The Bank for International Settlements — known as the the central banks’ bank– issued its annual report earlier this week. And boy, was it a downer. It was full of gloomy remarks, for example, “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.” It’s tempting to shoot the messenger, but unfortunately my Google Reader feed is full of other articles and commentary that basically tell the same story.
Stepping away from the macro view, the BIS is also very bearish on the state of the banking industry.
[T]he cost of buying compensation for a bank default (the spread on bank credit default swaps) is as high now as it was at the peak of the crisis, and bank equities continue to lose ground relative to the broad market. Despite the progress on recapitalisation, many banks remain highly leveraged, including those that appear well capitalised but in fact have outsize derivatives positions. Big banks continue to have an interest in driving up their leverage without enough regard for the consequences of failure: because of their systemic weight, they expect the public sector to cover the downside.
Another worrying sign is that trading, after a brief crisis-induced squeeze, has again become a major source of income for large banks. These conditions are moving the financial sector towards the same high risk profile it had before the crisis. Recent heavy losses related to derivatives trading are a reminder of the dangers associated with such a development.
Solutions? Not many could be found within the report’s 200 pages.