The spread of covid-19 has caused an economic crisis that has caught banks, financial markets and business in its wake
frantically stocking up on essentials such as loo roll. But in financial markets, the staple that no one can do without in times of stress is cash—the flushing mechanism of the world economy. In theory, it should never dry up; money can be printed. But when firms are desperate for cash it puts a potentially devastating strain on the plumbing of the global financial system. That is why in the past week America’s Federal Reserve has unleashed a huge amount of liquidity.
Asset sales help reallocate the stock of existing cash. For every investor selling stocks or bonds to raise cash, there are those willing to take the other side—like Warren Buffett, the fabled “be greedy only when others are fearful” investor, who held $125bn in “dry-powder” at Berkshire Hathaway, his investment firm, at the end of 2019. He has already snapped up shares in Delta, an American airline. But reallocation can only do so much.
But banks have problems of their own. The first is that the thicket of global bank regulations imposed on them since the financial crisis may be exacerbating the funding crunch. Take regulations concerning “risk-weighted assets”. Banks must hold a certain amount of capital relative to the size and riskiness of the assets, such as loans, they have on their books. But as volatility in the value of the assets rises, they become more risky, forcing banks to shrink their balance-sheets.
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