Macroscope | ‘Silent killer’ liquidity crisis will stalk global financial system in 2023
- Few people seem aware as a liquidity crisis offers few clearly visible symptoms until it begins to affect the internal organs of the financial system
- It could be that the potential risks involved will not crystallise on a scale that threatens the financial system, but past crises offer little reassurance
There is another potential threat waiting in the wings to seize centre stage, and that is the risk of a liquidity crisis in the global financial system. As with high blood pressure, such a threat is hard to detect until it is too late and can likewise be seen as a “silent killer”.
One hidden threat is the vast amount of off-balance-sheet foreign exchange swap positions held by banks, which the Bank for International Settlements (BIS) said in December had reached more than US$80 trillion. This is a scary liability for 2023 as foreign exchange rates swing ominously.
A potential stock market crisis is evident from plunging share prices, a bond market crisis from yield volatility or a currency crisis from sharp swings in exchange rates. A liquidity crisis offers few such symptoms until it begins to affect the internal organs of the financial system.
What does such a crisis look like? The CFA Institute describes a “breakdown of an entire system rather than of individual parts. In a financial context, it denotes the risk of a cascading failure in the financial sector, caused by linkages within the system, resulting in a severe economic downturn”.
Financial history is littered with such crises, such as the great stock market crash and economic depression after 1929, the Asian financial crisis in 1997 and the global financial crisis in 2008, to name but a few. Relatively soon after the last of those, we now face the threat of another crisis.
