UK central bank concerned by investor appetite for credit risk

The purchase of credit derivatives instruments by some institutional investors in their hunt for yield is a cause for concern, the Bank of England said in its latest Financial Stability Review, released today.

The UK's central bank said low interest rates - especially in Europe and Japan – could have driven some investors to naively chase yield. “Anecdotal evidence suggests that non-traditional players have turned to buying credit risk as part of their search for yield,” said David Rule, London-based head of the gilt-edged and money markets division at the Bank of England, speaking in the forthcoming July issue of Risk.

The Bank of England’s review echoes concerns expressed by the International Monetary Fund (IMF) in its Global Financial Stability Report, published earlier this month. “More information is needed to properly ascertain if insurers’ management of market and credit risks has kept pace with some of these companies’ growing involvement in the financial markets,” said Garry Schinasi, who heads the financial market stability division in the IMF’s international capital markets department.

The Bank of England's Rule agreed: “This pressure to try and enhance earnings by taking on more complex, and perhaps riskier high-yielding assets, underlines the importance of participants having the capability to manage exposures effectively.”

Despite these concerns, the UK's central bank said institutional investors' appetite for credit risk from instruments such as synthetic collateralised debt obligations may be a benign trait, since many investors hold diversified portfolios for long periods of time.