Financial Stability Board Warns Sharp Market Adjustments May Expose System Vulnerabilities

By Geoffrey T. Smith

Large movements in interest rates could threaten the postcrisis economic peace, the Financial Stability Board said Monday. The world’s financial system is in better shape now than it has been in some time, thanks to the raft of overhauls that regulators have pushed through since the 2008 crisis. However, the FSB, which coordinates the global regulatory response to the crisis on behalf the Group of 20 largest industrial and emerging economies, warned that the system could again come under stress in the form of “sharp adjustments in interest and exchange rates.” “Some emerging markets may experience a combination of slower growth, capital outflows and higher borrowing costs which may expose vulnerabilities,” the FSB said in a press release after a plenary meeting in London. Although it didn’t spell out the source of such a shock, economists are concerned that the central banks of some major economies such as the U.S. and the U.K. may have to raise interest rates earlier than currently predicted as their recoveries gain momentum. FSB Chairman Mark Carney said the group had made good progress on the central plank of its policy agenda, ending the threat of banks that are “too-big-to-fail.” Progress on this issue has been slow, owing to the difficulty of persuading individual regulators to cooperate effectively in cleaning up a failed bank with business in multiple countries. The FSB is due to present a set of proposals to the G-20′s leaders at a summit in Brisbane in November. On the issue of how to treat derivatives in a cross-border resolution–a particularly thorny issue–Mr. Carney said the FSB would ask the financial industry to come up with a solution by September. Regulators have tried to persuade the International Swaps and Derivatives Association, or ISDA, to revise the terms of a master agreement governing derivatives contracts so as to suspend derivatives claims on a failed bank until it is clear how the institution can be resolved. ISDA argues that the idea is unworkable. Mr. Carney said that the desire to let the industry work out a “contractual” solution to the problem didn’t represent a lessening of the FSB’s ambition. “The mandate is there – to move this out of the technical and into the practical,” he told a press briefing. Elsewhere in the briefing, Mr. Carney noted that the FSB is still “dead set” on creating a global capital standard and minimum capital requirements from the world’s largest insurers, despite the industry’s protestations that they don’t represent the same kind of threat to the financial system as global banks. “There are risks in the non-traditional businesses of some of the insurers, especially among the largest groups, and they are very, very large,” Mr. Carney said. When asked whether Russia, one of the FSB’s 24 member nations, had raised the issue of potential threats to financial stability from an escalation of the western sanctions on it following its annexation of the Ukrainian region of Crimea, Mr. Carney confirmed that “there was a discussion of geopolitical risk” but declined to elaborate. So far the sanctions have had little direct impact on the financial system, being targeted at individuals rather than institutions.

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