Raghuram Rajan foresees fresh trouble for banking sector after US crisis

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Weeks after the collapse and subsequent rescue of two major banks fresh trouble may be brewing for financial institutions in the US. Former IMF chief economist Raghuram Rajan has warned of fresh trouble within the banking system, after the rescues of Silicon Valley Bank and Credit Suisse. 

The former RBI governor opined that a decade of easy money and a flood of liquidity from central banks has caused an “addiction” and a fragility within the financial system as policy makers tighten policy.

“I hope for the best but expect that there might be more to come, partly because some of what we saw was unexpected. The entire concern is that very easy money (and) high liquidity over a long period creates perverse incentives and perverse structures that become fragile when you reverse everything,” Rajan said in an interview in Glasgow.

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An uneasy calm has settled over the US banking sector after the collapse of Silicon Valley Bank, with many waiting for top companies to report their earnings. Meanwhile in Switzerland – the other banking crisis hotspot – the parliament is holding a special three day session from Tuesday to debate government support and guarantees provided to secure UBS’ takeover of Credit Suisse Group. 

Bank shares slumped following the crises at SVB and Credit Suisse but central banks have pushed ahead with policy tightening to rein in inflation.

Rajan – who had predicted the global financial crisis more than a decade ago –  also said that central bankers have been given a “free ride” as policy makers rapidly reverse the ultra-accommodative stance taken in the decade following the financial crisis.

“This sense that the spillover effects of monetary policy are huge and aren’t dealt with by ordinary supervision has just escaped our consciousness over the last so many years,” Rajan said.

He said banks are vulnerable to unwinding after central banks “flooded the system with liquidity.”

(With inputs from agencies)

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