The demise of demise of risk-free investing, as highlighted by the IMF’s latest stability report, is a worrying trend for an industry that relies on safe assets, says Reactions’ contributing editor Garry Booth.
The International Monetary Fund’s latest Global Financial Stability Report includes a chapter that will make interesting reading for the bosses of big insurers and reinsurers. It is to do with the demise of risk-free investing, a worrying trend for an industry that relies on safe assets.
The IMF’s analysis notes that the price of assets regarded as safe is on the rise, with supply dwindling and demand rising amid uncertainty in financial markets, regulatory reforms, and increased demand from central banks in advanced economies.
It adds that the growing demand and shrinking supply of safe assets, predominantly government bonds, could have negative effects on global financial stability.
The global economic crisis and rising government debt concerns in some advanced economies have shown that no asset can be viewed as truly safe, the IMF said.
Absolute safety implicit in credit rating agencies’ highest ratings, and embedded in financial regulations and investor mandates, created a false sense of security prior to the crisis. Before the crisis, the excess demand for assets categorized as safe was driven by booming emerging economies that had accumulated reserves and used these to buy large amounts of safe assets.
Now, the demand for safe assets creates pressures due to new financial regulations that require banks to hold more safe assets; higher collateral needs for over-the-counter derivatives transactions or their transfer to centralized counterparties; and the increasing use of safe assets in monetary policy operations, such as purchases of government securities by central banks, according to the IMF.
On the supply side, concerns about high government debts and deficits in some advanced economies have reduced the perceived safety of government debt, however. Recent rating downgrades of sovereigns, previously considered to be virtually riskless, show that even highly-rated assets are subject to risks.
The number of sovereigns whose debt is considered safe has fallen. The IMF estimates that safe asset supply could decline by some $9 trillion, or roughly 16 per cent of the projected sovereign debt, by 2016. Private sector issuance of safe assets has also contracted sharply on poor securitization practices in the US....MORE