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Macroprudential regulators lack tools to address corporate debt risk: Knot

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Macroprudential regulators lack tools to address corporate debt risk: Knot

Macroprudential tools, used by central banks and other regulators to manage financial risks to the economy, are not designed to deal with threats emanating from corporate debt markets, said Klaas Knot, FSB vice chair and president of the Dutch central bank.

"Most of the macroprudential instruments we have actually are related to housing markets, and banking and consumer finance, but not to the corporate space," he said during the Institute of International Finance's annual meeting in Washington.

In its latest Global Financial Stability Report, the International Monetary Fund warned that the current environment of low interest rates has encouraged corporations to take on more debt, while the ability for companies to service that debt has weakened. A look at the effects of that development in the event of an economic downturn is "sobering," the IMF said.

The somewhat common comparison made between collateralized loan obligations, or CLOs, and collateralized debt obligations, or CDOs, which played a key role in the global financial crisis of 2008 — is not entirely fair, said Knot. However, they still may pose a risk to the financial system, he said.

"The CLO structures that we've seen are actually simpler and more transparent than the CDO structures that we saw 10 years ago. There's less dependence on short-term funding. The role of the banks, fortunately, this time is a little bit different," Knot said.

"But the fact that the analogy is made, I think that tells something about sort of the worries that we have in this space," he added.

The Bank for International Settlements warned in September that certain similarities between CLOs and CDOs could still give rise to financial distress, particularly the rising share of low-rated leverage loans in CLOs and the difficulty in quantifying banks' indirect exposures to such derivatives.