Loose global monetary conditions are stoking credit and asset price booms in some emerging markets that could lead to a new financial crisis, the Bank for International Settlements (BIS) warned on Sunday.
Such a boom-and-bust cycle might have severe global repercussions, not least due to the increased weight of emerging markets in the world economy and in investment portfolios, the BIS said in its annual report.
It urged central banks to pay more attention to the global spillovers from their domestic policies, an echo of complaints from Brazil and others that the ultra-loose monetary stance in older economies has touched off large, destabilizing flows of capital into emerging markets in search of higher yields.
“This creates risks of rising financial imbalances similar to those seen in advanced economies in the years immediately preceding the crisis,” the BIS said.
Credit growth that is well above its long-term trend in relation to economic growth opens up a gap that has often presaged serious financial distress when it has exceeded 6 percent in the past, the report said.
Asset prices also look increasingly frothy in many emerging economies, the BIS said. In some local Brazilian markets, real-estate prices have almost doubled since the subprime crisis. Prices in some Chinese cities have risen even faster.
High debt loads could be a problem, too. The fraction of GDP that households and firms in Brazil, China, India and Turkey are allocating to debt service stands at its highest level since the late 1990s, or close to it, even though interest rates are low.
The BIS said that emerging market central banks were nursing a policy headache: Raising interest rates might attract even more capital inflows and thus fuel domestic credit growth.
As a result, it said, monetary policy in emerging markets may be systematically too loose.
“One way out is to accompany higher interest rates with macroprudential measures, such as higher capital ratios or tighter loan-to-value ratios. Even if these tools fail to slow credit growth significantly, they should at least reinforce the financial system against the consequences of a credit bust,” the BIS said.
The BIS — an intergovernmental organization of central banks based in Basel, Switzerland — said it was key for governments to make banks take responsibility for their losses and force them to rebuild their finances.
“The world is now five years on from the outbreak of the financial crisis, yet the global economy is still unbalanced and seemingly becoming more so as interacting weaknesses continue to amplify each other,” the BIS said in the report. “The goals of balanced growth, balanced economic policies and a safe financial system still elude us.”
Stephen Cecchetti, the head of the BIS’s monetary and economic department, said central banks should not be expected to carry the entire load of supporting growth and debt reduction.
“In the middle of all this, we find the overburdened central banks pushed to use what power they have to contain the damage, but there are very clear limits to what central banks can do,” he said.
The report emphasized the need to increase the safety of the banking system by pushing banks to be responsible for their losses, add to their financial buffers and avoid risky practices. It added that big banks still have an interest in using high-risk debt — so-called “leveraging” — to magnify any trading gains because they can expect taxpayers to step in and cover their losses if things go bad.