By Simon Miller

Growing demand and a shrinking supply of safe assets could destabalise global financial stability, the International Monetary Fund (IMF) has warned.

In its latest Global Financial Stability Report, the IMF warned that the price of assets regarded as safe was on the rise, with supply dwindling and demand rising amid uncertainty in financial markets, regulatory reforms, and increased demand from central banks in advanced economies.

As a result, these assets – predominantly government bonds – could have a negative effect on financial stability worldwide.

The IMF said that prior the financial crisis, excess demand for safe assets was driven by booming emerging economies that had accumulated reserves and used these to buy large amounts of safe assets.

However, the demand for safe assets now faces pressures “due to new financial regulations that require banks to hold more safe assets; higher collateral needs for over-the-counter derivatives transactions or their transfer to centralized counterparties; and the increasing use of safe assets in monetary policy operations, such as purchases of government securities by central banks”, according to the IMF.

The fund estimated that the number of safe assets could decline by some $9trn — or roughly 16 percent of the projected sovereign debt — by 2016.

In addition, private sector issuance of safe assets has also contracted sharply on poor securitisation practices in the United States.

“Safe asset scarcity will increase their price, with assets perceived as the safest affected first. Investors unable to pay the higher prices would have to settle for assets that have higher levels of risk,” the fund said.

It added: “Shortages of safe assets could also lead to more short-term spikes in asset volatility, and shortages of liquid, stable collateral. If collateral became too expensive, funding markets would be compelled to accept lower-quality collateral, raising funding costs.”

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