BIS Quarterly Review, February 1998

BIS Quarterly Review  | 
09 March 1998
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Introduction

The Asian crisis had important repercussions in international financial markets in the fourth quarter of 1997. Firstly, the sharp rise in risk premia and the general flight to quality affected financing conditions for all but the most highly rated borrowers and resulted in an abrupt drop in announced issues of international long-term debt securities (by almost 30%, to $188 billion). The sharp increase in repayments led to an even more pronounced decline in net issuance (including money market paper, by 60%, to $66.8 billion). Secondly, the less receptive attitude of international investors encouraged lower-rated borrowers to seek alternative sources of financing in the syndicated loan market. Of note in this respect was the previously accelerating pace of aggregate international bank lending to Latin American and Eastern European countries in the third quarter of 1997, as compared with substantial declines vis-à-vis certain Asian countries, according to the latest BIS banking statistics. This, together with the limited movements in risk premia in the third quarter, suggests that the abundance of liquidity worldwide and the associated competitive pressures delayed a reconsideration of exposures until the crisis had become more widespread. Thirdly, renewed volatility in world currency and equity markets, by revealing highly exposed positions, boosted end-user interest in hedging products. This contributed to the further recovery of trading on derivatives exchanges, bringing the turnover of financial contracts to a near record of $94.2 trillion in the fourth quarter of 1997. The heavy losses faced by some intermediaries in Asia also prompted a broader reassessment of risk management strategies.

At the turn of the year the financial turmoil in Asia had reached systemic dimensions, requiring an immediate injection of cash and the rolling-over of maturing debt. Surprisingly, contagion outside that region seems to have been contained. The risk premia on Latin American and Eastern European countries' foreign currency securities quickly retreated from their late October peak. These countries' currencies were little affected, and equity indices in North America and Europe rapidly recouped their losses. In a context of continuing ample global liquidity and a further lowering of US and European long-term rates, the subdued pace of securities issuance in the second half of the quarter reflected borrowers' willingness to delay issuance in anticipation of improved conditions as much as outright rationing by international investors. This view is supported by the fact that issues launched by highly rated borrowers found a very favourable market reception, as well as by the rapid return to international issuance by many non-Asian borrowers and the renewed narrowing of risk premia at the beginning of 1998. In the absence of improvements in external financial indicators in many of these countries, particularly given the anticipated impact of the Asian crisis, questions can be raised concerning the lessons that have been drawn from the recent events.

Although the turmoil in Asia occupied centre stage during the quarter, a number of underlying trends continued to assume growing importance. Prime among these was the accelerating pace of consolidation in the financial industry. A new wave of mergers and acquisitions accentuated the dichotomy between strategies aimed at providing a full range of financial services and those based on niche business. The forthcoming introduction of the single European currency is reinforcing this consolidation process by putting pressure on European banks to improve their competitiveness through more efficient management of their balance sheets. The fact that, for the year as a whole, issuance by financial institutions accounted for two-thirds of the growth of the international debt securities markets shows that cross-border capital flows are increasingly motivated by the active management of risks. At the same time, the efforts to consolidate and innovate on derivatives exchanges continued unabated. However, with the diminishing returns of competitive strategies structured around new interest rate products, adjustments to contract specifications and reductions in fees, the locus of innovation shifted to equity products and the development of increasingly sophisticated electronic trading systems. The growing popularity of electronic trading and linkages, as well as progress made in bringing together cash, exchange-traded and over-the-counter business, provides an illustration of how advances in technology are forcing a reshaping of the industry's structure. At the same time, the Asian crisis has served as a painful reminder that the interconnections between markets are becoming increasingly complex. Adjusting to such a rapidly evolving but uncertain environment will be a challenging task for market participants and regulators.