'Crisis Not Over': Former RBI Governor Raghuram Rajan's Warning On Global Banking Turmoil

Raghuram Rajan said that a decade of easy money and a flood of liquidity from central banks has caused an “addiction” and fragility within the financial system as policymakers tighten policy

In 2005, while serving as the IMF's top economist, Rajan foresaw the global financial crisis and warned against it.

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Former Governor of Reserve Bank of India (RBI) Raghuram Rajan has warned that the banking system is heading towards more turmoil after the rescues of Silicon Valley Bank and Credit Suisse, reported Bloomberg.

Rajan also said that a decade of easy money and a flood of liquidity from central banks has caused an “addiction” and fragility within the financial system. The comments come as policymakers are tightening policy.

The former IMF chief economist, who also predicted the global financial crisis, said, "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's remarks underscored the fact that the issues at SVB and Credit Suisse are a sign of more serious underlying issues with the banking system.  In 2005, while serving as the IMF's top economist, Rajan foresaw the global financial crisis and warned against it, prompting former US Treasury Secretary Larry Summers to label him a "Luddite." 

Following the crises at Silicon Valley Bank and Credit Suisse, banking shares fell, but central banks globally continued to tighten monetary policy in an effort to control inflation.  “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 according to Bloomberg. He said banks are vulnerable to unwinding after central banks “flooded the system with liquidity.”

“It’s an addiction that you’ve forced into the system because you flood the system with low-return liquid assets and banks are saying, ‘we’ve got to hold this, but what do we do with it? Let’s find ways to make money off it’ and that gives makes them vulnerable to the withdrawal of liquidity,” Rajan added. 

Also: Unchanged Repo Rate, GDP, Inflation Forecasts, Unclaimed Deposits: Key Points Of RBI Monetary Policy Statement

On Thursday, the RBI Monetary Policy Committee, headed by Governor Shaktikanta Das, announced to keep policy rate unchanged at 6.5 per cent.

The surprise move to hold the repo rate should not be seen as an indicator of carrying out similar moves in the future, and the central bank will "not hesitate" in taking further action on rates if needed, Das said. Talking to the reporters, the RBI governor said, "If I have to characterise today's monetary policy in just one line...it's a pause, not a pivot." RBI also said that it is keeping a close watch on the banking sector turmoil in some developed countries.

Das said that the global economy is now witnessing a renewed phase of turbulence with fresh headwinds from the banking sector turmoil in some advanced economies. Bank failures and contagion risk have brought financial stability issues to the forefront.

Amidst this volatility, the banking and non-banking financial service sectors in India remain healthy and financial markets have evolved in an orderly manner, Das added.