Stylized Financial System

Transcription

1 Procyclicality and Capital Flows: Emerging Market Perspective Hyun Song Shin Bank of Thailand International Symposium 2010: Challenges to Central Banks in the Era of the New Globalization October 14 15, 2010 Bangkok, Thailand Stylized Financial System ultimate borrowers Households Nonfinancial firms govt intermediated credit mortgages corporate credit Banking (intermediary) sector direct credit Treasury & municipal bonds corporate bonds equity debt claims deposits financial paper MBS, ABS ultimate claim holders Households Pension funds Insurance companies Rest of world

2 Banking (Intermediary) Sector Not just a passive player Instead, is the engine that drives the financial cycle Balance sheet management drives the financial cycle Stage of the financial cycle shows up in the composition of liabilities Composition of Northern Rock's Liabilities (June June 2007) Billion pounds Equity Other Liabilities Securitized notes Retail Deposits 20 0 Jun-07 Dec-06 Jun-06 Dec-05 Jun-05 Dec-04 Jun-04 Dec-03 Jun-03 Dec-02 Jun-02 Dec-01 Jun-01 Dec-00 Jun-00 Dec-99 Jun-99 Dec-98 Jun-98

3 Consequence 1: Reliance on External Funding Holders of US GSE debt $ Trillion Other ABS Issuers GSEs Banks & securities firms Insurance, Pension and Mutual Funds State & Local Govts Households 0.0 Mar-80 Mar-82 Mar-84 Mar-86 Mar-88 Mar-90 Mar-92 Mar-94 Mar-96 Mar-98 Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Foreign Sector

4 Proportional holdings 1.0 Other 0.8 ABS Issuers GSEs Banks & securities firms Insurance, Pension and Mutual Funds State & Local Govts Households Foreign Sector 0.0 Mar-80 Mar-82 Mar-84 Mar-86 Mar-88 Mar-90 Mar-92 Mar-94 Trillion Won Mar-96 Mar-98 Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Non-Core Liabilities for Korea [Other] FX borrowing 500 [Lf] Debt Securities 400 [Lf] Repos 300 [M2] Promissory Note [M2] Promissory Note [M2] Certificate of Deposit 0 Jan-09 Jan-07 Jan-05 Jan-03 Jan-01 Jan-99 Jan-97 Jan-95 Jan-93 Jan-91

5 Ratio of Non-Core Liabilities Non-Core to M2 Liabilities in as Korea Fraction of M2 Jan Jan Jan-10 Jan-09 Jan-08 Jan-07 Jan-06 Jan-05 Jan-04 Jan-03 Jan-02 Jan-01 Jan-00 Jan-99 Jan-98 Jan-97 Jan-96 Jan-95 Jan-94 Jan-93 Jan-92 Jan-91 $ Billion FX Liabilities (Korean Commercial Banks) crisis 2008 crisis q1 2008q1 2007q1 2006q1 2005q1 2004q1 2003q1 2002q1 2001q1 2000q1 1999q1 1998q1 1997q1 1996q1 1995q1 Short- term FX liabilities Long- term FX liabilities

6 FX Liabilities (Foreign Bank Branches in Korea) $ Billion Crisis 2008 Crisis 2009q3 2009q1 2008q3 2008q1 2007q3 2007q1 2006q3 2006q1 2005q3 2005q1 2004q3 2004q1 2003q3 2003q1 2002q3 2002q1 2001q3 2001q1 2000q3 2000q1 1999q3 1999q1 1998q3 1998q1 1997q3 1997q1 1996q3 1996q1 1995q3 1995q1 Shor t - t er m FX liabilities Long- t er m FX liabilities Hedging Long-dated Receivables with Short-term Liabilities Banking sector A L $ Export firm Long-dated $ receivables Bonds Forward Long $ Short debt

7 Leveraging and Deleveraging Adjust leverage Adjust leverage Stronger balance sheets Increase B/S size Weaker balance sheets Reduce B/S size Asset price boom Asset price decline Equity Inflows/Outflows (Korea) $ Billion Inflow 10 5 Subprime crisis starts Lehman bankruptcy 2008/10 Foreign investors 0 Outflow -5 Domestic investors / / / / / / / / / / / / / / / / / / / /10

8 Net Equity Inflows/Outflows (Korea) $ Billion / Equity Inflows/ Outflows / / / / / / / / / / / / / / / /01 Inflows Equity and FX Bank Liability Flows (Korea) Lehman $ Billion bankruptcy Bank FX liabilities Outflows Equity / / / / / / / / / / / / / / / / / / / /10

9 Capital Flows and USD/KRW Rate $10 억 inflow Exchange rate outflow USD/KRW rate 2008/ / / / / / / / / / / / / / / / / / / / /01 Bank FX liabilities Equity USD/KRW exchange rate Consequence 2: Increased Complexity

10 Expanding Balance Sheets Imply Greater Cross Holding Loans Bank 1 Deposits Ultimate Borrowers Interbank Claims Depositors Loans Bank 2 Deposits Short Intermediation Chain mortgage deposits households mortgage bank households

11 Long Intermediation Chain households households ABS mortgage securities firm commercial bank money market fund ABS issuer mortgage pool MBS Repo Short-term paper MMF shares Apr Aug Aug Sep Sep % 30% 40% 50% 60% 70% 80% 90% Jul41990Jan301991Aug281991Mar251992Oct211992May191993Dec151993Jul131994Feb81995Sep61995Apr31996Oct301996May281997Dec241997Jul221998Feb171999Sep151999Apr122000Nov82000Jun62001Jan22002Jul312002Feb262003Sep242003Apr212004Nov172004Jun152005Jan112006Aug92006Mar72007Oct32007Apr302008Nov262008Repos and Financial CP as Fraction of M2 (weekly) Source: Adrian and Shin (2009)

12 8.0 Overnight repos, Financial CP and M2 (weekly, July as base date) Overnight repo Financial CP M2 Mar Aug Apr Jan Jun Dec May Nov May Oct Apr Sep Mar Aug Feb Jul Jan Jul Dec Jun Nov May Oct Apr Sep Mar Aug Feb Aug Jan Jul Booms Higher leverage of financial intermediaries Larger balance sheets of intermediaries Greater intertwining of intermediaries Longer chains Maturity mismatch to sustain longer chains

13 Architectural Analogy Adding extra capacity (more rooms) to a house when constrained by limited footprint The only way is to build up (like a Manhattan skyscraper) Except that Manhattan skyscraper is planned ahead, as a coherent whole Better analogy is adding extra floors to a building without anticipating future floors on top Sutyagin House in Archangel

14 Busts Deleveraging Shrinking balance sheets Unraveling of interbank lending Runs Retrenchment Northern Rock

15 Policy Response G20 Reform Agenda for Bank Capital Regulation Quality, quantity of bank capital Procyclical capital buffer SIFI surcharge (for systemically important financial institutions, or too-big-to-fail ) Leverage ratio cap

16 Global Financial Safety Net Bilateral swaps Lessons from 2008 Global Financial Safety Net Pre-emptive provision of liquidity FCL, PCL and the GSM Complementary to Bilateral swaps Regional arrangements Other Tools (1) June 2010 leverage cap on FX derivative positions (Korea) Indirect limit on short-term foreign currency liabilities by capping forward and swap positions

17 Hedging Long-dated Receivables with Short-term Liabilities Banking sector A L $ Export firm Long-dated $ receivables Bonds Forward Long $ Short debt Other Tools (2) Bank Levy as a Prudential Tool IMF s Financial Stability Contribution is a levy on non-deposit liabilities Leans against non-core liabilities directly Automatic adjustment of burden (burden is high in bubble build-up stage) Macroprudential rationale, not just revenue motive

18 Other Tools (3) Non-core liabilities as monetary aggregate Perspective from monetary policy Tracking growth of monetary aggregates but with financial stability motive rather than as second anti-inflation pillar Other Tools (4) Long-term structural reform Focus on banking sector liabilities Covered bonds keep assets on-balance sheet Close substitute for government securities Deep bond market with long-term investors De-coupling domestic liquidity from (foreign) bank deleveraging

19 Directions for Future Financial System Shorter intermediation chains Less volatile Less maturity transformation With better regulatory safeguards Lower market-required ROE Less expensive bank capital Greater weight on core liabilities