Bank of England’s financial policy committee voices concern about exchange traded funds
A spending spree by international investors on commodities using exotic financial instruments could pose huge risks for the global financial system, according a senior Bank of England official.
Financial regulators should be alert to the potential for destabilising asset bubbles posed by new financial products that are growing in demand as investors seek higher returns in a low interest rate environment, said Paul Fisher, one of the bank’s senior watchdogs.
Although markets had been on the mend since the financial crisis in 2008, the eurozone debt crisis, coupled with uncertainty about the economic recovery and the progress of banking regulation, could undermine efforts to rebuild the financial system on a more sustainable footing, Fisher said.
He saw little evidence of “excessive risk-taking on a generalised basis” across the financial system. But he warned: “The intelligence we have gathered during 2011, notwithstanding the recent pull-back in June, has flagged a number of pockets of increasing risk appetite and a few specific markets which have been showing signs of excess.”
Exchange traded funds (ETFs) have become a particular focus of anxiety for regulators, who believe they could pose greater risks than are properly understood by many investors.
Britain’s new financial policy committee (FPC), which is housed in the Bank and counts Fisher as a member, voiced fears at its first meeting last week about the increasing popularity of ETFs, which it described as being shrouded in “opacity and complexity”.
ETFs, which track specially created market indexes, are being used as investors try to bolster returns. The market has grown quickly and is estimated to be worth $300bn (£190bn).
The FPC said it was concerned that ETFs “could become a source of risk to the system as the market evolves”. Sir Mervyn King, governor of the Bank, described ETFs as a “contributory factor” to the “tangled web” of risk in the financial system.
Fisher told a gathering of institutional investors: “The macro-prudential concern is that the reach for yield encourages financial innovation and growth in some parts of the financial system where the risks are not well understood, especially if it leads to greater interconnectedness within the banking system.”
He said: “This is one area which is likely to warrant further attention and analysis by the FPC in due course.”
The warning came as Bank of England figures showed a distinct lack of appetite among British businesses and households to borrow money.
The bank’s credit conditions survey showed that lending over the past three months was largely flat. A small increase in demand for house purchase borrowing reflects the subdued nature of the housing market, which showed a modest rise in values last month after a fall in May, according to the Nationwide building society.
The main area of strong growth in demand was for buy-to-let mortgages, said the Bank. In its monthly survey, it said the popularity of buy-to-let purchases had risen “substantially in the second quarter and was expected to increase in the third quarter”. Demand among small and medium-sized businesses also increased, though larger firms, which are known to be flush with cash, had little requirement to borrow.
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