September 2012 Quarterly Review: Investors search for yield as rates drop further
17 September 2012
- Weak growth and portfolio reallocations driven by concerns about euro area sovereign risk, combined with central bank policy actions, pushed government bond yields to unprecedented lows. And, as market participants searched for investment opportunities offering at least some yield, prices of equities and corporate bonds rose.
- Cross-border lending by internationally active banks increased slightly in the first quarter, partly offsetting the sharp contraction in late 2011.
- BIS economists Mathias Drehmann and Mikael Juselius show that recessions are likely to be deeper when a larger fraction of households' and firms' income is devoted to debt servicing. In addition, they show that a rapid increase in debt service costs (relative to income) raises the probability of a banking crisis.
- Boris Hofmann and Bilyana Bogdanova of the BIS show that, since the early part of the last decade, policy rates in both advanced and emerging market economies have mostly been below the level implied by a simple Taylor rule.
- The impact of the recent financial crisis on credit growth in Latin America was smaller than that of previous crises. Carlos Montoro (BIS) and Liliana Rojas-Suarez (Center for Global Development) examine whether this could have been a consequence of greater macroeconomic strength in the region at the onset of the crisis, combined with a new-found ability to implement offsetting policies.
Research by Michael Brei (University of Paris 10) and Blaise Gadanecz (BIS) finds that banks that were bailed out during the global financial crisis did not reduce the riskiness of their new lending more than banks that did not receive public assistance.
Summaries of individual chapters
During the period from mid-June to mid-September, the trajectory of global growth slowed and concerns about the sustainability of euro area government debt and the future of the monetary union gained new traction. Against this backdrop of lower growth, many central banks further loosened monetary policy, cutting interest rates or expanding unconventional measures. Some of these policy actions triggered large reactions in asset prices.
Together with central bank actions, the combination of weak growth and portfolio reallocations driven by concerns about sovereign risk in the euro area pushed government bond yields to unprecedented lows. In some European countries, nominal yields on short-term government bonds fell even below -0.4%. Such low yields on advanced economy government bonds spurred investors to search for investment opportunities that offered some extra return. The result was a rally in equities and corporate bonds. Search for yield may also partly explain the extraordinarily low volatility in credit, foreign exchange and equity markets over the past several months.
After a sharp fall in the previous quarter, the cross-border claims of BIS reporting banks expanded slightly during the first quarter of 2012. Despite this increase, banks' cross-border loan books (measured in US dollars) remained approximately 15% smaller than in early 2008, prior to the onset of the crisis.
The latest expansion of cross-border claims was mainly the consequence of the largest increase in lending to non-banks since early 2011. Cross-border interbank lending stabilised after the severe contraction in the previous quarter. And lending to banks in the euro area rose overall, albeit with considerable differences across countries.
BIS reporting banks' claims on emerging market borrowers rose by $86 billion or 2.8%. Borrowers in the Asia-Pacific region accounted for 79% of this increase. Lending to Latin America and the Caribbean and to Africa and the Middle East registered smaller increases. Only cross-border credit to emerging Europe continued to fall.
High levels of private sector debt can undermine economic stability. In this special feature, Mathias Drehmann and Mikael Juselius (BIS) show that the depth of a recession is often related to the debt service ratio (DSR) - that is, the ratio of debt service costs to income - prior to the slump. They also find that when the DSR rises above a certain threshold level, there is an increased probability of a banking crisis a few years later.
Boris Hofmann and Bilyana Bogdanova (BIS) show that, since the early part of the last decade, policy rates in both advanced and emerging market economies have mostly been below the level implied by a simple Taylor rule. This could be explained either by accommodative monetary policy or by a lower level of equilibrium real interest rates.
The impact of the recent financial crisis on credit growth in Latin America was smaller than that of previous crises. Carlos Montoro (BIS) and Liliana Rojas-Suarez (Center for Global Development) argue that this reflects stronger macroeconomic conditions in the region ahead of the crisis. Latin American economies were both less vulnerable to external shocks and better able to offset their impact through expansionary macroeconomic policy than in previous episodes. However, they caution that, compared with 2007, macroeconomic fundamentals have deteriorated in most cases.
Did bailouts during the financial crisis reduce the amount of risk banks took on in their lending operations? To shed light on this question, Michael Brei (University of Paris 10) and Blaise Gadanecz (BIS) analyse the balance sheets and syndicated loan signings of 87 large internationally active banks. They find that banks that were rescued during the crisis did not reduce the risk of their new lending significantly more than banks that did not receive public assistance.
* Signed articles reflect the views of the authors and not necessarily those of the BIS.