Currency Markets (2)
Fund Flows (10)
Global Banking (6)
Credit Default Swaps’ Naked Truth Trail
2013 April 25 by admin
The IMF’s April Global Financial Stability Report in the wake of capital controls endorsed for Cyprus’ “exceptional circumstances” directly challenged the preceding ban on uncovered “naked” sovereign CDS which has since shrunk the $3 trillion notional market. The absence of an underlying government debt position does not fuel speculation more than other fixed-income and derivative instruments and the connection between shorting and higher funding costs is unsupported by the research as a “negative perception.” As they rapidly reflect information overshoot can occur especially in crisis periods, but useful hedging and liquidity capacity is lost with outright prohibition instead of addressing imperfections with greater disclosure and central clearing mandates. Banks and corporations dominate the $30 trillion gross CDS space and in the top 10 sovereigns France, Germany, Italy and Spain have joined emerging economy stalwarts Brazil, Mexico, Russia and Turkey according to NY-based Depository Trust data. Under the EU’s November 2012 rule protection can be bought for 30 countries only if exposure can be “meaningfully” correlated under dealer status. The vague criterion for eligibility has led to participant withdrawal and stress reduction with the ECB’s bond-support program has diminished demand. The European Securities Authority will review the 6-month impact of the directive over the summer and may recommend clarifications and modifications as global alignment evolves on margin and netting procedures. On the other hand parliament members who will debate the findings have also called for outlawing sovereign CDS altogether, which will particularly hurt shallower developing capital markets with fewer short-selling options. The trade association EMTA has already noted a sharp quarterly volume drop outside the region since the European move went into effect and the Greek triggering raised new questions about default definitions and settlement pricing. For that universe spreads have declined post-crisis but commercial and regulatory doubts have deterred investors from reflecting a positive view. The study urges more aggregate data on the field for prudential supervision but sees “no evidence” it is a worse threat than normal bond engagement.
The US Treasury’s latest international exchange rate report in the same vein casts doubt on such “unconventional” policies in view of Cyprus’ forced depositor losses and withdrawal limits. It comments that money market normalization was aided by the ECB’s bond-buying and long-term refinancing operations, with one-quarter of the latter’s 3-year over $900 billion facility recently repaid mainly by healthier banks in the core Eurozone. The 2014 plan for a single supervisor and resolution regime further “eased pressure” but reversals may now loom with the island rescue’s capital flow implications, which has already raised secondary market debt spreads. Bank shares have fallen amid shorting restrictions there too by individual members. With Portugal due to return to commercial borrowing in September as the constitutional court annulled previous austerity moves the government survived another no-confidence vote as the Treasury cited higher periphery “uncertainty” with the obvious obstacles.
Global Bank Regulation’s Second Best Solution
2012 October 15 by admin
On the eve of the IMF-World Bank annual gathering a Brookings Institute working group issued a report advocating a “second-best” approach to cross-border capital flow rules in the absence of full self-correcting mechanisms and multilateral oversight. It assumes that unbridled banking and debt movements will bring distortions that must be managed while extracting savings, investment and technology benefits from financial integration. Selective controls may be imposed, although they are prohibited under the EU’s two-decade old single market regime. The euro area has seen fund reversal within a monetary union given banks’ home bias, and the lack of central resolution authority and fiscal oversight. The study emphasizes reference to gross rather than net and credit versus portfolio and direct equity flows as instability indicators. Pro-cyclical bank lending in particular magnifies asset price swings with regular resort to wholesale borrowing beyond the retail deposit base. Institutional leverage can be high even where local units must be capitalized and organized as subsidiaries as in Central and Eastern Europe. Parent lines are now shrinking despite the EBRD’s Vienna Initiative which was effective in the immediate post-2008 crisis period. In Latin America domestic operations were not as geared and have proven more resilient, although both credit demand and supply have fallen. Emerging Europe has net foreign currency liabilities with negative balance sheet valuations while other regions are “long.” Exchange rate fluctuations have not caused developing country financial crashes as in previous episodes with their better sovereign standing and prudential focus on potential mismatches. Flexibility alone did not bring relief as evidenced by forint fallout in Hungary, where weakness aided the trade account but elevated the burden of euro and Swiss franc obligations.
Basic international regulation should include data sharing, common enforcement practice, and loss division. In Europe the separate Systemic Risk Board and Banking Authority have no powers other than warning. The ECB may take primary responsibility under “union” plans but the responsibility split with national regulators must still be set. At the worldwide level the Basel Committee and Financial Stability Board have assumed these mandates but “momentum has dissipated” according to the expert panel of academics and former government officials. Capital adequacy and liquidity proposals were “watered down” with adjustment spans extended to end-decade. Shadow banking and OTC derivatives markets have seen even less regulatory progress. Administrative measures such as introduction of loan-to-value and debt-to-income ratios can be helpful and eliminating tax deductions for debt could contribute to safety. Liability restrictions such as special taxes have been tried in places like Korea but the low-interest environment abroad may offset its impact. The related web of inward capital curbs most prominent currently in Brazil may mitigate the boom tendency but they are an experiment still without “firm findings” the observers conclude.
Financial Stability Reports’ Grading Jitters
2012 January 17 by admin
An IMF working paper finds “major drawbacks” in the central bank financial stability reports now issued semiannually and yearly in 80 countries, especially in their forward-looking assessments of systemic risk as that topic grips both industrial and developing world economies contending with new crises. Before the 2008 shock only fifty authorities compiled publications, and recent big entrants include India and the US Federal Reserve. In Mexico and elsewhere it is produced by an intergovernmental council, although the central bank maintains a key role. The average document length is 100 pages and coverage has evolved beyond the banking sector to embrace a broad range of non-bank, household, infrastructure and regulatory issues and micro and macro data. Stress-testing at the industry and institution levels typically features, and increasingly results must be presented to national parliaments for examination and hearings. The Swedish Riksbank is hailed as a model with a 15-year record, and heavy emphasis on current capital-liquidity gaps and future prospects with the content submitted for outside evaluation. Its present head is chair of the Basel Committee, which just reiterated application of stricter global standards by mid-decade. In terms of clarity, consistency and scope a sampling of authors profiled – with Brazil, Iceland, Korea, Latvia and South Africa from emerging markets – has more mixed content. They state objectives and offer financial market details but often lack reference to currency and securities interrelationships and cross-border banking and portfolio investment linkages. Ties between the biggest universal groups and diversified conglomerates, and sovereign exposures in light of the Eurozone crisis have not been explored. Risk mapping over time is absent, projections are unavailable or cursory, and stress-tests are only revealed in the aggregate in many cases. However Korean and South African indicators look at foreign exchange impact, and Latvia’s overall financial stress index incorporates numerous components.
Macro-prudential and monetary policy discussion is extensive, and Brazil and others regularly address international supervisory trends, even if foreign-language versions are not posted on websites. Iceland, which has endured a spectacular banking crash predating the Lehman Brothers debacle, has been notable in identifying missing balance sheet statistics particularly regarding non-resident and individual borrowers. Release delays have occurred as with Latvia’s 2010 summary issued in July 2011, and data is frequently circulated separately from the report body. Regressions using a range of ratings agency soundness and credit and stock market volatility measures show scant correlation between the analyses and subsequent stability. The Fund staff cites a loose “association” between higher-quality FSRs and healthier banking environments, and calls for more research into the specific channels for better information and discipline which tag tail risk.
The Financial Stability Board’s Shaky Ground
2011 November 17 by admin
A 25-member task force commissioned at the November 2010 G-20 meeting to survey developing and emerging economy issues under the auspices of the Financial Stability Board submitted its report in advance of the Cannes gathering, highlighting gaps in areas ranging from international banking standards adoption to non-bank and capital markets commercial and regulatory development. Their combined bank assets are almost one-third of the global system, but activity is typically less complex and diverse with limited oversight and infrastructure capacity measured against developed country parameters. Foreign currency and ownership are often pervasive, and the shallower local investor base affords lower liquidity and greater disruption risk when private lenders and fund managers abroad lose confidence. All regions subscribe to the BIS Core Principles, although few had fully incorporated the multi-pillar Basel II version before its 2009 effective date which has now been superseded by the post-crisis Basel III proposals setting capital adequacy and liquidity ratios over the next decade. Supervisors often lack corrective action tools and means to assess operational readiness, and securities market enforcement and surveillance is weak posing a threat in universal financial services groups, which may in turn be linked to industrial conglomerates. Cross-border networks are even harder to monitor, and home and host country communication and information-sharing has been uncertain despite the signature of cooperation agreements. The EU has its own accord and Asian, Latin American and African officials have bilateral and multilateral pacts on consolidated approaches with mixed results in practice. Only half of eligible members have ratified IOSCO’s collective memorandum of understanding, and the IAIS insurance body has just launched such an effort.
Non-bank licensing for institutions ranging from specialist consumer and mortgage lenders to microfinance, foreign exchange and mobile money houses has been uneven, although such sources may handle 15 percent of deposits and intermediary transactions in the aggregate, the World Bank estimates. Data collection and reporting lag on these industry segments targeted by the aid community for additional analysis and prudential rules. Foreign exchange mismatches remain a problem as hedging mechanisms and spot and forward trading have evolved slowly. Central bank restrictions on open positions can offer protection, but derivatives may fill an important need as part of money and debt market deepening. Expanding the domestic retail and institutional investor base, benchmark yield curve creation, market-maker designation, and clearing and settlement modernization are all elements, and the Asian Bond Market Initiative and recent integration of Andean Pact stock exchanges have extended these strategies regionally. The report criticizes the arbitrary nature of intervention by authorities which brought outright closures in the 2008-09 crisis period, and calls for a “structured, transparent” response to price volatility which to date has not been even-tempered.
The Basle Committee’s Staggering Property Pronouncement
2011 March 4 by admin
In its annual report the BIS, while lauding developing economies for crisis “escape,” cited growing imbalance risks including “staggeringly rapid” property price and private debt rises. It commented that cross-border financial flows in net and gross terms were again stoking instability with current account surplus and deficit countries refusing overdue savings and exchange rate adjustments. Macroeconomic policies should be the main levers of change, but increasingly regulatory measures and capital controls have assumed the responsibility. The credibility fight has taken greater importance with monetary stances often seen as lagging commodity and credit-induced inflation. Central banks are also grappling with Basel III’s new proposals in liquidity and other areas, and as in China’s case a large and unmonitored “shadow banking” system with close formal institution links. In global supervisory data “serious” gaps remain across the board at the firm, commercial transaction and national account levels which could be compiled in aggregate in an initial phase to flag vulnerabilities, the agency urges. In Asia a caution light could be flashing with the double-digit run-up in property credit in Singapore not seen since the late 1990s crash. It is now equivalent to 40 percent of GDP and ahead of income gains, and housing and oversight authorities have introduced steps to brake momentum. Overall lending was up 25 percent in the latest monthly number, and with the currency the main monetary tool, administrative controls are the handiest cooling means. The segment has driven inflation to 5 percent, but services and construction are key output and employment linchpins as industrial production weakens elsewhere. Bank and developer share listings have suffered with recent overheating disquiet, while bond fund managers there have pared regional allocations notably to Chinese high-yield issuers. Their spreads widened 100 basis points since May on the CEMBI benchmark with yields for recent entrants heading toward 15 percent. Along with reservations about the sector and the mainland’s soft landing prospects generally, disclosure and corporate governance scandals have hit prominent members like Sino Forest, which is under criminal investigation for US filings.
In the corporate debt universe the comparison risk-return group often cited with these events are Kazakh banks, with one-quarter of their mostly business and residential construction portfolios still non-performing after state rescues. BTA, which had imposed an 80 percent haircut on foreign creditors, was forced to release a statement in June after poor earnings that it could meet upcoming repayments. Subordinated instruments are trading in the distressed range after a previous rally as investors stagger at the continuing blast from the original default rubble.
Capital Surfers’ Trillion Dollar Wave
2011 January 25 by admin
The IIF, in its January summary
of private capital flows to thirty emerging economies, reported that they
jumped 50 percent to just over $900 billion last year and will surpass $950
billion in 2011 on the way to reaching the trillion dollar mark again
subsequently. All regions benefited with China’s number at an historic high of
$225 billion, and portfolio as opposed to direct investment at $200 billion was
unusually strong, while bank lending at over $150 billion was in contrast to
2009’s net outflow. The group predicts medium-term momentum in these segments
will flag with the proliferation of inward control and policy tightening
measures as annual GDP growth above 6 percent and low industrial world interest
rates remain supportive. It suggests that a stricter fiscal stance and currency
appreciation could forestall a potential boom-bust cycle, and cites the
“downside risk” of sudden G-3 monetary shifts. Consumer and asset inflation is
another worry with spare output capacity and food and fuel price rises with
supply constraints, and developing country authorities have often been slow to
remove anti-crisis stimulus. The aggregate current account surplus in the
universe tracked was up a further $370 billion in 2010, and the “secular trend”
is for lower public debt and structural improvements. Emerging equities’ weight
in the benchmark MSCI global portfolio has tripled the past five years to just
under 15 percent, but is still only half the host economies’ world GDP contribution.
Despite recent control moves in Asia and Latin America including taxes, holding
periods, and prudential requirements that may be absorbed by fund managers,
they erode a longstanding reputation for openness and serve a “limited role” in
adjustment toward permanently greater inflows which may be eventually subject
to common G-20 regulatory norms.
will continue to dominate with 40 percent of the private capital total and $500
billion annual increases in foreign exchange reserves that continue to be
recycled by central banks as net outflows toward dollar and euro-denominated
government paper and other instruments. India is an exception with its
current account deficit, and the offsetting buildup of external corporate
borrowing may be excessive as a resumed privatization push hopes to lure FDI. Europe
outside Poland, Russia and Turkey
is still a soft spot and fiscal positions there too are sensitive as Romania and Ukraine continue to rely on
official finance. In Latin America, Brazil has resorted to regular
interventions and controls to stem real appreciation that is likely a long-term
trend while companies have accounted for roughly half the region’s $60 billion
international bond issuance. In MENA the spillover from political upheaval and
economic stagnation in Tunisia and Egypt could blight interest, while in Africa
South African GDP growth at 3 percent is only half commodity-exporting
neighbors as the budget picture also worsens to stem otherwise cresting capital