The Chinese central bank has called for the stepping up of dynamic monitoring of fluctuations in liquidity demand in order to address the potential risk issues created by asset securitisation.
On 26 February the People’s Bank of China released a working paper on risks that asset securitisation could bring to the financial system entitled “The Optimistic Mood of Banks, Information Accuracy Levels and Asset Securitisation” (银行乐观情绪、信息准确度及资产证券化).
According to the paper investors can be insensitive to relevant asset information, and lack the motivation to increase the accuracy of the information that they do receive.
The optimistic mood of banks brings can serve to considerably increase bank profits, yet excessive optimism can also cause sizeable declines in the accuracy of information, which has an adverse impact on profits.
The paper points out that the liquidity unleashed by asset securitisation will reinforce the optimistic mood of banks, but that if external shocks trigger a credit crisis, investors will withdrawal capital, leading to a collapse in the asset securitisation market.
The optimistic mood of banks will obscure the disparity of quality between securitisation products, leading to both banks and investors to overlook the importance of accurate information.
When some banks hold information which is inaccurate or liquidity demand is high, any external shock will compel investors to migrate to safer investments, and related risk will spread further from directly affected institutions.
“The irrational behaviour of microeconomic actors and the reciprocal influence between actors could both become channels for the transmission of fragility from financial innovation to the financial system.
“Regulatory departments should further strengthen dynamic monitoring of market liquidity demand fluctuations, control and regulate room for arbitrage, focus on specific methods (such as securitisation grades) that could engender irrational market behaviour, as well as strengthen controls on regulatory arbitrage.”