Bank for International Settlements worried about financial system

As speculation on Wall Street and other stock markets advances, researchers and analysts continue to delve into the events of March 2020 when global financial markets collapsed at the start of the pandemic and had to be rescued by a massive intervention by the US Federal Reserve.

So far, while some of the causes of the collapse, centered on the $ 22 trillion US Treasury market, have been identified, no solutions have been put forward.

The latest institution to examine the crisis is the Bank for International Settlements (BIS), the umbrella organization of central banks, which published a major analysis in its quarterly review published earlier this week. He called for tighter regulation of non-bank institutions, especially bond funds, which have played an increasingly important role in global financial markets over the past decade.

A graphic on the BIS website (

Much of the review consists of highly technical details about the operations of the financial system, but the findings of the analysis were clearly summarized in a foreword by Agustin Carstens, the managing director of the BIS.

He began by noting that non-bank financial intermediaries (NBFIs), such as bond funds and hedge funds, have “massively increased their footprint” since the global financial crisis of 2008. This largely unregulated non-banking sector is estimated to be largely unregulated. now accounts for almost half of all financial assets.

Carstens said these institutions offer a wide range of investment and funding opportunities and represent a “healthy source of diversity” in funding.

At least that’s the case when the markets are functioning normally and things seem to be going well. It’s a whole different story when they’re not.

“When the going gets tough,” he continued, “NBFIs can trigger or amplify market stress.” This was the case at the start of the pandemic.

“In March 2020 and during previous episodes of market turmoil, the NBFI sector has amplified stress due to inherent structural vulnerabilities including liquidity mismatches and hidden leverage. With the stability of the entire system threatened, massive central bank support was needed to restore calm. These repeated occurrences suggest that the status quo is unacceptable. “

Carstens said fundamental adjustments are needed in NBFI’s regulatory framework to make it fit for purpose.

In his summary of the March 2020 crisis, when the US Treasury market, the basis of the global financial system froze – at one point there were no buyers for US government debt – Carstens pointed out one of the fundamental contradictions of all capitalist markets. That is, what may be rational behavior for an individual participant may be irrational for the system as a whole.

When looking at the system as a whole, it was necessary to zoom out on the trees and consider the forest, he said.

“The overall system can be unstable even though individual establishments, viewed in isolation, may appear stable. In other words, actions that seem prudent from the point of view of individual institutions can destabilize the system. “

This is what happened in March 2020. Faced with investor redemption requests, the NBFIs attempted to obtain liquidity by selling assets under conditions where all sought “the advantage of the first come”, c that is, moving before others decide to do the same. The process was similar, Carstens noted, to a run of depositors on a bank.

Faced with actual or threatened withdrawals, fund managers tend to accumulate cash or liquidate assets.

“But what is prudent in their view has potentially negative repercussions for the system” and protecting the viability of individual funds “exacerbates the system-wide liquidity shortage.” These mechanisms “were in play in March 2020”.

The BIS review also noted that concerns about financial stability were on the rise in the world of cryptocurrencies or what it called decentralized finance (DeFi).

Carstens noted that, in what he called the crypto ecosystem, the problems so far have mainly come in the form of frequent and large price drops:

However, the danger should not be underestimated because “as history confirms, anything that grows exponentially is unlikely to remain self-sufficient and therefore deserves the greatest attention”.

As noted in the body of the review, if DeFi were to become mainstream, “its vulnerabilities could undermine financial stability.” And the disruptions could be severe “due to high leverage, liquidity mismatches, integrated interconnection and lack of buffer such as banks.”

The massive borrowing contracted by the IFNBs is also a source of destabilization. The archetypal example is the use of leverage by hedge funds and asset managers to purchase securities with borrowed funds. This included the use of repos – very short-term, often overnight purchases of cash – which are used to fund bets in financial markets.

“More recently,” Carstens noted, “leverage has also become high and pervasive in the DeFI world. In such a context, decreases in prices and increases in measured risks may cause the lender to request a loan or charge a higher discount, leading to a forced sale. “

Leverage was also pervasive in private markets which have gained ground in recent times. Here, risk taking is procyclical. That is, investments increase when stock markets are doing well and liquidity is plentiful, but increase instability when a downturn occurs.

“Such risk-taking has contributed to the recent build-up of debt in the system as a whole and may have broader implications for financial stability, not least because banks fund private market operations and investors.”

The thrust of the policy prescriptions outlined in the review was a call for greater regulation of NBFIs.

But here, Carstens was forced to recognize big hurdles, especially in the case of the crypto world, or DeFi.

“Regulatory challenges can seem overwhelming in the case of DeFi, which is designed to avoid central oversight and rule-making,” Carstens wrote.

However, the problems facing potential regulators do not end there as financial markets respond to increased controls by seeking new strategies to circumvent them. Carstens described the regulatory efforts as a “continuing effort” and the task has “no clear start and no clear end.”

“People inevitably want higher returns and higher cash flow. The financial system will try to deliver, in part by adapting to regulations [that is, seeking to get round it] as it evolves. All of this inevitably raises system-wide risks, ”Carstens wrote.

Recent history provides a graphic example of this process. After the 2008 global financial crisis, which focused on banks, new regulations were introduced in the United States, which somewhat restricted their activities in the Treasury market.

But these actions only led to the growth of NBFI activity which played a major role in the crisis of March 2020, and are now at the center of the persistent threat of another collapse.

Ongoing reports on the fragile state of the global financial system, including the latest BIS review, have major implications for the struggles of the working class.

First, they reveal the essential driving force behind the homicidal policies of all capitalist governments in relation to the COVID-19 pandemic. Their fear, as was revealed so clearly at the start, is that any meaningful, science-based public health action will precipitate a collapse of the financial house of cards.

Second, they clarify that at any time an adverse event in the financial system, such as a misplaced bet by a hedge fund or other financial institution, could trigger a chain reaction, causing the entire system to collapse. with untold economic consequences, including depression and mass unemployment.

No reform is waiting to be implemented. The only viable prospect for the working class is the struggle for political power as the first step in rebuilding the economy on socialist grounds, starting with the public ownership of the entire financial system under democratic control.

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Don F. Davis