December 2012 Quarterly Review: Policy measures and reduced short-term risks buoyed markets
10 December 2012
- Forecasts for global economic growth fell in the three months to early December, yet most risky asset prices increased. These prices benefited from further loosening of monetary policies and perceptions that some major near-term risks to the world economy had diminished.
- Cross-border claims of BIS reporting banks dropped sharply between April and June, for the second time in three quarters. Interbank claims - especially inter-office positions - fell significantly, whereas claims on non-banks remained relatively stable.
- Banks from emerging market economies in Asia-Pacific largely filled the gap left by euro area and Swiss banks pulling back from lending to the region.
- The OTC derivatives market continued to shrink. Notional amounts outstanding declined for the second half-year in a row, to $639 trillion at end-June 2012.
- Reinsurers transfer only part of the risk arising from natural catastrophes to other financial institutions and the broader financial market. Sebastian von Dahlen (International Association of Insurance Supervisors) and Goetz von Peter (BIS) argue that these transfers, though small, warrant attention because little is known about who exactly has taken over the risk.
- Research by Stefan Avdjiev (BIS), Zsolt Kuti (Magyar Nemzeti Bank) and Előd Takáts (BIS) indicates that the deteriorating health of euro area banks explains most of the sharp fall in cross-border lending to emerging market economies in the second half of 2011.
- Morten Bech of the BIS and Todd Keister of Rutgers University argue that central banks may have to adjust their operating framework to deal with the changed demand for liquidity once the liquidity coverage ratio of Basel III comes into effect.
The BIS has revised its debt securities statistics to enhance their comparability across different markets. The article by Branimir Gruić and Philip Wooldridge (BIS) explains the reasoning behind these changes.
Summaries of individual chapters
Prices of risky assets increased in the three months to early December, despite a weaker outlook for growth. Corporate bond yields fell to their lowest levels since before the 2008 financial crisis as forecasters cut their projections for global economic growth. Equity prices rose during the early part of the period but later fell back. Equity implied volatilities fell close to the historically low levels of the mid-2000s.
Bonds and equities benefited from further loosening of monetary policies and perceptions that some major near-term downside risks to the world economy had diminished. In particular, valuations reacted positively to new policy measures aimed at tackling the euro area crisis. They were also supported by news suggesting that a sharp and prolonged fall in Chinese economic growth was less likely. However, not all downside risks diminished. Uncertainty about the short-term outlook for fiscal policy in the United States encouraged cash hoarding and weighed on the prices of assets most vulnerable to budget cuts.
Significant longer-term risks also remained, including the euro area crisis and those related to the subdued outlook for global economic growth. Given that scenario, some asset prices appeared highly valued in a historical context relative to indicators of their riskiness. Indeed, numerous bond investors said that they felt less well compensated for risk than in the past, but that they had little alternative with rates on many bank deposits close to zero and the supply of other low-risk investments in decline.
Cross-border claims of BIS reporting banks contracted by 2% in the second quarter of 2012, the second largest decline since early 2009. Reporting banks' cross-border claims on non-banks remained relatively stable, but credit to banks in advanced economies and in offshore financial centres contracted sharply (-3%). The fall in interbank claims was driven by reductions in inter-office positions (-5%). The outstanding stock of cross-border claims on borrowers in emerging markets changed little.
The gap left by euro area and Swiss banks pulling back from lending to emerging market economies in Asia-Pacific has been largely filled by banks in the region. The estimated intraregional lending accounted for 36% of total international claims on emerging Asia-Pacific in the most recent quarter available, up from an estimated 22% a few years ago.
OTC derivatives markets continued to shrink. Notional amounts outstanding of all contracts declined for the second half-year in a row, to $639 trillion at end-June 2012. This was mainly driven by lower volumes of interest rate derivatives and credit default swaps, which more than offset an increase in positions in foreign exchange, equity-linked and commodity contracts.
Reference rates such as Libor and Euribor play a key role in financial markets. At least 14% of outstanding debt securities are linked to an identifiable reference rate. For US dollar- and sterling-denominated securities, this tends to be Libor, with Euribor serving as the main benchmark for euro-denominated debt. The role of reference rates is even larger in the syndicated loan market, where well over half of the loans originated in the 12 months to October 2012 are linked to these rates.
Natural disasters resulting in significant losses have become more frequent in recent decades, with 2011 being the costliest year in history. Sebastian von Dahlen (International Association of Insurance Supervisors) and Goetz von Peter (BIS) explore how risk is transferred within and beyond the global insurance sector and assess the financial linkages that arise in this process. While most of the risk is retained within the global insurance market, part is transferred through retrocession and securitisation to other financial institutions and the broader financial market. These links appear small, but little is known about who exactly ultimately bears the corresponding risks, as no comprehensive international statistics exist.
Cross-border bank lending to emerging markets dropped sharply in the second half of 2011 as the euro area crisis intensified. Stefan Avdjiev (BIS), Zsolt Kuti (Magyar Nemzeti Bank) and Előd Takáts (BIS) use the BIS international banking statistics to identify the key drivers of this decline. Their results suggest that the latest contraction in cross-border bank lending was largely linked to the deteriorating health of euro area banks.
Basel III introduces the first global framework for bank liquidity regulation. As monetary policy typically involves targeting the interest rate on interbank loans of the most liquid asset - central bank reserves - it is important to understand how this new requirement will impact the efficacy of current operational frameworks. Morten Bech (BIS) and Todd Keister (Rutgers University) extend a standard model of monetary policy implementation to include the new liquidity regulation. Based on this model, they find that the regulation does not impair central banks' ability to implement monetary policy, but operational frameworks may need to adjust.
The BIS has revised its debt securities statistics to enhance their comparability across different markets. This feature by Branimir Gruić and Philip Wooldridge (BIS) sketches the main changes and the reasoning behind them. International issues have been redefined as debt securities issued outside the market where the borrower resides, and statistics combining international and domestic issues are being released for the first time. The revised statistics highlight the growing size and internationalisation of bond markets.
* Signed articles reflect the views of the authors and not necessarily those of the BIS.