COVID-19 market turmoil raises questions about central bank liquidity strategy, says BIS

LONDON (Reuters) - Market turmoil due to coronavirus lockdowns in March raises questions about whether central banks should offer access to liquidity more widely in future shocks, the Bank for International Settlements (BIS) said on Monday.

FILE PHOTO: Queen Elizabeth II is seen with printed medical masks on the Pound banknotes in this illustration taken, March 31, 2020. REUTERS/Dado Ruvic/Illustration/File Photo

The BIS, a forum for the world’s central banks, said in a quarterly review article that banks’ cross-border claims on so-called non-banks - like insurers, clearing houses, money market funds and hedge funds - rocketed by 63% to $7.5 trillion between the first quarter of 2015 and the end of March this year.

The increase in links with non-banks was concentrated at lenders in the United States, Britain, the Cayman Islands, and Japan.

“The market turmoil unleashed by the COVID-19 shock brought to the fore vulnerabilities associated with these links,” the BIS said.

It led to margins or cash requirements to back trades at clearing houses worsening swings in prices and draining banks of money at an inopportune time, the BIS said.

It also showed that money market funds, used by banks and companies for day-to-day cash management, can be “fickle” funding providers, it added.

The sheer size of non-banks and their links to lenders warrants continued monitoring by the authorities, the BIS said.

“The fact that some non-bank financial institutions face a substantially different regulatory environment compared with banks – as well as no or limited formal access to central bank liquidity or public sector credit guarantees – only heightens this need,” it added.

Central banks have said that money market funds, meant to be low risk places to hold cash, would have had to suspend themselves without central banks like the Federal Reserve providing emergency liquidity.

The article bolsters the case made by central banks that regulatory reforms may be needed to ensure that non-banks hold enough liquidity to cope better in market shocks and avoid undermining the wider financial system but stops short of specifying any measures.

Securities regulators, which directly supervise funds, have been more cautious about jumping to reforms, with broad consensus needed for a global sector.

Claudio Borio, the head of BIS Monetary and Economic Department, said it was clear there can be tension between regulators over market finance, but the question of whether additional rules were needed and possible will be looked at very closely.

“There is scope to adopt a more systemic approach to regulation of this sector which looks in particular at the impact these institutions can have on the financial system as a whole,” Borio told reporters.

Reporting by Huw Jones; Editing by Mark Potter and Steve Orlofsky