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Investors turning towards risky assets, says Mervyn King

Banks need to set up new capital regulations.

Despite lessons from the earlier financial crisis, investors are looking forward to invest in risky assets in order to improve their returns, according to Sir Mervyn King, governor of the Bank of England (BoE).

King, who made his comments at a hearing focused on the stability of banks in the UK, warned that returns on the US junk bonds declined by 6 per cent. Anticipating that investors are turning toward risky assets, the global stock markets grew, he said. However, the UK and many continental European economies are still facing problems.

“The search for yield appears to be beginning again,” King told MPs on the treasury select committee. “A combination of a weak recovery and at the same time people searching for yield in ways that suggest risk being priced in is a disturbing position.”

Former investment manager Robert Jenkins and Michael Cohrs, a former head of investment banking at Deutsche Bank, told the Financial Policy Committee that banks should be forced to hold top quality capital equal to more than 4 per cent of their total balance sheets.

Meanwhile, Andrew Haldane, executive director of financial stability at BoE, and Thomas Hoenig of the US Federal Deposit Insurance Corporation have suggested for tougher leverage ratios to be implemented by banks.

Mr Haldane told the committee that banks’ risk models lacked “any robustness”. “They’re not a sound basis for the setting of capital regulations. That is increasingly recognised not just by regulators, but by investors in banks,” he said. “The regulatory community made a significant error in the 1990s in the reliance it placed on deeply complex and deeply fragile models. That balance now needs to be redrawn.”

Both Mr Cohrs and Mr Jenkins said they doubted banks would ever be able to price risks to the financial system properly. “They didn’t last time,” Mr Jenkins said. “There are many times in history where they’ve failed. It would be a bad bet to bet that they would.”

Andrew Tyrie, chairman of Financial Policy Committee, said: “Listening to the FPC, I had the impression they think that risk weights aren’t worth the paper they are written on and leverage is too high.”

The regulators also accepted that Royal Bank of Scotland (RBS) and Lloyds Banking Group would need to raise new capital or sell off large parts of their businesses.