2012.04.18 - SAFE ASSETS
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2012.04.18 - SAFE ASSETS

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described here.

nels. As discussed in IMF (2011a), even in cases where heightened
sovereign risk is not re#ected on banks’ !nancial statements—for
example, via banking book sovereign exposures and valuations at
amortized costs—creditor perceptions of balance sheet weakness
and heightened bank credit risk can increase bank vulnerability
since credit risk is assessed in economic rather than accounting
terms.

Key Conclusions and Policy Implications
Flexibility in policy design and implementation

is warranted to ensure a smooth adjustment to the
upcoming supply and demand pressures on the
markets for safe assets. Investors’ cost of safety will
inevitably rise, but an adjustment process that is
too abrupt or too volatile may compromise !nan-
cial stability. Stronger demand for certain assets
deemed the safest will put upward pressure on their
prices, while assets suddenly viewed as less safe may
be subject to downward pressures. Arguably, the
cost of safety was distorted before the crisis, but
the demands arising from regulatory reforms and
ongoing central bank policies suggest potentially
substantial pressure on certain safer asset classes.
Policymakers should be cognizant of the e"ects
of existing and upcoming policies on spurring
demand for safe assets.

Ultimately, e"orts to ensure that !ne distinctions
across safe assets are re#ected in regulation or policy
responses could help alleviate discontinuities or cli"
e"ects in their usage and pricing.
 • As shown in Box 3.3, the common application

of a zero percent risk weight on holdings of debt
issued by a bank’s own sovereign, irrespective of
its risk, tends to inflate bank capital adequacy
levels. This creates a perception of safety detached
from underlying economic risks and leads to an
inflated demand for such safer assets. Hence, for
banks, sovereign debt should ultimately carry
assigned risk weights that more accurately reflect

Figure 3.16. Government Bond Holdings and Risk Spillovers between Sovereign and Banks

Sovereign Banks

Government bonds

Rising sovereign
 risk

Government bonds

Loans

Equity

Debt

Rising solvency
 concerns

Higher funding
 costs

Real economy

Contingent liabilities

Lower market
 value

Deleveraging pressure

Lower credit
growth

Lower tax revenues Weaker economic
 growth

Higher bail-out
probability