Bond markets in the U.S., U.K. and Europe are signaling rising odds of a global recession. However, we are in unchartered territory. Financial institution risk managers urgently need to evaluate their risk models in order to mitigate credit, market, liquidity, and operational risks.
, had the 10-year German bund yielding less than a 3-month Germany treasury.
The rising odds of a global recession means that risk managers need to do more to measure their credit, market, operational, and liquidity risks in order to recalibrate their risk models. The model results should lead risk managers to focus on what assets to sell to reduce risks, enhancing internal controls, and likely changing derivatives positions that mitigate credit and market risks.
What should worry risk managers is that we are in unchartered territory. According to Sven Henrich, founder and lead market strategist for NorthmanTrader, “We’ve never faced a recession with so much debt and so little Fed ammunition available.” I agree with him that “With negative rates still in effect in many places, there’s no playbook for this. Historical data will be of little use.
The rising odds of a recession also means that financial institutions should increase their capital buffers to help them sustain unexpected losses. Banks, pension funds, and insurance companies have regulatory or legal requirements that will make them more attune capital deteriorating; non-banks tend to have lighter requirements so they could present a bigger challenge to the safety and soundness of the financial system.
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