive interviewed by the Financial Times, who declined to speak on the record due to BlackRock’s influence on Wall Street.
“Asset managers do not ‘fail’, and therefore they cannot pose systemic risk”
Over recent years BlackRock has managed to convince regulators that its activities do not create market-wide systemic risk, leaving the firm—and other asset managers—subject only to relatively light-touch regulation.
By comparison with banks, asset managers are subject to only minimal capital requirements, a preferential status they justify by arguing that they do not put their own balance sheets at risk when managing funds on behalf of clients.
“Asset managers do not ‘fail’, and therefore they cannot pose systemic risk,” BlackRock’s former vice-chairman, Barbara Novick, said last year.
According to the BIS general manager, since bank finance is not filling the void left by the potential withdrawal of market-based finance, central banks should consider more support schemes like that launched by the Fed last week.
There should be a global freeze on bank dividends and share buybacks
“The US Federal Reserve’s decision to enter the corporate bond market marks a bold step in the right direction,” Carstens said.
“But more may still be needed to build the last mile to the small businesses at the end of the line.”
The BIS general manager called for two immediate steps to help shore up capital flows to individuals and small- and medium-sized businesses.
First, he said, there should be a global freeze on bank dividends and share buybacks.
Last week the European Central Bank imposed such restrictions for banks based in the eurozone, but the move has not so far been copied elsewhere.
In 2019, big banks globally paid out about $325bn in share buybacks and dividends. In the US alone, regulators have approved buybacks and dividends at the eight largest banks for the 12 months beginning 1 July 2019 totalling approximately $155bn.
Carstens’ second recommendation was that governments around the world could guarantee loans to each small- and medium-sized company, equal to the amount of taxes they paid last year.
These ‘tax deferral loans’ could be provided by banks upon simple evidence of taxes having been paid last year and then be refinanced, in a securitised form, through a central bank facility, the BIS said.