June 2013 Quarterly Review: Markets under the spell of monetary easing
3 June 2013
Further monetary easing boosted asset prices despite negative macroeconomic news.
Cross-border claims of BIS reporting banks fell in the fourth quarter of 2012 as a sharp reduction in cross-border interbank lending more than offset higher cross-border credit to non-banks.
Paul Melaschenko and Noel Reynolds (BIS) propose a mechanism to recapitalise banks that are too big to fail.
Mathias Drehmann (BIS) finds that the reliability of credit gap indicators as an early warning signal for incipient systemic crises can be improved by using data on total credit to the private sector rather than bank credit data only.
Chen Zhou (Netherlands Bank) and Nikola Tarashev (BIS) measure banks' systemic importance on the basis of information about rare events that they compute using tools from extreme value theory.
Summaries of individual chapters
Further monetary easing helped market participants to tune out signs of a global growth slowdown. The spate of negative economic news between mid-March and mid-April did little to interrupt the rise of equity prices in advanced economies. Further policy easing, followed promptly by an improved US outlook in early May, boosted market sentiment and lifted the main equity indices to new highs.
The Bank of Japan surprised markets in April by unveiling an ambitious new monetary easing framework, triggering a surge in equity prices and a drop in the exchange rate. But the rapid gains left equity valuations vulnerable to changes in sentiment, as witnessed in the recent bout of volatility. The announcement also triggered sharp price movements in the Japanese government bond market as investors weighed the yield implications of official purchases against expectations of higher inflation down the road.
The new phase of monetary policy accommodation in the major currency areas spilled over to financial markets around the world. With yields in core bond markets at record lows, investors turned to lower-rated European bonds, emerging market paper and corporate debt to obtain yield.
BIS reporting banks cut their cross-border claims during the fourth quarter of 2012, after little change in the previous quarter. A sharp reduction in cross-border interbank lending more than offset higher cross-border credit to non-bank borrowers. Across all reporting areas, banks curbed their cross-border exposure to advanced economies but increased it to emerging market economies and offshore financial centres.
Notional amounts outstanding of over-the-counter (OTC) derivatives remained stable in the second half of 2012 owing to several offsetting factors. Accelerating compression of trades with central counterparties pushed down the outstanding notional amount of interest rate swaps, but this was offset by higher amounts outstanding of forward rate agreements as bilateral contracts between reporting dealers were replaced with contracts between dealers and a central clearing counterparty.
Paul Melaschenko and Noel Reynolds (BIS) propose a creditor-funded resolution mechanism to recapitalise too-big-to-fail banks at the point of failure. The mechanism ensures that the shareholders and uninsured private sector creditors of banks, rather than taxpayers, bear the cost of resolution. The template fully respects the existing creditor hierarchy and can be applied to any failing entity within a banking group. The mechanism partially writes off creditors to recapitalise the bank over a weekend, providing them with immediate certainty on their maximum loss. The bank is subsequently sold in a manner that enables the market to determine the ultimate losses to creditors.
Rapid growth in credit to the private sector has often preceded a systemic banking crisis. Based on this observation, the deviation of the bank credit-to-GDP ratio from its long-term trend can help identify impending financial vulnerabilities. Using the new BIS database on total credit presented in the March issue of the BIS Quarterly Review, Mathias Drehmann (BIS) finds that taking account of all sources of credit to the private non-financial sector, rather than just bank credit, provides a more accurate indication of systemic banking crises.
Systemic crises are rare events. This greatly complicates the use of statistical tools for gauging systemic risk and the contributions of individual banks to it. Using tools from extreme value theory, Chen Zhou (Netherlands Bank) and Nikola Tarashev (BIS) compute price-based measures of the systemic importance of individual banks. They find that the more systemically important banks in their sample tend to be larger, more leveraged and more active in the interbank market than their peers. By contrast, the banks of lesser systemic importance tend to have a higher share of net interest income in total income, resort more to stable sources of funding and have lower operational costs.
* Signed articles reflect the views of the authors and not necessarily those of the BIS.