To make more money, you have to take more risk. Unless, it seems, you are a bank. In this week's Financial Stability Report, the Bank of England highlights the recent rise in trading profits as a proportion of income at UK commercial and global investment banks. But exposure to market risk, as shown by disclosed value-at-risk (VaR) measures, has increased by far less. VaR measures the maximum loss likely to occur over a given period at a certain level of probability.
The BoE suggests two explanations. First, banks may be diversifying their portfolios more efficiently. Expansion into a broader range of assets, such as commodities, and the development of new credit derivatives confers some plausibility on this view. It falls down, however, if previously unrelated asset classes start moving in tandem. According to Capital Economics, in the last six months, the negative correlation between equities and bonds, that held for the previous five years, has disappeared. Emerging markets, gold and base metals are now highly correlated with developed equity markets.
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