Andrew Haldane and the race for safety by investors

In a fascinating speech given to the Institute for New Economic Thinking, the Bank of England's Andrew Haldane looks at the race for safety and how it is effecting the funding of Eurozone banks.

Specifically, he observes that in refinancing the $1.1 trillion in unsecured debt that is coming due this year, most of this debt is being replaced with secured debt.  A major contributor to this is the ECB's Long Term Refinancing Operation.

However, the central bank is not the only source of funding requiring security.

Investors are asking why they should refinance on an unsecured basis when more and more of the bank's balance sheet is becoming encumbered.

This is a feedback loop with positive reinforcement.  The more the bank balance sheet is encumbered, the more the unsecured investors want to race for safety and become secured lenders too.

The question is how to stop this race for safety.

Mr. Haldane proposes that a macro prudential solution that will make a difference is required and that this solution must be explicitly applied across the entire banking system.

An example of such a solution is a restriction on how much of a bank's balance sheet can be encumbered.

Readers know your humble blogger prefers that the solution is that banks are required to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.

Market participants need this information if they are going to be able to assess the riskiness of holding unsecured debt in a bank.