The Basel-based Bank for International Settlements (BIS), an international organisation which aims to foster cooperation between central banks, has published its annual report, warning that capital markets have increasingly become out of touch with reality.
“It is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally” warns the report, which argues that the accommodative monetary policy of the previous years has created unsustainable debt levels.
According to the BIS: “Near zero policy rates and large-scale asset purchases by the Federal Reserve and other major central banks have boosted asset prices around the globe and fuelled investors’ appetite for risk.”
Based on a financial cycle analysis, the report argued that strong credit and property price growth have created a dangerous level of exposure to interest rate hikes.
At the same time, the report highlighted mixed results for the investment banking sector, while M&A activity increased, secondary market trading of fixed income products and commodities weakened.
“Early warning indicators cannot predict the exact timing of financial distress, but they have proved fairly reliable in identifying unsustainable credit and property price developments in the past” the report stated.
Despite the fact that capital ratio’s improved, it warns”Most banks grew in size but lowered the average risk weight of their asset portfolio.”
With regard to the current monetary policy, it warned that “when policy responses fail to take a long-term perspective, they run the risk of addressing the immediate problem at the cost of creating a bigger one down the road.”
Overall, the BIS urges the financial sector to develop a new long term perspective, a “new compass” to end its dependency on monetary stimulus.