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Moody’s reports: Global banking fears exaggerated

Fears of a global banking systemic crisis remain exaggerated, despite the most recent events, given that the ‘core’ of the system is still comfortably shock-resistant. However, the ongoing resilience of the system may remain more dependent on episodic liquidity assistance from central banks than originally thought, says Moody’s Investors Service in a new report entitled “Banking Systemic Fears Are Exaggerated -- Vanishing Liquidity in An Abundantly Liquid World”.

The events of recent weeks - which featured some small-size bank casualties in Germany and large scale interventions by several central banks to restore orderly conditions on money markets - potentially cast into question Moody’s contention, outlined in a report published last month, that fears of global banking systemic risk were exaggerated. Nonetheless, Moody’s believes that the intensity of the crisis will depend whether or not the ‘core’ financial institutions - the pillars of the system - are shock-resistant.

“Notwithstanding the possibility of a severe depression of earnings attributable to asset impairment, higher funding costs and lower business volumes, our long-held view that the largest and most sophisticated US and international financial institutions have a high pain threshold remains unchanged,” explains Pierre Cailleteau, Moody’s chief international policy analyst and author of the report. “Isolated casualties, if they happen, are therefore much more likely to occur at the periphery, among smaller institutions that may or may not be assisted depending on their respective countries’ aversion to bank failures,” Cailleteau adds.

That having been said, Moody’s acknowledges that the nature of today’s global financial system - in which risks are dispersed - while it has favorable implications in terms of the solidity of the pillars of the system, also fuels anxiety at times of stress -- and results in a system as a whole that is vulnerable to confidence shocks and, by extension, liquidity shocks. “Therefore, although systemic risk is very likely to be avoided because the core financial institutions are able to absorb losses, the system may remain dependent on episodic market ‘peace-keeping’ operations carried out by central banks - which may become an enduring feature of our global financial system,” Cailleteau says. “The anxiety over where risk coagulates in a largely opaque and leveraged system may have made the system more prone to confidence shocks, sometimes affecting indiscriminately banks, and therefore requiring more frequent market-stabilizing operations”.

With regard to the inevitable debates about the timing, magnitude and cost of these operations, Moody’s believes that the cost of a premature market-smoothing operation is minimal when compared to the widespread damage that would be caused by a potential money market dislocation. (