WASHINGTON — Markets have become too complacent as risks from the coronavirus pandemic threaten global prosperity, the Bank for International Settlements warned in its annual report.
“The success of central banks in calming markets and shoring up confidence has even helped spark some market exuberance,” the global group, which supports the world’s central banks, said in the Tuesday release.
In a nod toward the recent disconnect between financial markets and the economy, the group said high stock prices and the lower premium on corporate debt suggested a divergence from the reality of economic weakness.
“Underlying financial fragilities remain,” the group said, adding that “this feels more like a truce than a peace settlement.”
The coronavirus pandemic roiled markets in March and April, as countries outside Asia began to lock down operations and it became clear that the health crisis would inflict pain upon major economies other than China’s.
Central banks responded rapidly as businesses and individuals scrambled to sell assets and raise cash, and the real-world crisis began to infect financial markets — making it hard for corporations to issue debt and difficult to trade even U.S. Treasury securities, which are usually highly liquid. Monetary policymakers bought huge sums of bonds and stepped into new markets as lenders of last resort, intent on staving off a full-fledged meltdown.
Investors were soothed, and they began buying stocks and debt again as they became confident that the Federal Reserve and its global counterparts stood ready to provide a backstop. Global stock indexes have rallied, and corporations have been issuing debt at a breakneck pace.
But now they might be overdoing it, the Bank for International Settlements and its leaders warned.
“Financial markets may have become too complacent — given that we are still at an early stage of the crisis and its fallout,” Agustín Carstens, the group’s general manager, warned in a speech tied to the release. He pointed out that the path of the virus and its effects on businesses still posed risks.
“Importantly, the shock to solvency is still to be fully felt,” Mr. Carstens said, warning that banks, which have extended loans to companies and consumers, will find themselves on the hook as businesses crash, taking workers down with them. That situation, the group warned, could be “triggered by cliff effects as initial fiscal support runs out and payment moratoriums expire.”
The report said that a surge in corporate defaults “is on the cards” and that such an event would “call for prompt and orderly debt restructuring,” along with other action from elected leaders with spending and lending powers.
If such problems are widespread, time-consuming bankruptcies could be a poor way to deal with them.
“Governments could play a useful but delicate role,” the report said. “This could range from setting some broad directions for restructuring to introducing some abbreviated, less granular processes, or possibly taking equity stakes in firms.”
The report also pointed to other vulnerabilities. Thanks to the U.S. dollar’s dominance in global commerce and finance, the Federal Reserve had to step in to calm global funding markets as conditions deteriorated in March.
The “huge scale” of the Fed response points to a vulnerability in the global monetary and financial system “when contrasted with the much smaller firepower of international organizations” like the International Monetary Fund, the report said. It said emerging market economies must rely on a “fragmented combination of mechanisms” to meet their liquidity needs in times of crisis until a “lasting political and practical solution” is found.
Mr. Carstens also urged central bankers to fix vulnerabilities in the financial sector outside the banking system, known as shadow banking.
While global regulators strengthened banks after the 2008 financial crisis, now “they need to help ensure that the nonbank financial sector optimally supports the real economy over the medium term,” he said.
If there is good news, according to the Bank for International Settlements, it is that formal banks — both the origin and the amplifier of the 2008 crisis — have performed better this time around, absorbing big balance sheet inflows and meeting credit line drawdowns, in some cases with the help of regulatory easing.
“A silver lining in this sobering picture is the state of the banking system,” the report said. “The pandemic found banks much better capitalized and more liquid, thanks largely to the post-crisis financial reforms coupled with a more subdued expansion.”
The Fed released the results of its annual stress tests last week, showing that large banks in America are prepared to sustain a shock but that a substantial chunk of them — about a quarter — will bump up against or even breach their capital minimums if the economy experiences a second pandemic wave and double-dip recession.
The Fed stopped short of barring banks from paying dividends next quarter, as some lawmakers and former regulators have urged — a decision that drew public criticism from one of the Fed’s governors, Lael Brainard, who said not taking stronger measures could “impair the recovery.”
Published at Tue, 30 Jun 2020 12:37:37 +0000-A Truce, Not a Peace Treaty: A Global Economic Body Warns of Risks