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Debt bubbles could burst as economies slow, threatening stability, bankers warn

Virginia Furness

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STOCKHOLM, May 16 (Reuters) - Heavy reliance on debt financing and slow economic growth are leading to the creation of debt bubbles which risk destabilising the entire financial system should a major shock occur, bond bankers and investors warned at a conference on Thursday.

They were in Stockholm for the annual meeting of the International Capital Markets Association, an industry body.

Speakers on the first day warned about an unsustainable build up of debt and that liquidity would dry up in certain asset classes in stress scenarios -- although they did not expect that to happen any time soon.

Ultra-low interest rates have prompted companies and governments to load up on debt faster than ever before, often selling bonds with less protection for investors. That has led to concerns that a turn in market sentiment could result in a credit crunch.

"Of course there are bubbles building up," Hans Stoter, global head of core investments at AXA Investment Managers told the conference.

"There is much more debt in the world than there was before ... and most of that growth is coming out of debt financing with interest rates so low."

Leverage in the system has increased some 50%-60% since the financial crisis a decade ago, with debt now worth some 230% of economic output globally according to IMF estimates, said Frank Czichowski, treasurer at KfW.

"There is no banking system in the world that can cope with the flood coming out of this," he said.

Affordability is not an issue while rates remain low but a rise in borrowing costs could create major problems, Axa's Stoter said: "The question is, with the debt level where it is, can central banks ever afford to let interest rates go back up because it will lead to a major bankruptcy wave."

A key risk for markets is low liquidity -- the ease with which assets can be bought or sold.

Alexi Chan, global co-head of capital markets at HSBC, said a reduction of up to 50% in banks' holdings of bonds -- the result of regulation and increased costs -- meant banks are no longer major providers of market liquidity.

"The question is, when a serious stress point comes, how this constrained liquidity we are now seeing will impact that," he said. "It is a big question for the system. And I think we are not really tested on that."

Other speakers said investors had to be made aware liquidity in some asset classes would disappear in any credit crunch.

Sebastian Domanico, head of debt capital markets at Credit Agricole CIB, said investors and issuers "need to realise that if something happened to the specific corporate sector or the high yield market ... they will be stuck.

"And I'm not sure the end-investors in the fund completely realise that," he said, describing it as a systemic risk.

Roman Schmidt, divisional board member capital markets at Commerzbank, said a proliferation in electronic trading platforms would exacerbate the problem.

"Platforms don't really see crises," he said. "The machines will react exactly like the humans did 10 years ago -- they will withdraw liquidity if something bad does happen."

But that risk may never materialise. Axa's Stoter said that central bank bond-buying, or QE, was here "permanently".

"We will be in a super-low rate environment for a very long time," he said. (Reporting by Virginia Furness; Editing by Catherine Evans)