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Sounding the Alarm on Leveraged Lending

Tobias Adrian, Fabio Natalucci, and Thomas Piontek, (2018), “Sounding the Alarm on Leveraged Lending”IMF Blog, 15 November

Regulators in the United States and Europe have taken steps in recent years to reduce banks’ exposures and to curb market excesses more broadly. The effectiveness of these steps, however, remains an open question. For example, there is evidence that these actions have contributed to a shift of activities from banks to institutional investors. These investors have different risk profiles and may pose different risks to the financial system than banks.

While banks have become safer since the financial crisis, it is unclear whether institutional investors retain a link to the banking sector, which could inflict losses at banks during market disruptions. Furthermore, few tools are available to address credit and liquidity risks in global capital markets. So it is crucial for policymakers to develop and deploy new tools to address deteriorating underwriting standards. Having learned a painful lesson a decade ago about unforeseen threats to the financial system, policymakers should not overlook another potential threat.

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