BIS Quarterly Review, December 1997

The BIS is releasing today its regular quarterly commentary and statistics on recent "International Banking and Financial Market Developments". The report notes that, with the scope for a further significant reduction in interest rates perceived to be limited in major fixed income markets, world financial activity in the fourth quarter of 1996 encompassed a widening array of currencies, signatures and structures. In their ongoing search for higher yields, investors showed a greater willingness to move down the credit spectrum and explore new market niches. This, in turn, accentuated the broad reduction in risk premia, provided renewed incentives for the introduction of increasingly complex structures and stimulated cross-border capital flows.

In this context, it is not surprising that total net new issuance of international securities broke all previous records. Investors' appetite for enhanced returns led to a further opening to emerging market borrowers and to a proliferation of structures involving the repackaging of assets and/or the use of derivative features. At the same time, data from a number of countries indicate that intermediaries continued to make heavy use of OTC products, while demand for well-established derivative instruments traded on exchanges tended to stagnate. Overall, the return to favour of structured securities appears to have involved a lower degree of leverage than in earlier periods of market buoyancy. However, questions remain as to whether the risk and return characteristics of complex structures, as well as the liquidity of the underlyings, have all been properly assessed, particularly in the case of new entrants to the international market-place.

The dramatic expansion in international securities issuance last year stands in sharp contrast to the persistent weakness of international bank credit (according to data available up to the end of September 1996). The reduced presence of Japanese banks in foreign markets and, from June, the sharp cutback in total new lending to highly indebted countries in Asia were contributing factors. However, the contrast in the levels of activity between the international bank credit and securities markets last year underlines more fundamental changes taking place in the structure of financial intermediation worldwide, including the gradual fading of the traditional boundaries between instruments and sectors. Of note is the fact that financial institutions accounted for nearly two-thirds of total net new international securities issues. The particularly strong pace of issuance by US, UK and German entities and, correspondingly, the smaller market presence of other major competitors also point to important differences among intermediaries in addressing the challenges currently faced by the global financial industry. These challenges extend well beyond the implementation of the single European currency.