BIS Quarterly Review, September 1998
31 August 1998
BANK FOR INTERNATIONAL SETTLEMENTS, CH-4002 BASLE
Following some easing of market tensions in Asia in the earlier part of the year, there was renewed financial turbulence in the second quarter of 1998. Nervousness about economic and financial conditions in Japan accentuated the coolness towards yen-denominated assets. At the same time, problems of policy credibility in several Asian countries put downward pressures on currencies in the region, with markets paying increasing attention to the risk of a devaluation of the Chinese yuan. These events, together with the weakness of commodity prices and, in some countries, political uncertainty, initiated a new wave of contagion to other emerging market economies, triggering a flight towards the perceived safe-haven markets of the United States and Europe. Thus, long-term bond yields in the United States and continental Europe resumed their downward trend, helped in the latter case by improved confidence in the process of establishing monetary union.
In this unsettled environment, announced issues of international debt securities receded from the all-time record of the first quarter. This was in part a natural slowdown after the hectic pace of issuance seen in the previous quarter. Nevertheless, activity was fairly well sustained, suggesting that positive factors remained sufficiently strong to offset heightened concerns about risk. Prime among these supportive elements were the ongoing diversification of international financing, the search for higher returns, the wave of mergers and acquisitions and the development of a pan-European securities market. In contrast, increased awareness of country and counterparty risks was reflected in a rise in the risk premia attached to syndicated bank loans and securities arranged for emerging market names. Simultaneously, credit derivatives were increasingly used for adjusting exposures as an alternative to secondary market sales, contributing to progress in the area of credit risk management.
The comprehensive BIS banking statistics now available for the first quarter of 1998 show that the unprecedented expansion seen in international bank lending during the fourth quarter of last year was not sustained. This turnaround reflected the retreat of Japanese banks from both interbank and final lending business and masked the continuing buoyancy in the activity of EU banks. The expansion recorded by the latter group was largely driven by intra-European transactions, reflecting some redirection of activity back to Europe in the wake of the Asian crisis and positive perceptions concerning EMU. In contrast, and notwithstanding the ample supply of loanable funds worldwide, reporting banks sharply reduced their exposure to Asia. This appears to have only marginally benefited other regions in the developing world, although special factors sustained lending in a small number of countries.
The resurgence of financial turbulence in the second quarter of 1998 lent a new sense of urgency to addressing the issues of crisis prevention and resolution. Despite the numerous initiatives that have been spurred by the Asian crisis, national and international authorities continue to face difficult trade-offs, such as the need to reconcile domestic and external constraints and to provide liquidity while limiting the risk of moral hazard through an appropriate sharing of the financial costs of crises. Recent events have also underlined the need to reconsider the "architecture" of the world financial system, which is increasingly beyond the reach of national regulatory powers. Other recent developments, such as the wave of mega-mergers and alliances in the financial industry and the restructuring currently taking place in derivatives markets, are also likely to lead to a reconsideration of supervision and regulation. Compounding these challenges are the pressing issues related to the advent of the euro and the transition to the next millennium. All these developments will test the ability of the various groups of actors, in both the private and public sectors, to cope with the greater interdependence of global financial markets.