Earlier in the week I mentioned a report from the Bank for International Settlements (BIS). That report explicitly warned about the risks of a rising US dollar to debt markets, especially emerging market non-financial borrowers. But there was another item in the report of interest to UK investors.
A full explanation of the leverage ratio is beyond the scope of today’s e-letter. But the BIS is essentially talking about how much risk banks can take. By raising the leverage ratio from 3% to 5%, it hopes globally systemically important banks will be more prudent in their risk taking. Combined with capital requirements from Basel III regulations, the whole suite of controls is designed to prevent ‘the next Lehman Brothers’.
According to the report:
“The models used [by banks] to generate the risk weights may understate risk. That is, measured risks tend to become artificially compressed in times when credit spreads are tight, defaults are rare and volatility is low. In addition, models may provide incentives for ‘gaming,’ by making assumptions that are hard to verify and result in artificially low risk weights.”
It sounds pretty wonky. But the nub of the issue is that no one really knows how banks will fare if and when the next credit crisis hits. Of course I’m assuming there will be a ‘next credit crisis.’ With $57trn in debt added to the global tab since 2009, and interest rates at 5,000 year lows, it’s hard to imagine there won’t be another crisis. The only question is when.
For investors, 2016 is about balancing the risk of getting blindsided by the next crisis and having to do something with your money. The consensus of the panel is that a balance between growth stocks and value is about the only sensible strategy. Otherwise, you can head for the hills and watch civilisation fall down around itself.
What did you think about The War on Cash?
One last note. Tim Price has been autographing copies of his monograph The War on Cash. If you’ve ordered your copy and read it, let me know what you think. Send comments and your review to [email protected].
Category: Central Banks