September 2013 Quarterly Review: Markets precipitate tightening
15 September 2013
- Higher yields in advanced economies generated serious tremors in emerging markets.
- Cross-border claims of BIS reporting banks were broadly stable in the first quarter of 2013. Banks redirected lending from the advanced economies to emerging markets, especially to China, Brazil and Russia.
- Japanese banks returned as the world's largest providers of cross-border credit, a position they had lost in the aftermath of the crisis in the 1990s.
- Corporations from emerging markets have overtaken firms from the advanced economies as the largest group of issuers of corporate debt securities in offshore financial centres.
- Benjamin Cohen (BIS) finds that large banks raised their capital ratios mainly by increasing retained earnings rather than by reducing their assets or loan books.
- Stefan Avdjiev, Anastasia Kartasheva and Bilyana Bogdanova (BIS) discuss the structure of contingent convertible capital instruments (CoCos) and analyse the evolution of the market.
- Anamaria Illes and Marco Lombardi (BIS) show that in many countries the difference between lending and policy rates remains well above its pre-crisis level.
- There is no aggregate collateral shortage, argue Ingo Fender and Ulf Lewrick (BIS), although collateral may be distributed unevenly.
- A database on monetary and prudential measures aimed at moderating housing booms and busts is presented by Ilhyock Shim, Bilyana Bogdanova, Jimmy Shek and Agne Subelyte (BIS).
Summaries of individual chapters
Announcements in May that the Federal Reserve envisaged phasing out quantitative easing reverberated through global financial markets. They triggered a surge in benchmark bond yields that spilled over across asset classes and regions. Equity prices in both advanced and emerging market economies fell sharply, as did a number of emerging market currencies. The downward pressure on prices abated in early July when the Federal Reserve, the ECB and the Bank of England reassured markets that monetary policy would remain accommodative until the domestic recovery was on a solid footing. In advanced economies, equities quickly recovered and yields, despite their rise, remained low by historical standards. This led to a continuing squeeze of credit spreads and increased issuance of riskier bonds, a phenomenon reminiscent of the exuberance prior to the global financial crisis.
The market-led tightening of financial conditions generated serious tremors in emerging market economies. Together with the already deteriorating outlook for growth in these economies, this amplified pressures on local bond, equity and foreign exchange markets, all of which compounded vulnerabilities created by dependence on fickle foreign capital.
During the first quarter of 2013, the cross-border claims of BIS reporting banks remained broadly unchanged, reflecting two diverging trends. First, lower interbank lending, especially to banks in the euro area, was largely offset by higher claims on non-banks. Second, lower lending to advanced economies contrasted with higher claims on borrowers in emerging market economies, especially in China, Brazil and Russia. As a result, the share of interbank credit to emerging market economies reached its highest level on record. This underpins a longer-term trend: especially in emerging Asia and Latin America, countries generally have been affected less by the global financial crisis.
Japanese banks have returned to their position as the world's largest providers of cross-border credit. They have increasingly been lending out of their offices abroad, whereas the share of cross-border claims booked in Japan has been declining. The international advance of Japanese banks has been funded largely through sources in Japan.
Financial and non-financial corporations headquartered in emerging market economies have overtaken firms from the advanced economies as the largest group of issuers of corporate debt securities in offshore financial centres. The surge in issuance is primarily due to borrowers in just two countries, China and Brazil. Issuing bonds through controlled entities in offshore centres allows them to reach an investor base that would find it hard to invest locally.
Spurred by tighter regulatory requirements and market pressure, banks have steadily raised their capital ratios since the financial crisis. Benjamin Cohen (BIS) documents how banks went about increasing their risk-weighted capital ratios. He finds that retained earnings account for the bulk of the increase. Banks lowered the share of profits paid out as dividends and, in the advanced economies, increased lending spreads. Reductions in risk weights played a lesser role. Fears that banks would stop lending have thus not been borne out, at least at the aggregate level. On average, banks continued to expand their lending, though lending growth was slower among European banks than others. Banks that came out of the crisis with higher risk-weighted capital ratios and stronger profitability were able to expand lending more.
Private investors are usually reluctant to provide additional external capital to banks in times of financial distress. Contingent convertible capital instruments (CoCos) offer a way to address this problem and prevent taxpayers from having to pick up the bill. CoCos are hybrid capital securities that are either written down or converted into equity if the capital of the issuing bank falls below a certain threshold. Stefan Avdjiev, Anastasia Kartasheva and Bilyana Bogdanova (BIS) explain the structure of CoCos and trace the evolution of the market. Not surprisingly, the issuance and design of CoCos depends on whether or not they help banks to meet regulatory capital requirements. The bulk of the demand for CoCos has come from small investors, while institutional investors have been relatively restrained so far. The cost of issuing CoCos, as measured by their spreads over other subordinated debt, greatly depends on whether they are written down or converted into equity and on the level of the capital ratio at which the loss absorption mechanism is activated.
Policy rates in advanced economies are at record lows and central banks have resorted to unconventional policy tools, but there are concerns that the low policy rates have not been transmitted to lending rates for households and firms. Anamaria Illes and Marco Lombardi (BIS) investigate whether the pass-through of monetary policy to rates on bank loans to non-financial firms has been impaired in the aftermath of the Great Recession. They find that the spread between lending rates to the non-financial corporate sector and policy rates is currently close to the pre-crisis level in the United States and Germany, but remains higher in peripheral euro area countries.
Increasing demand for collateral assets in the aftermath of the financial crisis has raised concerns about a shortage of high-quality assets (HQA). Drawing on a recent report by the Committee on the Global Financial System, Ingo Fender and Ulf Lewrick (BIS) argue that such concerns seem unjustified. In aggregate, the increase in the supply of HQA appears sufficient to meet the additional demand arising from both market forces and regulatory changes. But given the uneven distribution of HQA among market participants, higher demand is likely to trigger market responses that could themselves generate risks for the financial system and thus warrant further monitoring.
Housing markets have been at the core of many financial crises in advanced and emerging market economies alike. Central banks and financial authorities around the world have adopted various types of monetary and prudential policy measures to moderate the frequency and severity of booms and busts in housing credit and house prices. Ilhyock Shim, Bilyana Bogdanova, Jimmy Shek and Agne Subelyte (BIS) present a new database for such policy actions. It covers 60 economies worldwide from January 1990 (or earliest date available) to June 2012. Policy actions are summarised by type, region, timing and whether they tightened or loosened borrowing conditions.
* Signed articles reflect the views of the authors and not necessarily those of the BIS.