Global liquidity indicators: background and interpretation

BIS Quarterly Review  |  March 2015  | 
18 March 2015

(Extract from pages 20-21 of BIS Quarterly Review, March 2015)

Over the past several years, BIS researchers have developed indicators intended to track global liquidity conditions. The term global liquidity is used here to mean the ease of financing in global financial markets. Defined this way, it encompasses both funding liquidity (the ease of raising cash by selling new obligations to investors) and market liquidity (the ease of raising cash by selling assets). Global liquidity thus depends on the actions of private investors, financial institutions and monetary authorities. It is essentially an unobservable property of the financial system - we can gauge it by analysing different price and quantity indicators, but no single indicator on its own will give a full picture. The information content of these indicators changes over time, implying that a flexible approach is needed when assessing global liquidity conditions.

Financial institutions provide market liquidity to securities markets through their trading activities, and provide funding liquidity to borrowers through their lending activities. The terms on which these intermediaries can fund themselves, in turn, depend on the willingness of other market participants to interact with them. Macroeconomic and prudential policies are another factor, including the terms and conditions on which central banks provide funding.

The interaction between these private and official factors determines the economy's overall ease of financing. This, in turn, influences the build-up of financial system vulnerabilities in the form of asset price inflation, leverage, or maturity or funding mismatches. Indicators tend to measure these "footprints" of liquidity rather than liquidity itself, which is unobservable.

On this basis, and seen from a financial stability perspective, global credit is among the key indicators of global liquidity. The stock of credit outstanding shows how far ease of financing has led to the build-up of exposures. In other words, global private sector credit reflects the outcome of financial intermediation activity in global markets. Changes in these stocks are closely associated with the build-up of vulnerabilities, with potential implications for financial stability. These flows comprise both a domestic and an international element.

Of particular interest for assessing global liquidity is the international component of credit (cross-border lending to non-residents or lending in foreign currency). This cross-border element has often provided the marginal source of financing in credit booms. Although often small relative to the total stock of credit, swings in these international components can amplify domestic trends and are highly correlated with booms and busts in global financial conditions. Global liquidity is thus linked to - but distinct from - domestic liquidity conditions and the financial cycle in a given country or region.

Any assessment of global liquidity conditions requires that measures of global credit be put into perspective. Much of this credit, although not all, is provided by banks, so that the indicators focus on this component. More, however, is also being provided by other investors in debt securities, as the asset management industry has grown. A range of supplementary price and quantity indicators can be used to capture additional aspects of global liquidity that are relevant for financial stability. These include measures of financing conditions in key financial markets and incentives for position-taking across market segments. Key indicators in this regard are proxies for risk perceptions and tolerance (such as the VIX), which are a major driver of leverage and the willingness of private investors to provide funding. One would also be interested in the terms and conditions at which finance is granted, as well as the consequences of these terms for credit volumes and prices.

These concepts have been developed and elaborated in a series of BIS research papers, committee reports and speeches. Some of the most useful ones are the following: