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DAVOS, Switzerland (Reuters) - Central banks' withdrawal of emergency U.S. dollar lending is a positive sign that financial markets are returning to health, the head of the Bank for International Settlements said on Thursday.
In interviews with Reuters and Reuters Insider Television, BIS general manager Jaime Caruana also warned commercial banks against being too greedy with profit targets as the financial environment improves.
Major central banks late on Wednesday said they will stop the emergency U.S. dollar lending introduced during the financial crisis, the first unified retraction of central banks' extraordinary support for financial markets.
"To some extent that is a very positive indication that markets have started to work and have started to work properly," said Caruana. "It is not necessary for the central banks to step in there."
The expiry of "swap" arrangements central banks had set up with the U.S. Federal Reserve expire on February 1 and indicate growing confidence that the financial system is returning to health after extraordinary liquidity support and rate cuts by central banks and extra government spending.
"You have to reduce dependence, it's very important that markets work themselves," Caruana said.
The head of the BIS, which acts as a forum for central banks, said he would not give policymakers advice on when to raise policy rates.
But he noted they should take seriously the risk of leaving liquidity support in place for too long, which could lead to potential distortions in competition and incentives to take too much risk.
"It's a narrow path," he said. "Neither too early nor too late ... the abyss or the chaos was avoided, now we really have to think about how all the extraordinary measures are withdrawn with the necessary flexibility."
Central banks have repeatedly urged their commercial counterparts to improve their capital backing and increase lending to the private sector, a key element in the economic recovery and a theme U.S. President Barack Obama stressed in his State of the Union speech on Wednesday.
But banks are also concerned about tough new regulations coming in, such as U.S. plans to curb big banks, which many fear will weaken their performance.
Caruana said the U.S. plans sent a "strong message" and went in the right direction and were already part of the wider discussion in reforming the financial system.
"I think it's very important that these things are coordinated. We are in a global world and that requires global solutions," he said.
Caruana cautioned banks against rushing to take on too much risk, echoing comments by People's Bank of China deputy governor Zhu Min on Tuesday.
Zhu said a 10 percent return on equity (ROE) ratio for banks was maybe more reasonable than the 14 to 15 percent levels seen before the crisis, and the 19 to 20 percent targets of some banks.
"Taking risk is part of the solution, it is excess risk that is the problem and that's a very delicate balance," Caruana said.
"ROE that is only based on leverage has been part of the problems of this crisis, it should not be like that. We should not go back to these very high ROE that are based on leverage."
The timetable for implementing reforms would allow countries discretion, he said.
"It is always difficult to say 'press the button now' but there are good experiences of countries that have done so, so discretion will always be there," he said.
Additional reporting by Peter Thal Larsen