BIS Quarterly Review June 2010 International banking and financial market developments BIS Quarterly Review Monetary and Economic Department Editorial Committee: Claudio Borio Frank Packer Christian Upper Stephen Cecchetti Eli Remolona Paul Van den Bergh Robert McCauley Philip Turner General queries concerning this commentary should be addressed to Christian Upper (tel +41 61 280 8416, e-mail: [email protected]), queries concerning specific parts to the authors, whose details appear at the head of each section, and queries concerning the statistics to Philippe Mesny (tel +41 61 280 8425, e-mail: [email protected]). Requests for copies of publications, or for additions/changes to the mailing list, should be sent to: Bank for International Settlements Press & Communications CH-4002 Basel, Switzerland E-mail: [email protected] Fax: +41 61 280 9100 and +41 61 280 8100 This publication is available on the BIS website (www.bis.org). © Bank for International Settlements 2010. All rights reserved. Brief excerpts may be reproduced or translated provided the source is cited. ISSN 1683-0121 (print) ISSN 1683-013X (online) BIS Quarterly Review June 2010 International banking and financial market developments Overview: fiscal concerns shatter confidence ..................................................... 1 Euro area sovereign risk goes global .................................................... 2 Box 1: Back to the future? Comparing recent events with the 2007–09 financial crisis ..................................................................................... 6 Contagion temporarily halted by policy actions ..................................... 7 Box 2: Policy actions to avoid a global confidence crisis ....................... 8 US and euro area monetary tightening expected to be postponed ......... 10 Box 3: Higher public sector holdings of US public debt ......................... 12 Highlights of international banking and financial market activity ......................... 15 The international banking market ......................................................... 15 Box 1: Measuring banking systems’ exposures to particular countries ... 20 The international debt securities market ............................................... 22 Derivatives ........................................................................................... 23 Box 2: A new trade repository for OTC interest rate derivatives ............ 26 Special features Policy responses to dislocations in the FX swap market: the experience of Korea 29 Naohiko Baba and Ilhyock Shim Global deleveraging and FX swap markets ........................................... 30 FX swap market dislocations in Korea and policy responses ................. 31 Effectiveness of policy responses ......................................................... 35 Box: Regression analysis and data .................................................... 36 Conclusion ........................................................................................... 38 Currency collapses and output dynamics: a long-run perspective ....................... 41 Camilo E Tovar Defining currency collapses ................................................................. 42 Output dynamics around the time of currency collapses ........................ 43 Box: Econometric methodology ......................................................... 44 Concluding remarks ............................................................................. 46 Was it credit supply? Cross-border bank lending to emerging market economies during the financial crisis .................................................................................... 49 Előd Takáts Empirical strategy ................................................................................ 50 Analysis ............................................................................................... 51 Robustness .......................................................................................... 52 Conclusion ........................................................................................... 55 European banks’ US dollar funding pressures..................................................... 57 Ingo Fender and Patrick McGuire Cross-currency financing and the FX swap market ............................... 58 Measuring US dollar funding gaps ........................................................ 59 Dollar funding during the crisis ............................................................. 61 Possible implications ............................................................................ 63 BIS Quarterly Review, June 2010 iii Statistical Annex ........................................................................................ A1 Special features in the BIS Quarterly Review ................................ B1 List of recent BIS publications .............................................................. B2 Notations used in this Review e estimated lhs, rhs left-hand scale, right-hand scale billion thousand million … not available . not applicable – nil 0 negligible $ US dollar unless specified otherwise Differences in totals are due to rounding. iv BIS Quarterly Review, June 2010 Jacob Gyntelberg Peter Hördahl Michael R King [email protected] [email protected] [email protected] Overview: fiscal concerns shatter confidence Global financial markets were highly volatile from mid-April to early June as fiscal concerns and the risk of weaker growth caused investor confidence to deteriorate rapidly. Investor worries about unsustainable fiscal positions crystallised around the problems of Greece and other euro area sovereigns. Faced with growing uncertainty, investors cut risk exposures and retreated to traditional safe haven assets. The announcement of a significant European rescue package bought a temporary reprieve from contagion in euro sovereign debt markets, but could not allay market concerns about the economic outlook. Instead, the flight from risky assets continued, resulting in additional increases in risk and liquidity premia. A number of developments led investors to question the robustness of global growth. In advanced economies, investors and market commentators focused on the risk that the surge of public debt could derail the economic recovery. At the same time, rising Libor-OIS spreads reflected growing concerns that the financial system is more fragile than previously thought. Economic policy tightening in China, Brazil and India, among others, fuelled doubts that emerging economies could provide the necessary global growth momentum. Market confidence was further dented by rising geopolitical risk on The retreat from risky assets Equity prices1 Credit spreads Prices of safe haven assets North America4 Ten-year Treasury (lhs) Europe4 Ten-year bund (lhs) 170 6 EMBI Global 1,500 120 Gold (rhs) 1,280 Diversified5 135 1,000 110 1,120 Advanced economies2 3 Emerging markets 100 500 100 960 65 0 90 800 2009 2010 2009 2010 2009 2010 1 3 March 2009 = 100. 2 Average of S&P 500, DJ EURO STOXX, TOPIX and FTSE 100 indices. 3 Average of Asian, European and Latin American emerging market equity indices. 4 Five-year on-the-run credit default swap (CDS) mid-spreads on sub- investment grade (CDX High Yield; iTraxx Crossover) quality, in basis points. 5 Stripped spreads, in basis points. 6 Spot price per troy ounce, in US dollars. Sources: Bloomberg; Datastream. Graph 1 BIS Quarterly Review, June 2010 1 Implied volatility and exchange rates Equity implied volatility1 Credit implied volatility2 Euro exchange rates3 VIX (S&P 500) United States USD DJ EURO STOXX 41 Europe 35 JPY 105 Nikkei 225 GBP 34 29 100 27 23 95 20 17 90 13 11 85 2009 2010 2009 2010 2009 2010 1 Volatility implied by the price of at-the-money call option contracts on stock market indices, in per cent. 2 Volatility implied by the price of at-the-money one- to four-month option contracts on CDS indices (CDX High Yield; iTraxx Crossover), in basis points. 3 1 January 2009 = 100. Sources: Bloomberg; BIS calculations. Graph 2 the Korean peninsula and Spain’s second downgrade, together with the difficulties of a number of Spanish savings banks, in late May. Over the six weeks to the end of that month, prices of risky assets fell and volatility rose. Stock markets fell in advanced and emerging markets alike, bringing global equity prices below end-2009 levels (Graph 1, left-hand panel). Corporate credit spreads, which had remained broadly stable for several months, widened in late April (Graph 1, centre panel). Faced with significantly higher uncertainty, investors increased their demand for US Treasuries, German government bonds and gold (Graph 1, right-hand panel). Implied volatilities of equity prices and credit spreads rose sharply, reaching new highs for the year (Graph 2, left-hand and centre panels). The challenging fiscal situation and uncertainty about the growth outlook for the euro area also led to a significant weakening of the euro against other major currencies (Graph 2, right-hand panel). By the end of the period, investors had become increasingly concerned about the global growth outlook and, as a result, again pushed back their expected timing for the normalisation of monetary policies in the advanced economies. Euro area sovereign risk goes global Concerns about the fiscal positions of Greece and other euro area sovereigns Euro area fiscal had been on investors’ radar screen since November 2009. These worries concerns rise … were evident in the