The next financial crisis…?

The 2008 financial crisis was brought about by, among other things, excessive risk-taking by banks throughout the western world, the most famous victim being Lehman Brothers, which filed for bankruptcy in 2008, ending 158-years of banking history dating back to 1850.

The Lehman Brothers saga unleashed the true systemic risk that had been hidden in the world markets, setting off a shock-wave across global financial markets, causing the Global Economic Downturn, and followed by the European Debt Crisis.

Subsequent legislation including the Dodd-Frank Act and the Basel III Capital & Liquidity Standards aimed to reign in the banking system and bring about financial stability to the markets.

A recent paper by the Bank of England (Financial Stability Paper 42) has suggested that the next crisis might not be because of the banking sector, but as a result of the BOND MARKETS.

Bonds are debt instruments that are issued by Governments and Companies to raise funds to finance various projects, with the first ever Sovereign-Bond issued by the Bank of England in 1694.

The main problem with bonds is how difficult they can be to trade, compared to equities or equity-funds, and the liquidity squeeze may be felt most in the bond market during a crisis. Panic selling of bonds often leads to big falls in bond prices, and the cycle continues.

High bond redemptions, in addition to the rise in bond spreads (the difference between the bond yield and that of a government debt), can have a major impact on bond prices.

Low interest rates have caused investors to look at diverting funds away from bank accounts and into bond markets over the past few years, and some may be reluctant to hold on to these assets if prices were to fall.

A sell-off of bonds probably wouldn’t be as damaging as the financial crisis of 2008, as investments into bonds are not generally funded by credit, and only tend to make up a small percentage of portfolios. However, the Bank of England wouldn’t be maintaining its fiscal responsibility if it wasn’t making consumers aware of the risks.

For more information about diversifying your portfolio, call Northern Cross Wealth Management on +27 (0) 21 200 5858

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