Oct 21, 2019

Bank heads warn of looming liquidity crisis

Ron O'Hanley, president and chief executive officer of State Street Corp., at a House Financial Services Committee hearing on April 10, 2019 in Washington. Photo: Alex Wroblewski/Getty Images

A growing number of market analysts are voicing concerns that the repo market shock in September may have been the first signal of a wide-ranging liquidity shortage, and now those warnings are being echoed by the heads of major banks.

The state of play: "Despite the fact that bank balance sheets are quite strong, I think you’ll see more moments like this going forward," Ron O'Hanley, president and CEO of State Street, said during the Institute of International Finance's annual membership meeting on Saturday.

What's happening: Even with the Fed's commitment to pump $60 billion a month into financial markets, there still may not be enough funding because of regulations, changes to market structure, and banks' desire to keep their reserve levels high.

  • Strategist from JPMorgan, Goldman Sachs and Bank of America sent recent notes also warning of the funding issues.
  • Additionally, the increase of passive investments and major flows from pension funds and large asset managers into private equity funds is drying out typical sources of liquidity to the stock market and could mean major outflows in the face of bad news.

What they're saying: Brian Porter, president and CEO of Scotiabank, said he also is worried about the health of the so-called shadow banking sector — firms that are not banks but lend money to consumers for things like auto loans or home mortgages and aren't subject to the same regulations.

The shadow banking sector is largely private and little is known about how much money the insurance companies, hedge funds, private equity funds and payday lenders that make up the industry actually have.

  • "Regulators have been very successful in distributing risk," O'Hanley said. "It’s now been very much deconcentrated. But it hasn’t gone away; it’s been moved."

Don't sleep: IIF president and CEO Tim Adams likened it to the market for mortgage-backed securities before the housing bubble burst in 2007, triggering the global financial crisis.

  • "We used to make the same case on securitization of mortgages — that we could slice them and dice them and we distribute risk globally and it was a safer system because it was distributed," Adams said.
  • "We found out that wasn’t necessarily the case."

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