In a letter to the G20, Financial Stability Board chairman Randal Quarles warned that a toxic combination of high corporate debt and a disconnect between investor sentiment and economic fundamentals could lead to a repeat of the volatility that rocked markets in March.
“We cannot be complacent,” Mr Quarles said. “The crisis is far from over and we must not lose sight of the hard work we must do together to support global recovery. We also must not close our eyes to the lessons of this crisis.”
Mr Quarles also warned that extraordinary measures taken by central banks to ease the liquidity crisis – including the Fed’s reinstatement of its overnight repo program and the RBA’s historic move into quantitative easing – could not be the norm.
“The impact of the COVID [event] on credit markets has highlighted vulnerabilities in the non-bank financial intermediary… and investor behaviour related to certain funds that they may treat as cash equivalents during economic calm but not during crisis,” Mr Quarles wrote. “While extraordinary central bank interventions calmed capital markets, which remained open and enabled firms to raise new and longer-term financing, such measures should not be required,” Mr Quarles said.
Mr Quarles said that the reforms undertaken by regulators in the wake of the GFC mean that banks were able to “absorb rather than amplify” the financial shock despite the fact that shock originated outside the financial sector, while central bank action had proved that markets were responsive to “quick and decisive” policy actions.
“Notwithstanding actions on this unprecedented scale, further liquidity stresses remain a risk. Volatility in markets has decreased but may well return,” Mr Quarles said. “The impacts of these economic strains may be amplified in emerging markets, given the risks to their currency and debt markets from capital outflows.”
