Current high levels of financial repression create significant costs and lower long-term investors' ability to channel funds into the real economy, a new Swiss Re study shows

26 March 2015 Swiss Re

• Since the financial crisis, US savers alone have lost roughly USD 470 billion in interest income • Artificially low interest rates that go with financial repression lower incentives for policymakers to tackle much needed structural reforms in Europe • Other unintended consequences of financial repression include potential asset bubbles, crowding out long-term investors in otherwise functioning private markets, increasing economic inequality and the potential of higher inflation over the longterm besides distorting private capital markets • Swiss Re developed a Financial Repression Index, the first of its kind, measuring the extent of policymakers' actions. Swiss Re has also quantified the costs of interest rates being at artificially low levels for households and long-term investors • Financial repression describes official policies directing funds to markets that would otherwise go elsewhere and reduces diversification of funding sources to the economy, representing a risk for financial stability

Seven years after the financial crisis, central banks are still keeping interest rates at historically low levels. Low interest rates help finance governments' debt and lower funding costs, as well as support growth. But such policy actions cause financial repression. This comes at a substantial cost for both households and long-term investors such as insurance companies and pension funds, according to a new Swiss Re report Financial repression: The unintended consequences.

With continued increases in bond prices, expensive stocks and relatively low volatility, the impact of financial repression on markets is undisputable. Meanwhile, the impact of foregone interest income for households and longterm investors has become substantial: in the US alone, savers have lost about USD 470 billion in interest rate income (net) since the financial crisis (2008-2013).

Over the same period, EU and US insurers have lost around USD 400 billion in yield income. This currently corresponds to an annual "tax" of roughly 0.8% of total financial assets on average, lowering long-term investors' capacity to channel funds to the real economy.

Swiss Re's own index, the first such index to measure financial repression, shows that financial repression remains very high, albeit down from its 2011- 2012 peak. The major driver of change post 2007-2008 has been monetary policy.

Swiss Re's Group Chief Investment Officer, Guido Fürer, says: "Besides the impact on long-term investors' portfolio income, the consequence for capital market intermediation is not negligible either. Crowding out investors due to artificially low or negative yields will reduce the diversification of funding sources to the real economy, thus representing a risk for financial stability and economic growth potential at large."

The index is based on three broad categories including monetary components, such as real yields and the difference of long-term government bond yields to their 'fair value', as well as regulatory and "other" components, such as banks' domestic sovereign debt holdings and capital flow development.

Long-term investors are part of the intermediation channel that helps move saving funds to the real economy. In Europe alone, insurance companies have roughly USD 9.5 trillion in assets under management, amounting to about 60% of European long-term investments funds available.

Keeping interest rates artificially low through official intervention hampers the ability of long-term investors to deploy risk capital into the real economy. It has broken the financial market intermediation channel by crowding out viable private markets, lowering the funds available from long-term investors to be used for the real economy. Investments in infrastructure could repair this damage and address weak economic growth.

Policymakers face a trade-off between supporting the economic recovery and contributing to the further potential build-up of financial and economic imbalances. However, through lowering yields and thus distorting private market signals, financial repression serves as a disincentive for governments to tackle pressing public policy challenges and thus advance the structural reform agenda.

The longer such extraordinary and unconventional monetary policies are in place, the more challenging the exit phase will be. The increasing role of public versus private markets spurs economic and financial market imbalances, representing key vulnerabilities for the long-term stability of well-functioning financial markets.

Financial repression is likely to remain a key tool for policymakers given the moderate global growth outlook and high public debt overhang. Whether the costs outweigh the benefits largely depends on the ability of governments to take advantage of the low interest rate environment by implementing the right structural reforms. So far the record for doing so hasn't been comforting.

"Future policy actions to create more stable and well-functioning private markets are important for economic growth in the long-term. That said, today's environment already provides a great window of opportunity, particularly in the area of infrastructure investments. Here we need a tradable infrastructure debt asset class so we don't have to rely on the public sector for investments. Instead, the public policy environment should promote a wellfunctioning private infrastructure debt market," says Guido Fürer.


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