Bankers will not take a risk on a risk-return bond as the market is likely to go back to normal, says the head of a new group that is pushing for a more risk-reward bond.
“It’s important that you have a safe and flexible asset class,” said Robert E. Krosnick, head of the Risk-Reward Bond Association.
“If you can’t do that, it’s probably better to have something that’s risky, but not as risky as the bond.”
Risk-rewards are generally defined as securities that have higher rates of return than riskier bonds, such as corporate bonds or mortgage-backed securities.
The association wants to shift the risk-bearing responsibility of the banks to the public, and the group is developing a new bond class.
The new group, which includes the biggest banks and other financial institutions, is advocating for a risk reward bond, which would be issued by the banks.
It would be backed by government debt, meaning the government would hold the debt.
The bond would give banks more flexibility in the markets.
The idea would be to get banks to sell bonds in markets where rates of returns are low, and then sell those bonds as high as possible.
Krosnick said that’s a risk that banks are not willing to take.
“They want to do a risk free bond, but that’s going to require a little more risk,” he said.
Risk reward bonds have been used in the past, but they have not worked well in recent times.
A new bond market would be necessary to get them going, and it would take time.
A risk-adjusted bond is issued by banks with higher rates than they have to pay for the bond, such a high yield.
It has lower rates of repayment, but is more risky because it has a higher yield.
A yield of 5.5 per cent on a 30-year fixed rate bond is the maximum yield that a bank is allowed to pay to another bank.
That’s lower than the yields on many other types of debt, such mortgage-rated bonds, corporate bonds and sovereign bonds.
“The risk-weighted bond is going to be a good thing for the banks, but it’s not a good enough guarantee for the public,” said David Burd, a senior research fellow at the University of Sydney.
“We need something that is a little bit safer and higher yield.”
The group is calling for a bond that would have a yield of 3.8 per cent.
A bond with a yield lower than that could be risky.
“A risk reward has some benefits and some risks, but also has a lot of upside,” said Krosick.
Risks of a risk rewarded bond include:A bank could default, which is bad for its reputation.
That could result in a downgrade or even a default by the bank itself.
Borrowers would likely have to make more payments.
The risk of a company taking on debt that the bank can’t repay is also a problem.
In this case, the bank could face a legal obligation to repay the debt to its creditors.
The group also wants a bond with no interest payments, which could be a problem for companies that don’t have the cash to pay off debt.
“What I think banks are really trying to do is build a system that allows them to be more risk free,” said Burd.
The biggest banks in Canada have been among the biggest supporters of a bond market, having made more than $1 trillion in investments in bonds in the last decade.
Borrowers could be less inclined to take on riskier debt if they can see that the risk is higher than the rewards.
“If a bank has a high-yield bond and is able to pay it off, then it could be seen as a risk, because it’s going out of business,” said John Tackett, managing director at the Canadian Bankers Association.
But the risk of having to make those payments isn’t all that great.
“That’s one of the biggest benefits that comes from this risk-based approach,” said Tackott.
“You’re not going to lose the market because you have to repay a high interest rate, you’re not paying the principal, and you have the upside of being able to earn more profit,” he added.
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