Latest BIS Quarterly Review shows that sovereign risk shakes markets
1 March 2010
The BIS Quarterly Review for March 2010, released today, gives an overview of recent developments in financial markets. It attributes the fall in asset prices between mid-January and mid-February to, among other factors, the unevenness of the global economic recovery and concerns about sovereign credit risk in the light of large fiscal deficits.
It also provides highlights from the latest BIS data on international banking and financial activity.
The March issue features four articles. These focus on:
- The architecture of global banking. This article draws on the BIS banking statistics to distinguish between "international" and "multinational" banks and the implied geographical funding patterns. It also considers how the crisis put funding models to the test.
- What happens to exchange rates during financial crises. Comparing three recent financial crises, the article shows that exchange rate movements were unusual during the 2007-09 global financial crisis.
- How far the banking sector is still dependent on central bank and government support.
- The origins and evolution of the term "macroprudential".
An abstract of each of these articles is attached.
The rise in risky asset prices ran out of steam at the beginning of 2010. After 10 months of substantial increases, equity prices in both advanced and emerging market economies started falling from mid-January, while credit spreads widened. With volatility and risk aversion rising, increased demand for government bonds pushed benchmark bond yields downwards. Towards the end of the period under review, markets stabilised and some of the losses were reversed.
The reduction in the demand for risky assets seen during much of the period was the result of a number of factors. In an environment where uncertainty about growth prospects persisted, mixed news on the economic recovery in Europe and the United States weakened investors' confidence. The unevenness of the global economic recovery added to the uncertainty. Moreover, concerns about sovereign credit risk intensified as market participants increasingly focused on the fiscal woes of Greece. These worries spilled over to a number of other countries in the euro area, and generally placed downward pressure on prices of risky assets. These sudden market pressures served as a warning about the financial risks of prolonged fiscal deficits. Against this backdrop, the euro fell significantly against other major currencies. In addition, market interpretations of steps and future plans to normalise very expansionary policies seemed to amplify investors' unwillingness to take on risk. Global equity prices fell following decisions by the Chinese authorities to raise the reserve requirement ratio for large depository institutions. Moreover, bond yields rose and equity prices fell after the US Federal Reserve announced an unexpected increase in the discount rate.
Banks' international balance sheets contracted again in the third quarter of 2009, although the pace of the decline was much slower than in the preceding three quarters. Total gross international claims of BIS reporting banks fell by $360 billion during the period, mainly reflecting lower interbank lending. Cross-border claims on borrowers in emerging markets went up slightly for the second consecutive quarter, primarily due to increases in claims on residents of Asia-Pacific and Latin America and the Caribbean. Exchange rate adjusted local lending in local currencies also expanded in these two regions, but declined in emerging Europe. Reporting banks' international portfolios continued to shift towards claims on the public sector, which increased in both relative and absolute terms during the third quarter.
Activity in the primary market for international debt securities weakened markedly in the fourth quarter of 2009. Announced gross issuance declined by 10% quarter on quarter to $1,778 billion. Net issuance dropped to $303 billion, well below the $485 billion recorded between July and September. Residents in emerging markets raised 19% more funds in the international market than in the third quarter, whereas borrowers from developed economies reduced their issuance by 38%.
After pausing in the previous quarter, the recovery in activity on the international derivatives exchanges continued at a modest pace in the fourth quarter of 2009. Turnover measured by notional amounts went up by 5% to $444 trillion, 22% higher than at the trough in the first quarter but still well below its peak ($690 trillion) in early 2008.
The financial crisis has led to a reconsideration of banks' global business models. The feature by Robert McCauley, Patrick McGuire and Goetz von Peter (BIS) draws on the BIS banking statistics to distinguish between "international" and "multinational" banks and the implied geographical funding patterns, and to consider how the crisis put funding models to the test. The authors find that local positions proved to be more stable than cross-border positions, especially in emerging markets, where they tended to be in the local currency and funded by retail deposits.
Exchange rate movements during the global financial crisis of 2007-09 were unusual. Unlike in two previous episodes, many countries that were not at the centre of the crisis saw their currencies depreciate sharply. Such crisis-related movements reversed strongly for a number of countries. Marion Kohler (BIS) argues in her article that two factors probably contributed to these developments. First, safe haven effects went against the typical pattern of crisis-related flows. Second, interest rate differentials explain more of the crisis-related exchange rate movements than in the past.
How much does the banking sector depend on public support? Petra Gerlach (BIS) suggests that the decline in the utilisation of many support facilities was mainly due to a fall in demand. Supply factors play a smaller, but not insignificant role, as governments and central banks have tightened the conditions on which certain support measures are available or have phased them out entirely. However, Gerlach finds that not all financial institutions have reduced their use of support facilities, with some weaker banks continuing to depend on public support.
A core element of international efforts to strengthen the financial system has been to enhance the macroprudential orientation of regulatory and supervisory frameworks. This special feature by Piet Clement (BIS) traces the origins of the term "macroprudential" to the late 1970s, in the context of work on international bank lending carried out under the aegis of the Euro-currency Standing Committee (ECSC) at the BIS. Its first major public use was in the 1986 ECSC report entitled Recent innovations in international banking. Clement then describes the term's changing fortunes until its recent rise to prominence.