BIS Quarterly Review, December 2018

Financial markets swung widely, eventually netting a sharp correction, during the period under review, which started in mid-September. Asset prices fell across the board and US government yields widened in October before retracing that increase and dropping further as the selloff of risk assets spread. Volatility and term premia jumped. A further round of turbulence, this time accompanied by lower yields, hit markets in December. The repricing took place amid mixed signals from global economic activity and the gradual, yet persistent, tightening of financial conditions. It also reflected the ebb and flow of ongoing trade tensions and heightened political uncertainty in the euro area. These bumps were a reminder of the narrow path that central banks are treading in their quest for policy normalisation, in a generally challenging policy environment. ...

Where do non-US banks obtain the funding for the large amount of US dollars they lend? Traditionally, their branches and subsidiaries in the United States were a major source of dollar funding, but the role of these affiliates has declined. Instead, dollars are increasingly raised in the home country. Where dollar funding is raised, however, is distinct from the location of the funding provider, as cross-border liabilities play a large role. In aggregate, a larger share of dollar funding is provided by US residents than is raised at foreign banks' US branches and subsidiaries. In the light of these facts, we discuss potential challenges related to the current geography of dollar funding. ...

This study analyses two hypotheses that ascribe the 2008 US financial crisis to capital inflows. The Asian savings glut hypothesis posits that net inflows into high-grade US public bonds from countries running current account surpluses led to the housing boom and bust. An excess of savings over investment abroad led to an excess of US investment over savings. The European banking glut hypothesis holds that gross inflows into private bonds led to the boom. Leveragingup by European banks enabled the leveraging-up of US households. Gross flows from Europe better matched US mortgage market trends towards private credit risk, floating interest rates and narrow spreads. What is more, European banks produced, not just invested in, US mortgagebacked securities. Their US securities affiliates held huge exposures to such securities that deserve recognition. Furthermore, European banks' leveraging-up also provided credit that enabled housing booms in Ireland and Spain. These findings favour the European banking glut hypothesis. ...

Financial cycle booms can end in crises and, even if they do not, they tend to weaken growth. Given their slow build-up, do they convey information about recession risk? We compare the predictive performance of different financial cycle proxies with that of the term spread - a popular recession indicator. In contrast to much of the literature, our analysis covers a large sample of advanced and emerging market economies. We find that, in general, financial cycle measures provide valuable information and tend to outperform the term spread. ...

Systemically important banks and central counterparties (CCPs) interact in highly concentrated over-the-counter (OTC) derivatives markets. We outline the CCP-bank nexus to think about the endogenous interactions between banks and CCPs in periods of stress. As these interactions could potentially lead to destabilising feedback loops, the risks of banks and CCPs should be considered jointly, rather than in isolation. ...