Yet more bumps on the path to normal: BIS Quarterly Review

Press release  | 
16 December 2018

Financial markets went through a further sharp correction during the last quarter, marking another bump in the road as major central banks return policy to more normal settings.

Asset prices fell across the board. US government bond yields rose in October before retracing that increase and falling still further as the selloff of risk assets spread. A further round of turbulence, accompanied by still lower yields, hit markets in December. Mixed signals from the global economy and the gradual, yet persistent, tightening of financial conditions triggered the market repricing. Protracted trade tensions and heightened political uncertainty added to the flight to safety.

"The market tensions we saw during this quarter were not an isolated event," said Claudio Borio, Head of the Monetary and Economic Department. "Monetary policy normalisation was bound to be challenging, especially in light of trade tensions and political uncertainty."

The December 2018 issue of the BIS Quarterly Review also:

  • Maps where non-US banks raise their $12.8 trillion in US dollar funding and where that funding comes from. The footprint of banks' US branches and subsidiaries has been shrinking even as the share of dollars coming from US residents remains high. This could have implications for the availability of dollar funding in the event of a funding squeeze.

"Given the dollar's pivotal role as the currency that underpins the global banking system, tracking the shifting pattern of dollar funding can inform assessments of how financial conditions fluctuate and how vulnerable they are to a reversal of sentiment," said Hyun Song Shin, Economic Adviser and Head of Research.

  • Examines how the recent default of a single trader resulted in an extraordinary loss of more than €100 million for a Swedish central counterparty and its members - demonstrating the importance of preparation and a long-term perspective in risk management.

  • Highlights the sensitivity of financial conditions indicators to stock prices. Even indices with a small weight on equity valuations might overstate the boost to activity that would come from cuts to monetary policy rates.
  • Outlines the risks of equity pledge financing, or lending extended to key shareholders or managers of listed companies who pledge shares as collateral. This lending grew rapidly in China, but fell in 2018 amid rising risks and the Chinese stock market decline.

Four special features analyse developments in markets and the global economy:

  • Eugenio Cerutti (IMF), Catherine Koch and Swapan-Kumar Pradhan (BIS)* find that banks from emerging market economies (EMEs) extend most of their rapidly growing credit to other EMEs from affiliates abroad rather than from headquarters. In many African and Asian countries, EME banks provide more than half the cross-border credit to non-banks, sometimes exceeding 25% of GDP. EMEs with larger banking systems tend to borrow on cross-border interbank markets, while EMEs with smaller ones tend to provide funds.
  • Umar Faruqui, Wenqian Huang and Előd Takáts (BIS)* study the close interactions between systemically important banks and central counterparties (CCPs) in over-the-counter derivatives markets, which have become more concentrated as central clearing has increased. While central clearing has strengthened the financial system overall, these interactions can potentially amplify stresses in some scenarios, reinforcing the need to think about risks in banks and CCPs jointly rather than in isolation.
  • Robert McCauley (BIS)* argues that European banks' investments in US mortgage-backed securities more plausibly explain the pre-2008 US housing market boom and eventual bust than Asian countries' purchases of US government bonds. European banks not only bought risky US mortgage bonds, but also actively packaged and sold these products through their US securities subsidiaries.
  • Claudio Borio, Mathias Drehmann and Dora Xia (BIS)* consider whether financial cycle proxies may be useful in gauging recession risk, since financial cycle booms tend to usher in weaker growth. They find that these proxies provide valuable information about recession risk for both advanced and emerging market economies, even three years ahead, and that they tend to outperform the slope of the yield curve - a very popular business cycle indicator. 

*   Signed articles reflect the views of the authors and not necessarily those of the BIS.