BIS Quarterly Review, December 1997

The BIS is today releasing its regular quarterly statistics on recent developments in international banking and financial markets. The attached commentary points to the fact that strains in the world financial system were evident well before the severe turbulence of October. Surprisingly, the greater volatility of equity and currency markets was not reflected in any significant rise in the volatility and level of bond yields in the industrialised world in the third quarter of 1997. Indeed, developments in international securities markets show a continuing large supply of loanable funds to fixed income markets, fuelled by subdued inflation, fiscal consolidation and an accommodating monetary policy stance in the major economies. The Asian financial crisis reportedly led to some reallocation of portfolios away from the region, without reversing the broad-based search for higher returns seen in earlier periods. However, more recent events tend to support the argument that the previous underlying shift towards higher-yielding debt and complex structures may have induced certain categories of investor to underestimate credit and liquidity risk factors.

At the same time, the continuing rapid expansion in the stock of international securities outstanding in the third quarter of 1997 provides another illustration of the increasing importance of active risk management in cross-border financial flows and of the central role played by the market in accommodating it. Thus, over half of new international securities issuance reflected intermediaries' direct recourse to the market, with again a large proportion of transactions related to asset repackaging, mergers and acquisitions and the strengthening of banks' capital structures. While these developments underline the restructuring currently taking place within the world financial industry, other evidence points to the more specific tendency towards a functional and geographical concentration of business. Thus, partly reflecting the reallocation of funds between and within banking groups involved in the race to become global players, detailed international banking statistics available up to the middle of the year indicate a sustained rate of growth of overall credit aggregates. Meanwhile, developments in derivatives markets show that the prospective introduction of the single European currency added to pressures for restructuring across cash and derivatives markets.

The accelerating pace of consolidation in the world financial industry supported a number of new market and official initiatives during the third quarter of 1997. Several recommendations were also made concerning the adjustments required by two forthcoming important deadlines: the proposed introduction of the euro and the coming of the new millennium. These issues are discussed in various sections of the commentary, which also covers the spreading of the South-East Asian currency turmoil during this period, as well as recent developments in the international equity and swap markets.