Rising US interest rates could trigger financial risks and volatility in developing markets, China’s central bank and senior finance officials: Banking Regulations Assignment, UKM, Malaysia

University Universiti Kebangsaan Malaysia (UKM)
Subject Banking Regulations

Rising US interest rates could trigger financial risks and volatility in developing markets, China’s central bank and senior finance officials have warned, days after the collapse of California’s Silicon Valley Bank (SVB).

Addressing an industry forum in Beijing on Saturday, Chinese finance vice-minister Xia Xiande said market entities that had expanded rapidly – such as those with high leverage and mismatched assets and liabilities – faced rising risks, triggering a crisis of confidence in the US financial system.

“Recently, some banks in the United States and Europe, such as SVB, have been in trouble. The global high interest rate environment will continue in the future, and the need for countries to prevent financial risks has gradually emerged,” Xia told the event organised by the Global Asset Management Forum, a Beijing-based think tank, on Saturday.

Xuan Changneng, a deputy governor at the People’s Bank of China (PBOC), said financial institutions long used to arranging assets and liabilities in a low interest rate environment lacked the sensitivity to adjust their position for a tightening cycle.

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“The characteristics of SVB’s balance sheet made it more sensitive to changes in interest rates and ultimately triggered a risk event,” said Xuan, the first Chinese central bank official to comment on the bank’s failure, which has shaken the US financial system.

“There is still uncertainty about whether inflation in the major developed economies will fall significantly in the short term and continuing to maintain relatively high interest rates may have an adverse impact on the steady operations of the banking and financial system,” he told the forum in Beijing. The US Federal Reserve has raised interest rates several times since March last year to tame soaring inflation, but analysts expect the SVB crisis could affect the US central bank’s monetary policy.

“A week ago, markets thought the Fed would be raising rates to around 5.5 per cent by end-2023; now they see Fed rates much lower at 4 per cent,” Adam Slater, lead economist at Oxford Economics, said in a note on Friday.

China has already made containing financial risks a priority, and a regulatory shake-up announced at the close of annual parliamentary meetings last week included the setting up of a new watchdog.

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The enlarged super regulator will take over the role of the existing banking and insurance watchdog, as well as some functions of the PBOC.

Meanwhile, SVB Financial Group – the former parent company of the failed bank – has sought bankruptcy protection. Financial regulators shut down SVB and took control of its deposits on March 10, in what has been labelled the biggest banking failure since the 2008 financial crisis. The California-based bank, which mainly funded tech start-ups, saw investments fall greatly in value. US federal regulators decided to fully insure and protect all SVB’s depositors and their balances over concerns of contagion for the economy.

Former Chinese finance minister Lou Jiwei, who also addressed the Beijing forum, cautioned that rising volatility in international financial markets and rapid interest rate hikes might lead to a new round of crises. Citing a “historical perspective”, he warned of the spillover risks for emerging markets as he highlighted the need for better regulatory oversight and risk protection.

“The Chinese government attaches great importance to preventing and defusing systemic risks, and we are further improving financial supervision,” Lou said, referring to the new enlarged national financial watchdog.

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“We will continue to cooperate with the financial regulators of various countries to jointly prevent and resolve systemic risks to the global financial framework.”

Zhang Wencai, vice-president of the Export-Import Bank of China, warned that there may be more “grey rhino” and “black swan” events, referring to slow-moving risks that could trigger a crisis, and unexpected events, respectively.

“The spillover effect of the Fed’s aggressive interest rate increases is large, which has exacerbated global economic and financial turmoil, leading to more risks of various types,” Zhang said. Many developing countries were facing challenges like capital outflows, currency depreciation, deteriorating balance of payments, and rising default risks, Zhang told the forum. China is among emerging markets that have suffered capital outflows and currency depreciation since last year.

The world’s second-largest economy logged a record net portfolio outflow of US$80 billion in 2022, according to a report in February by the Institute of International Finance, a US-based trade group for the global financial services industry. The outflows were predominantly in bonds, suggesting the rate increases by the US Federal Reserve were the main trigger, the report said.

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