“Bigger Systemic Risk” Now Than 2008 - Bank of England
Balance sheet shenanigans
One of the ‘innovations’ being used by banks is the very same that was used in the run-up to and exacerbated the 2008 financial crisis. It is the use of special purpose vehicles which are used to hold riskier assets in order to free up capital.
Woods told the news conference:
“We have noticed that some institutions are now moving on-balance-sheet financing to off-balance-sheet formats using special purpose vehicles, derivatives, agency structures or collateral swaps.”
Practices such as these are being done in order to reduce the burden of new rules which have come or are coming into play. The Bank of England and the regulatory authorities are close to completing and implementing the reforms that were agreed to following the 2008 crisis.
However the changes designed to make banks less risky have meant margins are being squeezed from two directions, both by new regulations and record low interest rates.
The regulators’ concerns over these practices are that they circumvent a regulation designed to protect taxpayers from yet another bank bailout. These are the ring fencing rules much lauded about following the financial crisis. They require that those banks and building societies with more require financial institutions with more than £25bn of deposits to tie off their retail divisions from the riskier investment banking units by 2019.
This is the most costly of the reforms being put into place, rumoured to have a price tag of billions of pounds.
Widespread illiquidity leads to panic
Meanwhile, on the other side of the market (but still as entwined and as risky as banks’ circumvention tactics) the Bank of England study has shown that they have some significant concerns about the effects of non-bank lenders in a stressed market, particularly on corporate funding rates and their impact on the real economy.
The central bank is primarily concerned that those dealers making markets in bonds will not be able to cope with panic-selling levels by investors. The study found that 2008 levels of weekly mutual fund redemptions (1 percent of assets under management) could increase corporate bond interest rates for companies with high credit ratings by about 40 basis points.