BIS Quarterly Review, September 2011

Developments in financial markets during the review period largely reflect substantial downward reassessments of trajectories for economic growth. The prices of risky assets fell sharply in July and August as negative macroeconomic data cast a dark cloud over the strength of recovery in several major economies. Market participants' concerns about growth were amplified by perceptions that monetary and fiscal policies had only limited scope to stimulate the global economy. In Europe, concerns about sovereign debt spread from Greece, Ireland and Portugal to Spain and Italy. This led to tighter funding conditions for European banks and even affected pricing in euro area core sovereign debt markets. All these developments led to flows into safe haven assets, which appreciated in value. Yields on 10-year US Treasuries and German bunds fell to historic lows, while gold prices and the Swiss franc soared before the Swiss National Bank imposed a floor on the Swiss currency against the euro. More...

The aggregate cross-border claims of BIS reporting banks rose during the first quarter of 2011, mainly because of increased lending to US residents. BIS reporting banks increased their cross-border claims on residents of emerging market economies by the largest amount since the global financial crisis. The $178 billion (6.3%) expansion was primarily due to a rise in interbank claims, which increased by $147 billion (10%). Cross-border claims on Asia-Pacific grew by an unprecedented $126 billion (12%) in the first quarter, largely reflecting a surge in claims on China ($80 billion or 24%). Cross-border claims on residents in the other emerging market regions also increased. The political turmoil in North Africa and the Middle East led to outflows of funds from several countries in the region. Internationally active banks reported the largest single-quarter increase in liabilities to residents of Egypt ($6.4 billion or 20%). Liabilities to residents of Libya also increased considerably ($2.2 billion or 3.5%). More bilateral netting and higher collateralisation have reduced counterparty credit exposures in the OTC derivatives market. BIS statistics show that the amount of bilateral netting in this market has gone up since late 2007, as has the degree of collateralisation. More...

Globalisation has affected the relationship between the trade balance and the real exchange rate in two ways. On the one hand, the growth of trade taking place within industries makes the trade balance more sensitive to real exchange movements. On the other hand, a higher degree of vertical specialisation and more global supply chains act to reduce this sensitivity. The relative importance of these two effects varies across countries. According to the estimates presented in this article, changes in the real exchange rate could play a larger role in curbing the US trade deficit than in reducing the Chinese trade surplus. This confirms that real exchange rate adjustment is only part of the solution for global rebalancing, and needs to be accompanied by other policy actions.

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US dollar credit is growing quickly outside the United States, especially in Asia, and in some economies it has outpaced overall credit growth. Cross-border sources of credit bear watching in view of their record of outgrowing overall credit in credit booms. Foreign currency and cross-border sources of credit raise policy issues.

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The financial crisis and economic recession, and policymakers' responses to these events, have raised sovereign risk concerns in a number of advanced economies. This has increased the cost and reduced the stability of funding for banks. It has also meant that decisions about the maturity of government debt have become important to the dynamics of systemic financial distress. This article looks at the financial stability issues involved, drawing from two recent studies by the Committee on the Global Financial System (CGFS). A return to sustainable government finances over the medium term is fundamental to managing current difficulties. Banks improving their funding and asset risk management, lengthening of government debt maturities and sound banking regulation are also important. And the different policy agencies involved need to ensure that they are aware of each other's objectives and operational plans, while maintaining clear lines of accountability.

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