BF Symposium-session2-Shin-Slides

Hyun Song Shin - BIS, Banque de France, Nov 2014 - Changing Face of Financial Intermediation and Lessons for Central Banks
Changing Face of Financial Intermediation
and Lessons for Central Banks
Hyun Song Shin*
Bank for International Settlements
Banque de France Annual Conference
7 November 2014
* Views expressed are my own, not necessarily those of the BIS.
VIDEO: https://www.banque-france.fr/en/eurosystem-international/international-symposium.html
https://www.banque-france.fr/fileadmin/user_upload/banque_de_france/La_Banque_de_France/symposium-session2-shin-slides.pdf

VIDEO:
https://www.banque-france.fr/en/eurosystem-international/international-symposium.html

Direct and intermediated finance: what are the tradeoffs?
 What determines the supply of bank finance?
 What determines the supply of market finance?
 What role for the monetary environment?
3

Direct and intermediated finance: two phases
 Banking sector-led credit growth (2003 – 2008)
 Procyclical leverage
 Wholesale funding as marginal source of finance
 Driven by combination of
- steep yield curve
- certain path of short-term rate
 Bond market-led credit growth (2010 – )
 Long-term investors as creditors
 Focus on corporate borrowers, especially EME corporates
 Driven by low long rates and flat yield curve
4

US Treasury 10 year and 3 month rates
16.0
14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
Jan-84
Jan-86
Jan-88
Jan-90
Jan-92
Jan-94
10 year
3 month
Jan-96
Jan-98
Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
Jan-12
Percent
5

Term premium used to be determined by short rate; but
not any more
5.0
4.0
3.0
2.0
1.0
0.0
-1.0
-2.0
-3.0
-4.0
-5.0 -4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 4.0
12 month change in 3 month rate (%)
12 month change in term spread (%)
Jan 1985 -
June 2010
July 2010 -
Dec 2012
6

Year-on-year rate of growth in international bank claims
In per cent
7

McCauley, McGuire and Sushko (2014): Yield curve
flattening leads to preference for bond issuance
8

Direct and Intermediated Finance
Banks
Ultimate
Creditors
Ultimate
Borrowers
Intermediated
Credit Claim
Directly granted credit
9

Bond market as a “spare tire”:
Evidence from the US during the crisis
1
0

Bond market as a spare tire: credit to the US non-financial
corporate business sector (US Flow of funds, table L102)
9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
2012Q3
2011Q1
2009Q3
2008Q1
2006Q3
2005Q1
2003Q3
2002Q1
2000Q3
1999Q1
1997Q3
1996Q1
1994Q3
1993Q1
1991Q3
1990Q1
Trillion dollars
Corporate
bonds
Commercial
paper
Other loans
and
advances
Bank loans
n.e.c.
Total
mortgages
10

Bond market as a spare tire: credit to the US non-financial
corporate business sector (quarterly changes)
1990Q2
1991Q4
1993Q2
1994Q4
1996Q2
1997Q4
1999Q2
2000Q4
2002Q2
2003Q4
2005Q2
2006Q4
2008Q2
2009Q4
2011Q2
210
180
150
120
90
60
30
0
-30
-60
-90
-120
-150
-180
-210
Millions
Bond
change
Loan
change
12

Limits of spare tire: credit to non-financial non-corporate
business sector (US flow of funds, table L103)
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
2012Q3
2011Q1
2009Q3
2008Q1
2006Q3
2005Q1
2003Q3
2002Q1
2000Q3
1999Q1
1997Q3
1996Q1
1994Q3
1993Q1
1991Q3
1990Q1
Non-corporate business sector total borrowing
(trillion dollars)
other loans and
advances
depository
institution loans
n.e.c.
commercial
mortgages
multifamily
residential
mortgages
construction
loans on one-to-four
family
homes
home
mortgages
13

Spare tire comes at a price: risk premium of bond finance
(Gilchrist and Zakrajscek (AER 2012))
16
14
10
8
6
4
2
6
4
2
8
6
4
2
0
0
1997 1999 2001 2003 2005 2007 2009 2011
0
Percent of liabili ties Percentage points
8 18
12
Expected y ear-ahead def aults at t-12 (lef t axis)
10-y ear high-y ield corporate bond spread at t (right axis)
14

Bank and bond financing (1): before bank deleveraging
Aggregate
credit supply
Credit
demand
Total credit
Lending
rate
Bank
credit
supply
Bond
credit
supply
15

Bank and bond financing (2): bank deleveraging shock
Credit
demand
Total credit
Lending
rate
Bank
deleveraging
16

Bank and bond financing (3): bank and bond shares
Total credit
Lending
rate Bond
financing
Bank
financing
17

Bond financing during the crisis
 Bond financing played the role of “spare tire” in the US during
the crisis
 Corporate borrowers with access to bond market were able
to substitute bank finance with bond finance
 However, they had to pay for the privilege
 For unlisted firms, even this privilege was not available
 Bond financing during the crisis was driven by the negative
supply shock to bank financing
 Borrowers were “driven into” the bond market
 Increased demand for bond financing manifests itself as
higher bond spreads
18

Even as spreads fall,
issuance accelerates
Source: Bank of England
19
What happened after 2012?
An example from non-financial corporate financing in UK

Bond financing in the boom years (2012 – )
 The boom in bond financing after the crisis was accompanied
by low and falling spreads, not high spreads
 Growth in bond finance has been led by increased supply of
bond finance
 Search for yield with low and flat yield curve
 Switch to fixed income assets of long-term investors
 Focus shifts from banks to asset managers
20

McCauley, McGuire and Sushko (2014) again: yield curve
flattening leads to preference for bond issuance
20

Annual gross issuance of international debt securities by EM
non-bank corporations: residence basis
Emerging market economies1 (weighted average)
Maturity in # years
$ 152 bn
2000 2002 2004 2006
2008 2010 2012 2014
Year
12
10
8
6
4
1 Bulgaria, Brazil, Chile, China, Colombia, Czech Republic, Estonia, Hong Kong SAR, Hungary, Indonesia, India, Iceland,
Korea, Lithuania, Latvia, Mexico, Malaysia, Peru, Philippines, Poland, Romania, Russia, Singapore, Slovenia, Thailand,
Turkey, Venezuela and South Africa.
Sources: Dealogic; Euroclear; Thomson Reuters; Xtrakter; BIS.
22

Annual gross issuance of international debt securities by EM
non-bank corporations: nationality basis
Maturity in # years
2006
Year
12
10
8
$ 265 bn
6
2000 2002 2004 2008 2010 2012 2014
23

Traditional boundaries …
… are not sufficient in understanding the second phase of global liquidity
Bank
A L
Border
A L
Local
currency
Local
currency Local
currency
US
dollars
Non-financial
corporation
International
capital market
24

Amounts outstanding of international debt securities of EM
non-bank corporations at end-June 2014
USD bn
Nationality Residence
1,000
750
500
250
0
25

Projected redemptions on international debt securities of
EM non-bank corporations
Emerging market economies, in billions of US dollars
Nationality basis Residence basis
26

Longer maturity of outstanding debt securities
 Maturity of debt securities has been increasing
 Average maturity of outstanding EME non-bank corporate
international debt securities now exceeds 8 years
 Longer maturities have two effects
 Mitigates roll-over risk for borrowers
 But only at expense of increased duration risk for investors
 Longer duration may exacerbate potential for non-linear
market disruptions due to flight by investors
 Possibility of perverse impact of increased maturity on roll-over
risk if non-linear disruptions shut down dollar bond market for
extended period
27

Projected redemptions of securities of EM non-bank
corporations: by nationality basis
USD bn
600
450
300
150
0
16 18 20 22 24
Issued on any market
26 28 30
International debt securities
28

Yields of local EM government bonds and the
EM exchange rates
Five-year govt bond yields
Volatility of yields The exchange rate
0.045
0.030
0.015
0.000
2010 2011 2012 2013 2014
The black vertical line corresponds to 1 May 2013 (FOMC statement changing the wording on asset purchases).
Countries included: Brazil, India, Indonesia, Malaysia, Mexico, the Philippines, Poland, South Africa and Turkey.
29

Elements in possible distress loop
1. Steepening of local currency yield curve
2. Currency depreciation, corporate distress, freeze in corporate
CAPEX, slowdown in growth
3. Runs of wholesale corporate deposits from domestic banking
sector
4. Asset managers cut back positions in EME corporate bonds
citing slower growth in EMEs
5. Back to Step 1, and repeat...
30

Bank bond issuance in Europe
30

Annual gross issuance and average maturity (euro area
resident banks): long-term securities issued on any market
Euro area aggregate
Maturity in # years
$1782 bn
2001 2003 2005 2009 2011 2013 2015
2007
Year
5.5
5.0
4.5
4.0
3.5
3.0
2.5
Source: Dealogic.
32

Projected redemptions at end-June 2014 (euro area resident
banks): long-term securities issued on any market
Euro area aggregate
USD bn
600
400
200
0
14 15 16 17 18 19 20 21 22
Year
23 24 25
Currency decomposition:
EUR USD
Source: Dealogic.
Other
33

Annual future redemptions at end-June 2014 (euro area
Spain
USD bn
14 15 16 17 18 19 20 21 22
Year
23 24 25
EUR USD
Source: Dealogic.
Other
80
60
40
20
0
34

France
USD bn
100
80
60
40
20
0
14 15 16 17 18 19 20 21 22
Year
23 24 25
EUR USD
Source: Dealogic.
Other
35

USD bn
80
60
40
20
0
Italy
14 15 16 17 18 19 20 21 22
Year
23 24 25
EUR USD
Source: Dealogic.
Other
36

Netherlands
USD bn
60
40
20
0
14 15 16 17 18 19 20
Year
21 22 23 24 25
EUR USD
Source: Dealogic.
Other
37

Liability categories of the euro area credit institutions
Source: ECB.
USD bn
38

Liability categories of the euro area credit institutions
Source: ECB.
USD bn
39

“Leverage-like” behaviour without leverage
 Relative performance evaluation
 Ranking influences asset gathering ability
“The real business of money management is not managing
money, it is getting money to manage” [WSJ 16/11/95]
 Selling volatility through writing straddles and then hedging
price moves with delta hedging
 Marking to market with thin secondary market
 Risk limits and mandates on minimum credit quality
 What scope for feedback loop with real economy?
 What scope for interactions with other regulatory/accounting
restrictions in place for governance motives?
40

Leverage is not the only source of market disruptions
 Our understanding of crisis propagation is heavily influenced
by experience of 2008 crisis
 2008 crisis was made more potent by leverage
 However, it does not follow that future bouts of market
disruptions must follow the same mechanism as the past
 Long-term investors may be subject to forces that lead to
actions that are similar to leveraged players
 Risk mitigation or hedging techniques
 Incentives that arise from relative performance evaluation
 All these mechanisms are sharper when prices are more
sensitive to shifts in sentiment
40

Unfamiliar problems
 Asset managers (not banks) are at the heart of transmission
mechanism in the Second Phase of Global Liquidity
 Textbooks say long-term investors are benign, not a force for
destabilization
 How do we adjust to the new world?
41

Ambassador
Young-mok
(“Kpop”) Kim
fr/fileadmin/user_upload/banque_de_france/La_Banque_de_France/
symposium-session2-shin-slides.pdf
http://youtu.be/55DjXmOLjKA
https://www.banque-france.
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