BOE's Hauser: Every Reason to Expect More Frequent Market Dysfunction
7 January 2021
By David Barwick – FRANKFURT (Econostream) – The susceptibility of market-based finance to liquidity shocks requires more appropriate tools to handle the consequent market dysfunction, Andrew Hauser, Executive Director for Markets at the Bank of England, said Thursday.
Speaking at a Reuters event, Hauser, according to a text published by the BOE, said that ‘there is every reason to believe that, absent further action, we will see more frequent periods of dysfunction in the very markets increasingly relied on by households and firms, if business model vulnerabilities persist and intermediation capacity remains strained.’
While this cannot be ignored, it is also the case that always relying on central banks to do as they did during the pandemic would imply unacceptably ‘bloated public sector balance sheets and mispriced private sector risks’, he said.
Among other things, the public liquidity insurance for which central banks will be increasingly looked to has to be put on a clear foundation, he said. In some cases, existing tools of the sort used during the most recent crisis ‘may prove poorly suited to the task, and new ways will be needed to achieve those ends, whether through outright purchase and sale operations, repo facilities or other means’, he said.
Monetary authorities must determine what assets classes are subject to what new tools that might be designed, he said. Government bonds are the most salient example, whereas ‘[f]or other, riskier, assets to qualify, a case would need to be made both that they are sufficiently core to monetary and financial stability, and that central banks can price and risk manage them effectively’, he said.
Another question is whether central bank’s use of their balance sheets to counter market tensions ‘should remain primarily discretionary, or whether at least aspects of that role should be formalised into standing facilities, the terms of which are known in advance’, he said.
Giving only banks access to the relevant tools would probably not suffice to stabilise core financial markets, Hauser said, in view of non-banks’ growing role in finance. Criteria to establish access would still be needed, however, to limit risk, grant public insurance appropriately and ensure operational feasibility, he said.
Finally, he said, ‘the terms and conditions of such facilities will also need to be carefully calibrated to ensure those same risks are effectively managed.’ This means ensuring that such central bank facilities ‘remain strictly backstops that are used when conditions become materially dysfunctional, but leave the burden of ensuring safe operation during a wide range of normal and less-normal market conditions with market participants, and the regulatory regimes they are subject to’, he said.
Such risk management also means that facilities need to be ‘naturally self-liquidating, in that they build up exposures when markets are dysfunctional, but run them down when functioning returns to normal’, he said.