BF Symposium-session2-Shin-Slides

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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.

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







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











Direct and intermediated finance: what are the tradeoffs?

3

What determines the supply of bank finance?

What determines the supply of market finance?

What role for the monetary environment?








Direct and intermediated finance: two phases

4

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








US Treasury 10 year and 3 month rates

10.0

8.0

6.0

4.0

2.0

0.0

12.0

14.0

16.0

Ja

n-8

4

Ja

n-8

6

Ja

n-8

8

Ja

n-9

0

Ja

n-9

2

Ja

n-9

4

Ja

n-9

6

Ja

n-9

8

Ja

n-0

0

Ja

n-0

2

Ja

n-0

4

Ja

n-0

6

Ja

n-0

8

Ja

n-1

0

Ja

n-1

2P

erc

ent

10 year

3 month

5








Term premium used to be determined by short rate; but

not any more

-2.0

-3.0

-4.0

-1.0

1.0

0.0

2.0

5.0

4.0

3.0

-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

mo

nth

cha

nge

in

term

sp

read (

%)

Jan 1985 -June 2010

July 2010 -Dec 2012

6








Year-on-year rate of growth in international bank claimsIn 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 2012Q

3

2011Q

1

2009Q

3

2008Q

1

2006Q

3

2005Q

1

2003Q

3

2002Q

1

2000Q

3

1999Q

1

1997Q

3

1996Q

1

1994Q

3

1993Q

1

1991Q

3

1990Q

1

Trilli

on

dolla

rsCorporate bonds

Commercial paper

Other loansand advances

Bank loansn.e.c.

Total mortgages

10








Bond market as a spare tire: credit to the US non-financial

corporate business sector (quarterly changes)

19

90

Q2

19

91

Q4

19

93

Q2

19

94

Q4

19

96

Q2

19

97

Q4

19

99

Q2

20

00

Q4

20

02

Q2

20

03

Q4

20

05

Q2

20

06

Q4

20

08

Q2

20

09

Q4

20

11

Q2

210

180

150

120

90

60

30

0

-30

-60

-90

-120

-150

-180

-210

Mill

ion

s

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 2012Q

3

2011Q

1

2009Q

3

2008Q

1

2006Q

3

2005Q

1

2003Q

3

2002Q

1

2000Q

3

1999Q

1

1997Q

3

1996Q

1

1994Q

3

1993Q

1

1991Q

3

1990Q

1

No

n-c

orp

ora

tebusin

ess s

ecto

r to

tal borr

ow

ing

(trilli

on

dolla

rs)

other loans andadvances

depositoryinstitution loansn.e.c.

commercialmortgages

multifamilyresidentialmortgages

constructionloans on one-to-four familyhomes

home mortgages

13








Spare tire comes at a price: risk premium of bond finance

(Gilchrist and Zakrajscek (AER 2012))

0

2

4

6

8

0

2

6

4

1997 1999 2001 2003 2005 2007 2009 2011

0

2

4

6

8

10

Percent of liabili ties Percentage points

8 18

12

14

16Expected y ear-ahead def aults at t-12 (lef t ax is)

10-y ear high-y ield corporate bond spread at t (right axis)

14








Bank and bond financing (1): before bank deleveraging

Total credit

Lending

rate

Credit

demand

Aggregate

credit supplyBank

credit

supply

15

Bond

credit

supply








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

18

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



Source: Bank of England

Even as spreads fall,

issuance accelerates

19

What happened after 2012?

An example from non-financial corporate financing in UK






Bond financing in the boom years (2012 – )

20

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






McCauley, McGuire and Sushko (2014) again: yield curve

flattening leads to preference for bond issuance

20







Emerging market economies1 (weighted average)

Maturity in # years

Annual gross issuance of international debt securities by EM

non-bank corporations: residence basis

2004 2006

Year

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.

6

4

8

12

10

2000 2002 2008 2010 2012 2014

$ 152 bn

22









Maturity in # years

Annual gross issuance of international debt securities by EM

non-bank corporations: nationality basis

2006

Year





8$ 265 bn

6

10

12

2000 2002 2004 2008 2010 2012 2014

23








Traditional boundaries …

… are not sufficient in understanding the second phase of global liquidity

A L

A L

Local

currency

Local

currency Local

currency

US

dollars

Bank

Non-financial

corporation

Border

International

capital market

24









USD bn

Amounts outstanding of international debt securities of EM

non-bank corporations at end-June 2014





Nationality Residence

25

1,000

750

500

250

0








Residence basisNationality basis

Projected redemptions on international debt securities of

EM non-bank corporations

26

Emerging market economies, in billions of US dollars








Longer maturity of outstanding debt securities

27

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









USD bn

Projected redemptions of securities of EM non-bank

corporations: by nationality basis





600

450

300

150

0

16 2418 20 22

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

0.000

0.015

0.030

0.045

2010 2011 2012 2013 2014

Volatility of yields The exchange rate

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

30

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








Annual gross issuance and average maturity (euro area

resident banks): long-term securities issued on any market

Euro area aggregateMaturity in # years

2007

Year

2.5

3.0

3.5

4.0

4.5

5.0

5.5

2001 2003 2005 2009 2011 2013 2015

$1782 bn

Source: Dealogic.

32








Euro area aggregateUSD bn

Projected redemptions at end-June 2014 (euro area resident

banks): long-term securities issued on any market

0

200

400

600

14 15 16 17 18 19 20 21 22

Year

23 24 25

Currency decomposition:

EUR USD

Source: Dealogic.

33

Other








SpainUSD bn

Annual future redemptions at end-June 2014 (euro area


14 15 16 17 18 19 20 21 22

Year

23 24 25


EUR USD

Source: Dealogic.

34

Other

80

60

40

20

0








FranceUSD bn



0

20

40

60

80

100

14 15 16 17 18 19 20 21 22

Year

23 24 25


EUR USD

Source: Dealogic.

35

Other








80

60

40

20

0

ItalyUSD bn



14 15 16 17 18 19 20 21 22

Year23 24 25


EUR USD

Source: Dealogic.

36

Other








NetherlandsUSD bn



0

20

40

60

14 15 16 17 18 19 20

Year

21 22 23 24 25


EUR USD

Source: Dealogic.

37

Other








Source: ECB.

38

USD bn

Liability categories of the euro area credit institutions








Liability categories of the euro area credit institutions

Source: ECB.

USD bn

39








“Leverage-like” behaviour without leverage

40

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?








Leverage is not the only source of market disruptions

40

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








Unfamiliar problems

41

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?















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BF Symposium-session2-Shin-Slides