When long-term institutional investors turn pro-cyclical

September 12, 2013

A new IMF paper suggests that so-called “long-term institutional investors” have largely turned pro-cyclical in recent crises. This feature may be structural and reflect (a) underestimation of liquidity needs in boom times, (b) failure of traditional risk management systems to appreciate tail risk, (c) asset managers’ short-term performance targets, (d) links between short-term performance disclosures and asset outflows, and (e) regulations and conventions that encourage herding.

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A new Asian Crisis?

August 20, 2013

A Nomura research report looks at the rising financial risk premium across Asia. It shows that economic fundamentals are not as bad as they were in 1996. However, Asia’s external surplus has been eroded by a torrid financial expansion, which was fueled by very easy monetary policy. In the absence of a correction of this policy stance, there is an increasing danger that capital outflows will trigger a sudden stop to these accommodative financial conditions.

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The euro area’s persistent de-leveraging

July 30, 2013

The ongoing economic misery of the euro area periphery reflects the compounded deleveraging of corporates, households, financial institutions, and governments. According to a new IMF paper, the process could still take years to complete. Simultaneous deleveraging across all sectors typically causes negative feedback loops, constraining economic growth and credit conditions.

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Shadow banking: A review of the basics

July 23, 2013

The New York Fed’s Economic Policy Review provides a basic overview of past and current shadow banking activities in the U.S. and beyond. Securitization and non-bank wholesale funding remain at the heart of the system. The relevance of shadow banking is likely to recover, as capital and liquidity standards in the regulated banking system are tightening.

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Japanese banks’ vulnerability to rising bond yields

July 10, 2013

Standard & Poor’s research suggests that Japanese banks’ government bond holdings and interest rate risks of have almost doubled over the past 10 years. Against the backdrop of more aggressive reflation policies (view here) this translates into a systemic risk. An increase in long-term yields by 200bps compared to 2012 could already impair the banking system. An increase by 300bps or more could spell broadly based challenges for capital adequacy. A concurrent drop in equity would increase the pressure.

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Asia’s systemic credit risks

July 8, 2013

A new Standard Chartered Research Report investigates pockets of potential credit risk in Asia, by using a new comprehensive set of metrics. China’s overleveraged corporates are at the forefront of concerns, as mentioned in other posts (view here). Japan’s massive 400% debt-to-GDP ratio is a potentially large risk if real interest rates in the country ever increase. India is burdened with a high government debt ratio and an apparently deteriorating profile of corporate debt.

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New rules for euro area bank bailouts

July 6, 2013

Jacob Funk Kirkegaard, senior fellow of the Peterson Institute, has published an excellent summary on the euro area’s political deal for bank recapitalisation and resolution, targeted at breaking “doom loops”, i.e. escalating negative feedback of banking and sovereign solvency troubles. The key parts, from a market perspective, are (i) the possibility of direct recapitalisation of banks through the European Stability Mechanism (even retroactively) and (ii) stricter bail-in rules for private bond and equity owners.

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Europe’s financial transaction tax and the consequences

April 18, 2013

A recent HSBC report argues that the planned financial transaction tax in the Eurozone will have a profound negative impact on investment returns, as well as on liquidity in cash products and derivatives. The tax is expected to be introduced next year and have broad implication well beyond the countries that have agreed to it.

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On the risks of a new U.S. credit overheating

February 17, 2013

An interesting speech by Jeremy Stein emphasizes the ingrained tendency of financial institutions to boost earnings by selling tail risk insurance in forms not covered by covered risk measures and regulation. Hence, financial innovation, changes in regulation, and macroeconomic changes often result in credit market overheating through implicit subordination in conjunction with excessive maturity transformation. At present such tendencies may materialize in the rising share of low-grade credit issuance, the rapid expansion of agency mortgage REITs, and the increasing maturity of securities in bank portfolios. For the future, the expansion of collateral swaps and other forms of collateral transformation deserves attention.

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IMF reminder of incomplete euro area banking union

February 16, 2013

A new IMF Staff Discussion Note provides opinion and advice on the euro area banking union. It reiterates the urgent need for a single regulatory, resolution, and deposit insurance mechanism. The present legal and institutional reality falls well short of it and even last year’s adopted directives and plans only deal with the harmonization of rules and the creation of a single supervisory mechanism (SSM). A credible euro area-wide resolution and deposit insurance seems to be still a distant goal. The ESM’s ability to bear recapitalization losses, whether from “legacy assets” or not, remains uncertain.

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