Liquidity issues returning to the fore

Liquidity risk was the top risk keeping risk managers awake at night in 2008 but has since fallen down the list of priorities. Maybe banks have improved the stability of their funding driven by impending Basel III liquidity rules but maybe unknown unknowns lie ahead.

The chart below, based on data from Bankscope, highlights that median loan to deposit ratios for Eurozone banks remain high.

Jamie Dimon warned of reduced market liquidity in his annual letter to shareholders – when he previewed the causes of the next financial crisis. He cited increased regulation such as the Volcker rule and the leverage ratio (a hefty 6% for large American banks) as the prime reason for banks holding lower portfolios of debt securities and thus being less able and willing to absorb market stress. The IMF is also worried as evidenced by its study of systemic risk in asset managers in its April 2015 financial stability report. In theOctober 2015 report, the IMF takes the analysis further to review the impact of liquidity stress on both markets in general and emerging markets and banks in particular. It is 18 years since the withdrawal of liquidity caused the Asian banking crisis in 1997 – high time for the typical 17 – 20 year cycle of banking crises. Most Asian banks and economies enjoy surplus liquidity nowadays but there are pockets of concern.

Slide1Martin Wolf at the FT tells bankers to stop whingeing about the impact of regulation and reminds us that interbank and general bond market liquidity was unreliable even before tighter regulations were introduced. His advice to bankers and investors is sound – “markets characterised more by longer-term commitments, and less by hopes of finding “greater fools” willing to buy at all times”, might be better for most of us”.