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Thursday, April 12, 2012

IMF: New Regulations Make Safe Assets Scarce, Undermining Financial Stability

A recent IMF report warns that an increasing scarcity of safe assets pose a threat to financial stability. The report notes that new regulations are pushing up banks demand for safe assets. At the same time, sovereign debt crises are reducing the number of governments that can issue safe debt. The report notes that the regulations, aimed at creating financial stability, could instead undermine it. “Safe asset scarcity could lead to more short-term volatility jumps, herding behavior, and runs on sovereign debt,” warns the IMF.

The IMF finds $74.4 trillion in potentially safe assets today. These assets include gold, investment grade government and corporate debt, as well as covered bonds. The report warns that this figure could fall by up to 16 percent, or $9 trillion, by 2016. The report also notes that new liquidity rules for banks could push up demand for safe assets by $2 to $4 trillion.

The following factors are expected to have the largest impact on bank’s demand for safe assets:

Basel III – Under Basel III banks must increase their government debt holdings to meet the liquidity requirements of the Liquidity Coverage Ratio (LCR).

Regulatory Risk Weighting – The removal of a zero percent risk weighting for sovereign debt will increase the safe assets that banks need to hold.

OTC Derivatives Regulations - Moving a large number of OTC derivatives to central counterparties (CCPs) will require higher initial margin and contributions to guarantee funds that reside at the CCPs. This will push up demand for safe assets.

IMF Global Stability Report

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