November 8, 2011 / 4:41 PM / 9 years ago

UPDATE 3-World on cusp of liquidity retrenchment - FSB boss

* Carney urges EU banks to limit asset sales

* Authorities ready to act to offset liquidity swing

* Recent steps should prevent Lehman-style collapse

* Says Asians may want to draw on foreign reserves

* Sees no euro crisis impact on Canada funding market yet

By Louise Egan and Naomi Tajitsu

LONDON, Nov 8 (Reuters) - LONDON, Nov 8 (Reuters) - The new global financial regulatory policeman, Mark Carney, warned on Tuesday the world was “on the cusp of another retrenchment” in liquidity and urged careful management of European bank recapitalization.

In his first speech as head of the Financial Stability Board, the body responsible for implementing reforms to financial regulations, Carney, who also heads the Bank of Canada, urged European banks not to rely solely on asset sales to meet new international capital requirements.

The combination of bold moves by the European Central Bank and four trillion euros in unencumbered collateral at European banks should ensure that there is no European equivalent of a Lehman Brothers collapse, he said.

But the withdrawal of global liquidity as European banks deleverage needs to be well managed in order to limit the effects on the economy, said Carney. He predicted “at least” a brief recession in the euro area.

“As global liquidity recedes, volatility is increasing and activity falling. The effect on the real economy will soon be felt,” he said in the prepared text of a speech he was delivering in London.

He said the severity of the downturn will depend in part on how European banks raise new capital. Under new rules they are required to bring the key measure of core capital, known as Tier 1, to 9 percent by next June.

“One way European authorities could reduce these spillovers is to require European banks to meet at least part of their (new capital) requirements by raising private capital, including high-trigger contingent capital.”

Contingent capital normally refers to bonds held by banks that they can convert into equity if they are about to fail. The “high trigger” version is an instrument that can raise equity before that point is reached.

Avery Shenfeld, chief economist at CIBC World Markets, said Carney was suggesting European authorities did not go far enough with their rules for banks.

“Carney is implicitly pointing out a flaw in what Europe announced recently in terms of trying to deal with its banking system,” Shenfeld told BNN television in Canada.

“He’s really saying, not only should we have required the European banks to have a certain ratio or target (for capital), but also to require them to do it a certain way, which is to add capital rather than to cut back on lending.”

Less lending by banks would dampen the economic recovery.

Another way of mitigating that effect would be to conduct currency swaps to provide more foreign currency liquidity, such as those led by the U.S. Federal Reserve during the recent crisis.

Carney said major central banks could also resurrect liquidity facilities implemented during the worst of the downturn. He noted the Bank of Canada had doubled its balance sheet in response to the recent global recession, and “we stand ready to take similar steps if the international spillovers of the European situation prove severe.”

Turning to Asia, he said: “Now may be a time for Asian authorities to draw on official reserves to offset the withdrawal of private liquidity.”

During a question-and-answer session, Carney reiterated his view that International Monetary Fund remained the best institution to redistribute global liquidity.

He said that given the possibility of a liquidity shock, there could be a case for enhancing the IMF’s resources, while adding that arguments for such a case had yet to be made.


Carney said deleveraging by European banks was having an impact on Canada’s economy, adding that this was one of the reasons why the Canadian central bank had reduced its economic forecast for the country.

But speaking to reporters, he added that the euro zone debt crisis had yet to damage funding conditions in Canadian markets.

“The issue ultimately, for Canada, is about the scale of global financial contagion, spikes in risk premia,” he said.

“We have not seen that in Canada. Obviously we are watching the situation very, very closely, first and foremost in terms of the impact on Canada.”

Carney was endorsed by the G20 last weekend as the new chair of the Financial Stability Board. He said once the G20’s financial regulatory reforms are implemented, there will be less volatility in global liquidity.

He said that one of the FSB’s top priorities under his watch will be to regulate and enhance supervision of the shadow banking sector.

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