Looser monetary policy has pushed up stock and bond prices despite a weaker economic outlook and company profit warnings, creating a disconnect, with fundamental problems unresolved, the Bank for International Settlements said.
BIS economic adviser Stephen Cecchetti said action taken by central banks in Europe, the United States, Japan and elsewhere to help stimulate growth would not cut public debt levels or put banks on a firmer footing.
"Without structural adjustment, the economy won't return to a strong and balanced path," Cecchetti told a conference call on the latest quarterly review from the global forum of central banks, released on Sunday.
On a more positive note, the financial system was "clearly safer" as new regulation was being introduced, but there was "still more work to be done".
"We cannot wait and hope the problem will solve itself," Cecchetti said, defending Basel III, a global set of rules to make banks hold more capital due to take effect in January.
Critics in Britain and the United States have said the rules are too complicated and called for a greater reliance on a leverage ratio or balance-sheet cap.
Cecchetti said Basel's combination of complex risk-weight based rules to calculate a bank's safety capital buffer, backed by a simple leverage ratio, makes it harder for banks to game.
"We should and must continue to limit the size and complexity of financial institutions," he added.
World leaders agreed in 2009 to introduce Basel III from January but there are delays in finalising the rules in the European Union and United States.
But the major banks already meet or exceed the new capital requirements and central bankers appear not to be too worried over delays of a few months for rules that will make the financial system safer over coming years.
The BIS noted that new liquidity rules heralded by Basel III will have a profound impact on the way central banks operate monetary policy, but said monetary policy would not be impaired if central banks adjust.
The rules, which give banks liquidity credits for central bank deposits of at least 30 days but nothing for overnight money, could see a rise in the cost of longer-term central bank money and a fall in overnight rates, the BIS said.
(Reporting by Huw Jones and Laura Noonan; Editing by Catherine Evans)