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BIS reviews global financial systems

S. Venkitaramanan

BIS (The Bank of International Settlements), headquartered at Basel in Switzerland, is acknowledged to be the Central Bank of Central Banks. Its periodic review of the global financial situation is an eagerly awaited event of importance. The latest BIS q uarterly review for the quarter ending March 2001 has just come out. Global investors expect a slowing world economy, and market attention has focussed on the slowing of the principal engine of growth, the US.

As many as 744 US companies announced negative profit warnings and only 161 announced positive ones in the last quarter. The Standard & Poor's 500 index registered a decline of 8 per cent in the quarter, the Dow Jones index of large European companies wa s down 5 per cent, and Japan's TOPIX index fell 13 per cent.

The poor performance of equity markets in the fourth quarter, particularly the losses in hi-tech shares, led to a significant slowdown in initial public offerings (IPO) in the US. However, the BIS notes that this was not the case in other major markets. International equity issues, as a whole, remained steady in the fourth quarter, despite what happened in the US markets.

The BIS review notes the sharp decline in the technology sector of US equity market. The market, however, seemed to regain confidence after the Fed's rates cut on January 3, 2001, showing a gain of 19 per cent on the day of the cut. The BIS review does n ot pronounce judgment on whether the economy's growth was restored as a result of the Fed Chairman, Mr Alan Greenspan's action. What it does confirm is the considerable impact the decline in the stock market indices has had on the performance of both the debt and equity markets.

One of the important consequences of the economic downturn in the US has been a sharp widening of credit spreads. Bond investors have become increasingly concerned about the over-borrowed status of corporates. Doubts have emerged about the sustainability of corporate earnings growth. Further reinforcing these doubts is the turbulence in the stock market, both during Spring and Autumn.

Particularly, the investors' scepticism is reinforced in regard to the leverage-driven strategies of telecommunication companies, which have raised huge amounts of debt in the markets. These are compounded by other sector-specific problems, such as those resulting from the failure and bankruptcy of the electrical utilities in California. These reminded investors that even apparently safe credits can be subjected to sharp changes of fortune.

One of the important conclusions of the survey is that the third quarter of 2000 saw a large inflow of funds from oil exporting economies and other developing countries to commercial banks based in the developed world. This surge in deposits was not acco mpanied by the usual increase in the flow of debt to the developing countries, whereas cross-border loans to non-bank borrowers in developed countries rose. It is an interesting phenomenon that the banking activity of the international banks in developin g countries results in the flow of resources from the developing countries to the developed world.

Deposit flows from developing countries to banks in the developed world reached a record of $54 billion in the third quarter of 2000. This surge in deposits boosted net outflows from the developing countries to banks in the developed world to $120 billio n -- equivalent to 2 per cent of GDP of the developing countries concerned.

This is a considerable increase compared to the corresponding figure of just $61 billion in 1998 as a whole and $100 billion in 1999. The break-up of these deposits is also interesting. As is to be expected, OPEC members accounted for one-third of the de posit flows from developing countries, Saudi Arabia alone accounting for more than $7 billion. Among developing countries outside OPEC, the largest deposits were from Taiwan and mainland China.

This reminds us of the contrast with the situation in the 1980s, when large deposits from OPEC countries were recycled back as loans to developing countries. In the latest phase, however, there has not been such an expansion of lending to developing coun tries, except for credit of roughly $7 billion to Brazil, Turkey and Argentina.

The savings from developing countries are flowing into the developed countries, enabling the differential growth of investment activities in the richer half of the world. Developed countries sustain their high level of spending and investment by drawing on the savings from poorer half of the world.

An interesting conclusion in the report is that the agencies of the US Government, which are dislinked from the Government itself, viz. Fammy May, Federal Reserve Mortgage Agency, Federal Student Loan Agency and so on, raise large sums of money in the in ternational debt market sustained by inflows from developing countries.

These state Agencies of the US raised a net $60 billion in the fourth quarter of 2000. Gross issuance of US housing agencies alone was $48 billion. When we reflect on the comparatively easy availability of housing loans in the US, we need no further expl anation than the support of these housing agencies bonds by the debt market, sustained by the inflows from the developing countries.

Another interesting discussion in the BIS review concerns the holding of US Treasury securities by non-US central banks. Non-residents hold 1.2 trillion dollars of US Government securities. Of these, half is held by central banks of non-US countries. In other words, non-US residents have lent to the US Government, over the years, nearly $1.2 trillion and, of this, the non-US central banks hold half. What happens to these central bank holdings when the US Government reduces its borrowing? It is expected to stop issue of fresh Treasury securities as well as buy back securities to reduce the total outstanding.

This is a serious matter, which should concern the non-US central banks in general. They may perhaps be forced to shift to paper issued by US agencies, such as the Federal House Mortgage Agencies. As the US Government plans to buy back its debt securitie s, the central banks will find it harder to access avenues for investing their reserves. Increasingly, we may see the reserves of the central banks of the world financing the US and corporate securities with the implicit increased risks that are inherent in holding such papers. This is an unintended but serious consequence of the diminishing US public debt.

As is to be expected, the BIS review emphasises the need for implementing stricter international standards for global financial systems. The international community, as a whole, has joined the BIS in emphasising the need for concrete steps to make domest ic financial systems less crisis-prone. The BIS role in the development and implementation of standards to promote sounder policies and stronger institutional and market underpinnings has been central in the effort to safeguard national and international financial stability.

The BIS review notes the substantial progress achieved by the Implementation Task Force, established last year by the global Financial Stability Forum comprising standard-setting bodies, supervisory agencies, national authorities from emerging and develo ped countries as well as international financial institutions and groupings. The BIS review notes that even the strictest standards by themselves will not work unless they are ``owned'' by the concerned countries, who must have faith in the requirements of new norms.

One of the most important initiatives in this area has been the joint IMF-World Bank financial sector assessment programmes, aimed at assessing financial sector vulnerabilities and identifying development of priorities. Equally important have been the ex perimental IMF-World Bank reports on the observance of standards and codes. The report observes that a strong, healthy financial system per se is desirable as it contributes to faster growth and per capita income through higher savings rates, better reso urce allocation and more efficient provision of financial services.

The report emphasises the new initiatives taken by the Basel Committee on banking supervision in regard to financial supervision and capital adequacy. The Basel Committee accord of 1988 itself had been an important first step towards strengthening the so undness of the international banking system and enhancing competitive quality amongst the internationally active banks. However, there have been many innovations in the global financial market place and the earlier Basel capital ratios need revision, as they have become less accurate indicators of the banks' financial condition.

Turning our attention to India, the RBI is, no doubt, considering these revised recommendations in consultation with the Government and financial experts. There can be no doubt that India has to keep pace with the various changes that the BIS suggests. A t the same time, the changes have to be brought about in a manner that reflects the ability and the capacity of the Indian banking system to meet higher standards.