Even though banking turmoil will impact insurers’ investment portfolio, their asset-liability management operating framework means they are duration matched, and their “long liquidity” business models implies they are not vulnerable to rapid withdrawals like banks, said the Swiss Re Institute.
Turmoil in the US and European banking sectors has shaken market confidence and has drawn narrative parallels with the start of the global financial crisis (GFC) in 2007-2008, according to analysts.
On one side, the Swiss Re Institute’s US financial stability monitor shows worsening risk parameters, with measures of high-yield credit spreads and swaption volatility already reflecting lower liquidity and mounting stress.
However, while there are signs of market tensions, the monitor also suggests we are not currently in a systemic financial crisis.
Provided this endures, analysts at the Institute expect that key central banks will retain restrictive stances and continue to raise interest rates, although at a slower pace than seen last year.
Nonetheless, analysts also would not underestimate the second-round hits to confidence on smaller banks and non-bank financial intermediaries, as these are significant to the overall financial system.
A potential cumulation of US small bank defaults is a key concern, the Institute highlighted. This is mainly due to small US banks accounting for roughly 50% of US commercial and industrial lending, 60% of residential real estate lending, 80% of commercial real estate lending, and 45% of consumer lending, for example.
Analysts said: “Given the higher risk premium and subsequent higher funding costs facing the banking sector, a further tightening in credit conditions may reduce US GDP growth by 0.5 to 1.0 percentage points (ppt) in the coming quarters, and by 0.3% in the euro area.
“The extent of growth retraction will depend on the severity of contraction in bank lending.2 Meanwhile, non-bank financial intermediaries (NBFIs) own almost 50% of total global financial assets (as of 2021). Forced selling by NBFIs amid a rush of investor redemptions and margin calls could raise market instability like that seen in last autumn’s UK pension funds gilts crisis”.
They added: “However, even as financial market woes will impact insurers’ investment portfolios, their asset-liability management operating framework means they are duration matched, and their “long liquidity” business models implies they are not vulnerable to rapid withdrawals like banks.”
Uncertainty remains high, and the risk of a credit crunch and hard landings has increased, which would help to bring inflation down.
As the ECB has demonstrated that central banks can use separate tool kits to address inflation and financial market stresses, according to the Institute, analysts believe that other central banks use them as well.
By doing so, they would continue raising interest rates, though at a slower pace, mainly because of the current high inflation environment, which contrasts to prior years of financial stress when central banks cut policy rates.
“We look for central banks to stay the course on more restrictive policy, albeit more cautiously,” said analysts.
However, the Swiss Institute warns, if a systemic crisis were to develop, central banks could fall subject to financial dominance and cut their current tightening cycles short, prolonging the fight against inflation.
In turn, this could potentially necessitate renewed aggressive tightening in the medium term, threatening greater volatility in financial markets and a sharper economic downturn.
