Crisis could spread to equity and commercial property, Bank of England warns

In its latest financial stability review, released this morning, the bank said: "Market contacts had suggested that risk premiums were too low, but were afraid to stand against the tide for fear of losing market share. Sustained benign economic conditions and previously buoyant market liquidity appear to have fostered complacency among some investors, undermining standards of due diligence." The search for liquidity and a sustained low-stress, low-interest rate environment had left the industry ill-prepared for a crisis.

In particular, the bank said, institutions lack contingency plans for dealing with a sudden lack of liquidity in the capital markets – the root cause of the problems at Northern Rock – and fail to disclose enough details about the securitisation and on-selling of risk.

"In febrile financial market conditions, the benefit of the doubt is replaced by a fear of the unknown. Inadequate information about the final location of risk exposures has undermined the potential benefits of markets that transfer and disperse risk," the report said.

The authorities also receive criticism, with "shortcomings in UK crisis management", and a lack of stress testing and forward planning at an international level.

The next few months could see a variety of problems emerge: spreading trouble in the US housing market could again cause concerns about counterparty credit risk; re-intermediation in the UK, as banks take more risk back onto their own balance sheets, could restrict credit availability and damage highly leveraged borrowers; pricing could weaken further in commercial property; and equity prices "could be vulnerable to any further revision in growth prospects".

Most seriously, the bank warned the US dollar could fall sharply, triggering a much wider global crisis.

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