BIS Quarterly Review, June 1999
Introduction
The BIS is releasing today its regular quarterly review and statistics on recent international banking and financial market developments. Conditions in global financial markets showed signs of improving during the first quarter of 1999. The decision to float the Brazilian currency in January had a negative impact on market conditions, but this was short-lived since the announcement had been largely anticipated and leverage considerably reduced. While the rebound of yields on benchmark long-term bonds indicated a partial reversal of the flight to safety and liquidity, various indicators of market stress suggested that last autumn's global reassessment of risk had had a lasting influence. Thus, despite some decline, credit spreads, liquidity premia 1 and volatility all remained above their pre-Russian crisis levels. Finally, fears of a possible loss of confidence in the US currency dissipated as buoyant US economic growth gave rise to expectations of higher interest rates. In contrast, the initial enthusiasm of investors for the euro rapidly waned owing to the weakness of economic activity in the euro area.
The most striking sign of improved market confidence was in the area of long-term international debt securities. Announced issuance in the first quarter of 1999 surged by 58% from the fourth quarter of 1998, reaching an all-time high of $415 billion. The launch of the euro in January was evidently a factor, with a number of large borrowers seeking to create benchmarks. Primary activity in the new currency posted an 84% gain from the 1998 average for the 11 legacy currencies and the ECU, to $147 billion2. Announced US dollar denominated issues also recorded a strong increase, rising by 32% from last year's average to an all-time high of $200 billion. Financial institutions led the upsurge in overall activity, under the combined influence of consolidation and restructuring within the financial industry. The market also saw the return of emerging market names soon after the Brazilian devaluation, albeit at prices more commensurate with perceived risks.
In contrast, the volume of international syndicated loan facilities dropped from $225 billion in the fourth quarter of 1998 to $156 billion, hampered by the tightening of lending conditions. The decline in facilities may also have been partly related to the growing use of short-term credit lines, which are less capital intensive, but which are not included in the BIS data on announcements.
Meanwhile, the more detailed BIS statistics on international banking activity available for the fourth quarter of 1998 revealed a high degree of interdependence between bank lending and the strategies pursued by non-bank investors. There was a $100 billion drop in banks' outstanding loans to non-bank customers located inside the BIS reporting area (which includes the major financial centres), supporting other evidence that banks contributed to the overall market reversal. Interestingly, the even larger withdrawal of international deposits by the same non-banking sources (-$120 billion) shows that the abrupt reappraisal of global exposures in the wake of the Russian moratorium and the LTCM debacle hindered international bank intermediation. This sheds new light on the decision by monetary authorities to inject liquidity in order to avoid a credit crunch, although the advent of the euro possibly added to banks' reluctance to renew existing positions.
In the derivatives industry, the launch of the euro had somewhat contrasting implications for organised exchanges and over-the-counter (OTC) markets in the first quarter of 1999. Anticipation of the single currency had given rise in 1998 to a contest of new contracts among exchanges. The bund contract at Eurex and the Euribor contract at LIFFE were the clear winners, as liquidity played in their favour. Liquidity proved more elusive in the OTC market. Trading activity in the new currency was constrained by the lack of adequate references in the pricing of interest rate swaps and forex options. Markets also felt the absence of leveraged investors, who had previously provided substantial liquidity. Meanwhile, the trend towards electronic facilities crossing over cash and derivatives markets continued.
1For example, the yield differential between "off-the-run" and "on-the-run" US Treasury bond issues in the US fixed income market.
2It should be stressed, however, that the creation of the single European currency has further compounded the problem of distinguishing between domestic and offshore issuance, as illustrated by the recent confusion in various published sources over the size and composition of the international securities market.