Raghuram Rajan, the former governor of the Reserve Bank of India, said that economic risks have spread elsewhere even though the world’s banks have become safer since the global financial crisis.
“Almost certainly lightening doesn’t strike twice in the same place, probably because you take precaution,” Rajan said in a TV interview in Singapore.
“Banks are in a much safer place than they were. The problem is the overall level of risk in the economy hasn’t diminished considerably. If you make the banks safer, it has to go somewhere else,” said Rajan, who is currently a professor of finance at the University of Chicago Booth School of Business.
Particularly the high default rate on U.S. student loans, there were aspects of the shadow financial system that were now “a little more worrying,” Rajan said.
According to a Consumer Federation of America analysis of U.S. Department of Education data, the number of people who have defaulted on their federal student loans increased 17 percent from 2015 to 2016.
$1.3 trillion in federal student loans was owed by 42.4 million Americans last year. Up from 3.6 million in 2015, more than 4.2 million borrowers were in default as of the end of 2016. Last year, in all, 1.1 million more borrowers went into or re-entered default.
Expectations the U.S. Federal Reserve would continue to increase interest rates have compounded the risks of student loan defaults, Rajan said.
“This is before interest rate hikes are substantial. And so what happens if some of them are floating rate and interest rates go up more,” he said.
In line with a benchmark interest rate, the interest rate on some private student loans can “float”. A formula links the 10 year Treasurys to loans from the Federal government in the U.S.
And therefore, payments on new loans will rise as Treasury yields rise, which they are almost certain to do as the Fed hikes rates and as Congress may borrow increased amounts to finance the Trump administration’s policies.
He added that other segments of the global markets could also be impacted by tightening liquidity. “The question is, as the global environment tightens, are those effects going to spread to markets that haven’t yet experienced the consequences of the past,” he asked. “There are also countries that dodged the financial crisis but have had very buoyant markets since then: housing markets in Australia, housing markets in Canada.”
(Adapted from CNBC)