December 2015 BIS Quarterly Review: Uneasy calm awaiting lift-off
6 December 2015
The December issue of the BIS Quarterly Review explores how global financial markets have responded in recent months to the prospect that monetary policy paths will diverge across the major advanced economies.
Markets stabilised in October, following the episode of turbulence that took place in August.
In November, strong macroeconomic data from the United States increased the likelihood of a "lift-off" in the Federal Reserve's policy rate. The prospects for higher US rates posed challenges for a number of emerging market economies (EMEs), including currency weakness, higher bond yields, and possible capital outflows.
Data from earlier in the year point to a slowdown in international financial flows. Cross-border banking contracted in the second quarter, for the first time since mid-2013. International debt securities issuance slowed in the third quarter, particularly for EMEs.
- Currency movements may have affected banking flows, as the weakening of the euro coincided with increased euro-denominated borrowing outside the euro area.
Four special features address statistical, policy and regulatory issues:
A BIS-compiled data series gives a more detailed picture of how US dollar credit is distributed outside the United States, shedding light on dollar borrowing patterns in different EMEs, as Robert McCauley, Patrick McGuire and Vladyslav Sushko (BIS) report.
Ingo Fender and Ulf Lewrick (BIS) find considerable scope for increasing the Basel III minimum leverage ratio requirement without compromising the net macroeconomic benefits.
Dietrich Domanski, Leonardo Gambacorta and Cristina Picillo (BIS) argue that, while progress has been made in improving the resilience of central counterparties, the interaction of central clearing with the rest of the financial system remains imperfectly understood.
Marlene Amstad (Chinese University of Hong Kong, Shenzhen) and Frank Packer (BIS) show how sovereign credit ratings have evolved post-crisis, analyse the factors driving such ratings and ask whether there is evidence of a bias against EME borrowers.
Summaries of individual chapters
The interplay between the shifting prospects for policy normalisation in the United States, emerging market weaknesses and accommodation in other major advanced economies (AEs), drove market developments in the fourth quarter of 2015.
Markets stabilised in October following the August-September rout. Fears of a crisis centred on emerging markets faded as Chinese equity and currency markets - the rout's epicentre - stabilised. Policy interventions in EMEs and expectations for continuing monetary accommodation in AEs including the United States, supported sentiment. Asset markets rebounded strongly worldwide and volatilities fell.
Sentiment changed following the Federal Open Market Committee's October meeting and early November's strong US labour market report. Both events raised the odds for a US interest rate hike this year. US bond yields rose and the dollar re-asserted its strength, reflecting market expectations that the gap between the US policy rate and those of other AEs would widen.
Although EME markets suffered a particularly sharp re-pricing, market reactions were short-lived. In the first five days following the US payroll data, equity, bond and foreign exchange markets seemed to replay the mid-2013 "taper tantrum". But, in contrast to the earlier episode, markets across the different emerging market asset classes had largely recouped these losses by mid-November.
The market's recovery might suggest that EMEs could ride out the prospect of US monetary tightening. However, less favourable financial market conditions, combined with a weaker macroeconomic outlook and increased sensitivity to US rates, heighten the risk of negative spillovers to EMEs once US rates do start to rise. Tighter financial conditions could also accentuate rising financial stability risks.
Cross-border banking activity shrank significantly between end-March and end- June 2015, more than reversing the first quarter's large expansion. Cross-border claims fell by $902 billion in exchange rate-adjusted terms during Q2 2015, according to the BIS locational banking statistics, slowing their annual growth rate to 1% at end-June 2015, down from 6% at end-March 2015. Claims also declined in the BIS consolidated banking statistics, although by a smaller amount.
Bank credit to AEs and EMEs diverged during Q2 2015. Cross-border claims on AEs fell by $916 billion, more than offsetting the $761 billion increase in Q1 2015 and cutting year-on-year growth to less than 1%. By contrast, cross-border claims on EMEs grew by $46 billion, almost wiping out the previous quarter's $57 billion dip. Despite the latest quarterly increase, the annual growth rate of cross-border lending to EMEs turned negative (-1%) for the first time since end-September 2012.
By contrast,international debt securities issuance was generally strong throughout the first half of the year. But growth faltered in the third quarter, when net issuance fell to $50 billion, the largest contraction since 1Q 2013. This represents a decline of almost 80% compared to the previous quarter and to the third quarter of 2014. Issuance plummeted both in AEs and EMEs. AE-based borrowers issued $22 billion net of repayments, $100 billion less than in the preceding quarter. EME borrowers issued only $1.5 billion net, about $89 billion less. Offshore centres and international organisations accounted for the remainder.
This feature sets out economy-level detail on US dollar debt incurred by borrowers in emerging economies. Robert McCauley, Patrick McGuire and Vladyslav Sushko (BIS) profile such debt for a dozen prominent economies that account for the bulk of total US dollar debt owed by EMEs. The authors measure the dollar borrowing of non-banks resident in these economies as well as that of their affiliates offshore, and relate these to commonly used debt measures. They also discuss the limitations of their data.
The Basel III leverage ratio (LR) is designed to restrict the build-up of leverage in the banking sector and to backstop the existing risk-weighted capital requirements (RWR) with a simple, non-risk-weighted measure. But how should a minimum for the LR requirement be set? Ingo Fender and Ulf Lewrick (BIS) present a conceptual framework for the LR's calibration, focusing on the LR's cyclical and structural dimensions as well as its consistency with the RWR. They then apply the framework to historical bank data. Taking an explicitly conservative approach, the authors suggest that - subject to caveats - there is room to raise the LR requirement above its original 3% "test" level, to about 4-5%.
Central clearing of standardised financial instruments, as promoted by the G20 Leaders, addresses some of the financial stability risks that materialised during the Great Financial Crisis. Its rapid evolution since 2009, while undoubtedly strengthening systemic resilience, may have changed the linkages between central counterparties and the rest of the financial system. Against the backdrop of these trends, Dietrich Domanski, Leonardo Gambacorta, and Cristina Picillo (BIS) discuss how central clearing might have affected systemic risk.
Post-crisis, the three major credit rating agencies have reassessed sovereign credit risks and increased the transparency of their methodologies. According to Marlene Amstad (Chinese University of Hong Kong, Shenzhen) and Frank Packer (BIS), this has materially changed the rank-ordering of risks. Simple statistical models explain the lion's share of ratings differentials and capture some of the methodological changes. Support is not found for the hypothesis of bias against EMEs. Some rating agencies other than the big three offer alternative risk rankings that are more favourable to EMEs. However, these tend to be less closely aligned with the rankings provided by market prices and institutional investors.
1 Figures include Hong Kong SAR and Singapore.
* Signed articles reflect the views of the authors and not necessarily those of the BIS.