On 26 April 2018, the Bank of England (BoE) published a speech by Alex Brazier (Executive Director for Financial Stability and Risk, BoE) that discusses some of the hidden risks in the market. Mr Brazier explains that there are generally two types of hidden risk which he calls “bears” and “icebergs”.
The risks that are bears are the risks that hide in plain sight. Mr Brazier states that the risk adjustment in the stretched prices (and compressed yields) in corporate debt markets are a bear. He also adds that in global markets investors seem to be willing to take the same risk for less compensation. Appetite for risk taking has increased.
Mr Brazier explains that icebergs can lurk beneath the surface of the financial system and they can make navigation of markets uncertain and hazardous. He states that excessive leverage and liquidity mismatches were the bergs of the 2008 financial crisis.
These risks have now been addressed but regulators must stay alert to any possible new icebergs of the future. In terms of existing icebergs Mr Brazier argues that these include leverage (specifically leverage arising from the use of derivatives) and liquidity mismatch in investment funds.