price of assets regarded as safe is on the rise, with supply dwindling and
demand rising amid uncertainty in financial markets; coupled with regulatory
reforms, and increased demand from central banks in advanced economies, the
International Monetary Fund said on Wednesday. The IMF also said that several
governments are likely underestimating the life expectancy of their ageing
populations, a risk that could boost pension liabilities by nearly 10% and add
to already massive public debt levels.
Growing demand and shrinking supply of safe assets
- - typically
predominantly government bonds - - could have negative effects on global financial
stability, according to the IMF’s latest analysis in the
Global Financial Stability Report.
To make sure these pressures don’t destabilize financial markets:
- reforms of financial regulation should gradually seek to differentiate
better across assets based on underlying risks;
- governments in danger of losing their securities’ safe asset status need to
place themselves on a sustainable debt path;
- The private sector should be encouraged to issue safe assets following
transparent and sound methods.
The global economic crisis and rising government debt concerns in some
advanced economies have shown that no asset can be viewed as truly safe, the IMF
Absolute safety—implicit in credit rating agencies’ highest ratings and
embedded in financial regulations and investor mandates—created a false sense of
security prior to the crisis.
Demand on the rise, supply scarce
Before the crisis, the excess demand for assets categorized as safe was
driven by booming emerging economies that had accumulated reserves and used
these to buy large amounts of safe assets.
Now, the demand for safe assets faces pressures due to new financial
regulations that require banks to hold more safe assets; higher collateral needs
for over-the-counter derivatives transactions or their transfer to centralized
counterparties; and the increasing use of safe assets in monetary policy
operations, such as purchases of government securities by central banks,
according to the IMF.
On the supply side, concerns about high government debts and
deficits in some advanced economies have reduced the perceived safety of
government debt. Recent rating downgrades of sovereigns, previously considered
to be virtually riskless, show that even highly-rated assets are subject to
The number of sovereigns whose debt is considered safe has fallen. IMF
estimates show that safe asset supply could decline by some $9 trillion—or
roughly 16 percent of the projected sovereign debt—by 2016. Private sector
issuance of safe assets has also contracted sharply on poor securitization
practices in the United States.
Safe asset scarcity will increase their price, with assets perceived as the
safest affected first. Investors unable to pay the higher prices would have to
settle for assets that have higher levels of risk.
Spikes and shortages
Shortages of safe assets could also lead to more short-term spikes in asset
volatility, and shortages of liquid, stable collateral. If collateral became too
expensive, funding markets would be compelled to accept lower-quality
collateral, raising funding costs.
For banks, the preferential treatment of sovereign debt in banking
regulations can allow more leverage to build up. The upward bias to
capitalization ratios can lead to an overestimation of the buffer available to
meet pressures during a time of stress. Under current regulations, banks’
holdings of debt issued by their own governments—and in the case of the European
Union, of the debt of any sovereign in the Union—are commonly assigned zero risk
Risk weights are adjustments, based on the riskiness of assets, for the
purpose of determining how much capital banks should hold. When these are set at
zero, banks can hold government debt without any required capital to cover
potential losses associated with such holdings.
Policies can help supply and demand pressures
The IMF said policy responses to the pressures in the markets for safe assets
should be implemented gradually to avoid unnecessary volatility in the prices of
The IMF also pointed out that to mitigate pressures on the demand
side, regulations and policy responses should differentiate better
across assets based on underlying risks. The categorizations of assets based on
risk should be reviewed at regular intervals to ensure that they reflect
adequately such risks. Specifically:
- For banks’ capital adequacy requirements, risk
weights on government debt should eventually reflect more accurately the
relative credit risk of sovereigns.
- For banks’ liquidity requirements, the IMF
suggested future regular revisions in the calibration of discounts,
known as haircuts, of liquid assets in the estimation of the yet-to-be
implemented liquidity coverage ratio.
- In the derivatives markets, the IMF advocated that
regulators of central counterparties ensure a sufficiently broad range
of acceptable collateral—with appropriate risk-based valuations—in
default funds, funds meant to cover losses in the event of default of a
The IMF stressed that credible plans to reduce government debt levels and
strengthen debt management over the medium term would help increase the supply
of safe assets. However, where financing conditions allow, the near-term pace of
reducing government debts and deficits needs to be mindful of the dampening
effects on economic growth.
The private sector could once again become a key supplier of safe assets.
Sound reforms and effective regulations would be needed to govern the pooling of
various types of lower-rated contractual debt into higher-rated financial
instruments, for example through securitization.
The build up of the capacity of emerging economies to issue their own safe
assets with the improvement of domestic financial infrastructure would also
alleviate the imbalances in the global markets for safe assets.
While the “price of safety” will inevitably rise, a smooth adjustment process
can be ensured if policymakers are aware of their actions and their potential
People worldwide are living 3 years longer than
expected on average, boosting the costs of ageing by 50% and governments and
pension funds are poorly prepared, the International Monetary Fund said.
Already the costs are beginning to impact
government budgets, particularly in advanced economies where by 2050 the elderly
will match the numbers of workers almost one for one. The
IMF study shows that the problem is global and that longevity is a bigger
risk than thought.
"If everyone in 2050 lived just three years
longer than now expected, in line with the average underestimation of longevity
in the past, society would need extra resources equal to 1 to 2% of GDP per
year," it said in a study to be released in its World Economic Outlook next
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