Rising Debt Could Make Central Banks’ Next Crisis Response More Difficult, BIS Chief Warns

Central banks will remain the first line of defense when the next financial crisis hits, but soaring public debt, large fiscal deficits and the growing influence of non-bank financial institutions could make their interventions more difficult and politically contentious, the head of the Bank for International Settlements said Monday.

Pablo Hernández de Cos, speaking in Vienna, said the experience of the past two decades had demonstrated the importance of rapid central bank action when financial markets seize up. But he warned that the environment around the next crisis would be markedly different from previous episodes.

Public debt in many major economies is now close to levels last seen in the aftermath of World War Two, while fiscal deficits remain elevated and governments face persistent financing pressures.

The development is creating a potential problem for monetary authorities. An intervention intended to restore market functioning could increasingly be interpreted as an attempt to support government borrowing costs or finance fiscal policy.

“If market dysfunction threatens financial stability or monetary transmission, central banks need to intervene,” Hernández de Cos said.

“But when debt is high and public financing needs are large, even a well-designed operation can be interpreted through a fiscal lens.”

The warning comes as global bond markets face renewed pressure from elevated government borrowing needs, inflation uncertainty and changing expectations for interest rates. The widening gap between French and German government bond yields has also revived concerns about financial fragmentation within the euro zone.

Hernández de Cos is among the names seen as potential candidates to succeed Christine Lagarde as president of the European Central Bank next year, adding significance to his assessment of how monetary policy may operate during the next major market shock.

The central banking playbook has changed considerably since the global financial crisis.

During periods of severe market stress, central banks have used interest-rate cuts, emergency lending facilities, asset purchases and foreign-exchange swap lines to restore liquidity and prevent financial-market dysfunction from spreading into the wider economy.

The Bank of England’s intervention during Britain’s 2022 gilt-market crisis is an example of how targeted asset purchases can stabilize a market without necessarily becoming a broad programme of monetary easing.

Hernández de Cos said the Bank of England’s response offered a “blueprint” for the use of asset purchases during future crises.

The effectiveness of the intervention came partly from limiting the purchases to specific windows and amounts, while providing clear communication and governance arrangements.

But the BIS chief warned that the same commitment could become less credible during a larger or more persistent crisis.

That is particularly of the essence when government bond markets themselves are at the center of the disruption. If a central bank buys government debt to prevent a disorderly market selloff, investors and politicians may question whether the institution is acting to preserve financial stability or to shield governments from the consequences of weak public finances.

The distinction is fundamental to central-bank independence.

A monetary authority may need to intervene when a dysfunctional bond market prevents interest-rate policy from transmitting properly into the economy. But the larger a government’s borrowing requirements become, the easier it is for such intervention to be interpreted as fiscal support.

That could leave central banks facing a difficult communication problem at the moment when speed and credibility matter most.

Non-Banks and Technology Could Accelerate The Next Shock

The financial system has also changed substantially since previous crises.

Hernández de Cos highlighted the expanding role of non-bank financial institutions, including hedge funds, pension funds and asset managers. These institutions have become major participants in government bond markets and provide substantial liquidity during normal periods.

But their business models can also amplify market stress.

Many non-bank institutions rely on leverage, derivatives and market-based funding, creating the possibility that a sudden fall in asset prices triggers rapid deleveraging and forced selling.

The March 2020 “dash for cash” in the US Treasury market demonstrated how quickly liquidity can disappear even from one of the world’s deepest financial markets. Britain’s 2022 gilt crisis provided another example, when forced selling by liability-driven investment funds contributed to a sharp deterioration in government bond-market conditions.

The increasing importance of non-banks means central banks can no longer focus exclusively on commercial banks when preparing for financial crises.

Economists have warned that regulators will need to understand how leverage, collateral requirements and liquidity mismatches can interact across the broader financial system. Otherwise, authorities could discover that institutions outside the traditional banking sector have become the transmission mechanism for a crisis before they have the tools or information necessary to contain it.

Technology could further compress the time available for intervention.

Hernández de Cos pointed to online banking, social media, stablecoins, and artificial intelligence as forces that could accelerate future financial shocks.

Digital banking allows customers to move large amounts of money almost instantly. Social media can transmit rumors and misinformation to millions of people within minutes. Stablecoins can facilitate rapid movement of funds between traditional financial markets and digital-asset markets, while AI-driven systems could accelerate trading decisions and amplify market reactions.

That means a bank run or liquidity shock that once unfolded over days could potentially develop within hours or even minutes.

The speed of information can also become a source of instability. Investors no longer need to wait for traditional news channels or official announcements before reacting to a rumor, while automated systems can respond to market signals at a speed that human policymakers cannot match.

For central banks, the implication is that crisis-management tools may need to be deployed faster and communicated more precisely.

But Hernández de Cos argued that monetary authorities cannot solve the problem alone.

Stronger regulation of non-bank finance and emerging financial technologies will be necessary to reduce moral hazard and preserve the effectiveness of emergency interventions. Governments will also have to address fiscal vulnerabilities before they become constraints on crisis management.

“Central banks have a key role to play, but so do regulators and governments,” he said.

The international dimension will remain equally important. Financial stress can move rapidly across borders through currency markets, government bonds, banks and investment funds, making national responses less effective when liquidity shortages become global.

“Global cooperation” therefore remains essential, Hernández de Cos said, particularly through mechanisms such as central-bank currency swap arrangements.

“Central bank swap lines remain critical to stabilize the global financial system at times of acute distress.”

The broader warning is that the next financial crisis may not resemble the last one. Higher public debt could make conventional interventions politically harder to defend, non-bank institutions could transmit stress outside the regulated banking system, and digital technology could dramatically shorten the time available to respond.

Central banks may still be the institutions expected to stabilize markets when confidence collapses. But the conditions under which they operate could make that role more contested, more constrained, and potentially more difficult to execute.