February 13, 2015 / 6:10 PM / 5 years ago

ECB warns of market froth, insufficient grip on shadow banks

COVENTRY, England Feb 13 (Reuters) - ECB Vice President Vitor Constancio warned on Friday that ultra- low global interest rates had caused “froth” in some asset prices, and that more powers were needed to control the fast-growing, non-traditional or “shadow” banking sector.

The combination of near-zero interest rates and aggressive central bank stimulus in many major developed economies were necessary at present but were also having side-effects, he said.

“The very low inflation and subdued growth environment is accompanied by some froth in financial asset markets resulting from ‘search for yield’ in an environment of low interest rates,” he said in a speech at the University of Warwick.

While the level of “froth” was less pronounced in the euro zone, Constancio said that worries about asset bubbles should not sway central banks’ thinking on low rates and stimulus.

The problems should instead be tackled in other ways, with so-called macro-prudential tools such as higher levies on certain assets and transactions to cool any overheating.

“Monetary policy cannot abandon its priorities as clearly stated in the mandate of central banks,” such as controlling inflation, he said.

“Macro-prudential policy is therefore essential in any economy as the business and financial cycles are not synchronised.”

Constancio who also oversees financial stability at the ECB, also flagged worries about the increasing role of less traditional areas of the banking system, such as hedge funds, money market funds and offshoots of the insurance industry.

In terms of assets held, the so-called “shadow” banking sector as it is known could become bigger than the standard banking industry within just five years, he said.

That meant, Constancio said, that the sector may need to be reined in more than foreseen under planned global reforms.

“The tools needed to prevent the building-up of excessive risks in that sector are currently not in the set of instruments available to the ECB or to macro-prudential authorities at large - and some need yet to be devised.

“Shadow banks could in principle be subject to direct regulations. In this context, cash buffer requirements and redemption fees or gates have already been discussed by expert groups and cannot be excluded,” Constancio said. (Writing by Marc Jones; Editing by Louise Ireland)

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