FSB Chair Warns of Rising Strains in the Financial System
The war in Iran has so far primarily triggered a surge in energy costs, with consequences for industry, transport and inflation expectations. However, the financial system is also facing risks, as warned by Financial Stability Board (FSB) Chair and Bank of England Governor Andrew Bailey.
The global financial system has so far absorbed the economic shock caused by the Iran war. This is partly due to the reforms implemented after the 2008 financial crisis, Andrew Bailey emphasised in a letter to the G20. However, he cautioned that rising financing costs could exacerbate growing tensions in other parts of the system. There could be a «double or triple hit» if tighter financing conditions lead to several vulnerabilities materialising at the same time—including stretched asset valuations, leverage among non-bank institutions and pressures in private credit markets.
Abrupt Repricing Risks
In his letter, the FSB Chair noted that financial turbulence could be triggered if markets begin to price in a much larger impact on global economic growth. In such a scenario, an abrupt repricing of equity markets could coincide with an already heightened focus on valuations in private assets.
The use of high leverage by a limited number of funds pursuing similar strategies across different countries has increased the risk of disorderly unwinding of positions. This could lead to illiquidity in government bond markets and have cross-border spillover effects.
At the same time, global asset prices remain elevated by historical standards. Certain sectors, such as artificial intelligence (AI), where valuations were already stretched before the conflict, are particularly vulnerable to sharp corrections if economic conditions deteriorate.
Pressure on Debt Servicing Capacity
Investor sentiment in certain higher-risk credit markets, particularly private credit, had already weakened before the outbreak of the conflict. Bailey pointed out that the war could increase pressure on the debt servicing capacity of highly leveraged borrowers and impair asset quality, thereby adding further strain on private credit funds.
Despite the uncertainty, banks have so far proven resilient, reflecting the strength of post-crisis reforms and underscoring the importance of implementing Basel III capital requirements.
