BIS Quarterly Review, December 1998
30 November 1998
BANK FOR INTERNATIONAL SETTLEMENTS, CH-4002 BASLE
BIS Quarterly Review
BIS Quarterly Review
The BIS is releasing today its regular quarterly review and statistics on recent developments in international banking and financial market developments . The turmoil that had emerged in the developing world assumed global dimensions in the third quarter of 1998. Against a backdrop of severe banking problems in Asia, the decision by the Russian authorities on 17th August to float the rouble and declare a moratorium on some of the country's debt triggered a massive flight towards safety and a broad tiering of spreads according to credit quality. The crisis also led to a rush to liquidity, as illustrated by a sharp widening of liquidity premia between benchmarks and other government debt instruments. The unwinding of large and highly leveraged exposures added to price volatility, as evidenced by the swings seen in the yen/dollar exchange rate and in the yields on major government bonds. Towards the end of the quarter, fears of a systemic disruption prompted the US monetary authorities to sponsor the recapitalisation of a major hedge fund and contributed to the decision to lower US official interest rates.
Developments in the international securities markets during this period illustrated investors' growing aversion to risk. Demand dried up for all but the most highly rated names while primary market activity contracted for the second consecutive quarter. Similarly, activity in derivatives markets suggested a preference for the safety of exchange- traded transactions, whereas concerns about counterparty risk hampered business in swaps and credit-related products. Indeed, shifts in market liquidity from OTC to exchange-traded interest rate instruments accentuated demand and supply imbalances in underlying markets. Meanwhile, the wild swings recorded in foreign exchange markets in the third quarter seem to have boosted demand for currency options.
In the international banking market, the general tightening of lending conditions dampened overall loan syndication activity in the third quarter. At the same time, detailed BIS international banking data for the second quarter of 1998 show that BIS reporting banks substantially withdrew from emerging markets and stepped up their purchases of marketable paper in the G-10 countries during the period. Commercial banks have become increasingly important players in securities markets worldwide in recent years. To the extent that securities holdings are recorded in banks' trading books, this tendency for internationally active banks to securitise their claims and to rely more heavily on securities issues for their funding could have important implications for global financial intermediation.
The Russian announcement mentioned above can be seen as part of a series of mutually reinforcing events which have highlighted a number of deficiencies in the world financial system. For instance, the massive unwinding of leveraged positions has served as a painful reminder that linkages between markets have become highly complex and opaque. Recent events have also underscored the inadequacy of models in coping with abrupt shifts in market liquidity and provided another illustration of the increasing convergence in the behaviour of banks and other categories of market participants. It is now broadly acknowledged that national and sectoral regulatory oversight has significant shortcomings in view of the globalisation of markets. The Basle Committee on Banking Supervision has announced a wide-ranging review of the Capital Accord to take account of evolving financial practices. Finding the appropriate balance between market discipline, regulatory standards and supervisory practices in a way which enhances the effectiveness of market discipline and minimises moral hazard will be a challenging task.