When the alternative becomes the norm - Comment & Profiles -

Banks are safer but economic conditions are increasingly bizarre. Risk managers are struggling to understand the new dynamics, writes Brian Caplen.

Finnish central bank governor Olli Rehn refused to rule out the European Central Bank purchasing equities as part of its next stimulus programme in a recent interview with the Wall Street Journal. (Mr Rehn is a member of the ECB’s governing council.)

If enacted, this highly controversial move would add more fuel to global quantitative easing that has already raised asset prices to the sky. Investors terrified of an impending crash have rushed into safe-haven bonds to the extent that $15trn-worth of bonds, roughly one-quarter of the total, are now trading with negative yields. Banks that were struggling to deal with persistently low interest rates now have the further headache of coping with negative rates in some cases.  

Investment managers also face problems that are pushing them to take more risk. Traditional investment managers desperate to find returns are moving into alternative and less liquid assets that would have previously only have been touched by specialist firms. The problems that can occur when a fund holds illiquid assets have been illustrated by the suspension of the Woodford Equity Income Fund in the UK under pressure from redemptions.  

How are risk managers to make sense of these macro trends that have never occurred before? Some are using agent-based modelling as a way of understanding how a problem in one area of the market can spread across the system. The Banker looked at this approach in its March issue.

But this is still very much in the realm of blue skies thinking and is as yet untested. Smart risk managers are those who accept they cannot do scenario planning in these circumstances with any degree of certainty and content themselves with advising caution in both lending and position holding. These are indeed bizarre times. The risk manager who admits that he or she does not have all the answers is probably the one to listen to. 

Brian Caplen is the editor of The Banker. Follow him on Twitter @BrianCaplen

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