The thing that made banks safer has made the market riskier

Everyone is talking about bond market liquidity — and what would happen to it in the event of a crash.

Post-financial crisis regulations has forced banks to become better capitalised and amass larger amounts of liquid assets. That has made them less-risky institutions.

That though means that they won’t be able to step in when bond prices start falling and act as a shock absorber.

“They’re very well positioned to survive the crisis. Help in a crisis is a very different thing,” said Goldman Sachs’ head of global investment research, Steve Strongin, in a company podcast.

The fear is that in a volatile market investors may not be able to sell bonds, pushing prices down further and sending yields spiraling upwards.

Strongin said that to actually help in the event of a crisis, banks would need spare balance sheet capacity to take on risk trades for other market participants.

The thing is, they just don’t have that spare capacity anymore. New financial regulations require them to “optimise” their capital and balance sheet usage very carefully, he said — more so in than in the pre-crisis years.

“So while they’re much safer institutions,” he said, “they actually will be of less use to the overall market in a crisis.”

That means that the very thing that made the banks safer has made the bond market more dangerous.

Listen to the full interview here »

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