Bundesbank Warns Market Calm Hides Risks in Yield Search

New risks to financial stability could emerge from the combination of generous central bank policies and investors’ search for yield in a low-interest rate environment, Bundesbank board member Andreas Dombret said.

“We do see risks, despite the fact that the markets are calm,” Dombret said in an interview in Frankfurt yesterday. “Real-estate markets in some European countries are pretty high, corporate bond valuations seem stretched and high. The low volatility leads to market participants thinking that they don’t need to hedge.”

Record-low yields on debt from Spain to Ireland are adding to evidence that investors are leaving the euro area’s debt crisis behind them, and Germany’s DAX (DAX) Index of stocks is near an all-time high. Even so, consumer prices are proving slow to pick up, prompting the European Central Bank to consider adding yet more stimulus as soon as next month.

A risk measure that that uses options to forecast fluctuations in equities, currencies, commodities and bonds fell to its lowest level in almost seven years last week. Bank of America Corp.’s Market Risk Index dropped to minus 1.22 on May 14, the lowest level since June 2007. The measure was at minus 1.19 yesterday.

Leverage Ratios

Dombret, 54, will this month take charge of banking and financial supervision at Germany’s Bundesbank, after previously leading the financial stability department. His new role gives him a seat on the ECB’s Supervisory Board, which will be responsible from November for overseeing about 130 euro-area banks.

A challenge facing the ECB is bringing order to the array of models for assessing risk deployed by the region’s lenders. Dombret said regulators shouldn’t attempt completely to harmonize those models.

“If we unify risk models this could lead to herd behavior, with all those negative effects, and would also exclude the institute-specific measures, which are important for diversity,” he said. “I am a big believer in continuing to use risk models, and counter-checking them with leverage ratios.”

Lenders will be required to have capital equivalent to at least 3 percent of their assets, without taking into account the riskiness of their investments, according to rules formulated by the Basel Committee on Banking Supervision, a group of regulators. Banks will be required to disclose how well they meet the rule from 2015, with the measure slated to become binding in 2018. The committee softened rules on calculating the leverage ratio in January.

Banking Union

The ECB’s Single Supervisory Mechanism is the first pillar in a planned European banking union that aims to decouple the fate of lenders from government finances, a connection that was key to the severity of Europe’s debt crisis. Banks held large quantities of sovereign debt that fell in value when governments struggled with their fiscal position, causing lenders to pull back on credit supply for the real economy.

The banking union, including a mechanism for resolving failed lenders, will help to restore faith in the system, said Dombret, who has been on the Bundesbank’s board since May 2010 and has sat on the Financial Stability Board at the Bank for International Settlements in Basel, Switzerland. The job is still incomplete, he said.

More Work

“Ever since the Lehman crisis, a lot of work has been done,” he said, referring to the 2008 collapse of Lehman Brothers Holdings Inc. “But could we exclude the failure of a bank? If it’s really too big to fail, without making taxpayers pay, we’re not quite there yet.”

Dombret said global rule-makers need to do more to ensure banks have enough instruments to absorb losses in the event that they fail completely. So-called gone-concern loss-absorption is part of the Group of 20’s current work program for financial-sector reform.

“This is something that is very high up on the reform agenda of supervisors and the Financial Stability Board is working on this,” he said. “I am confident that we will get there at some point.”

To contact the reporter on this story: Jeff Black in Frankfurt at jblack25@bloomberg.net

To contact the editors responsible for this story: Craig Stirling at cstirling1@bloomberg.net Paul Gordon, Angela Cullen

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