08 December 2008

BIS Quarterly Review - December 2008

The overview of the BIS Quarterly Review surveys the recent developments in the financial crisis and the unprecedented policy actions launched to address it.

Overview

Financial stability concerns took centre stage once again over the period between end-August and end-November. In the wake of the mid-September failure of Lehman Brothers, global financial markets seized up and entered a new and deeper state of crisis. As money market funds and other investors were forced to write off their Lehman-related investments, counterparty concerns mounted in the context of large-scale investment fund redemptions.

The resulting sell-off affected all but the safest assets and left key parts of the global financial system dysfunctional. With credit and money markets essentially frozen and equity prices plummeting, banks and other financial firms saw their access to funding eroded and their capital base shrink, owing to accumulating mark to market losses. Credit spreads rose to record levels, equity prices dived and volatilities soared across markets, indicating extreme financial market stress. Government bond yields declined as recession concerns and safe haven flows increasingly outweighed the impact of anticipated increases in fiscal deficits. At the same time, yield curves steepened from the front end, reflecting repeated downward adjustments in policy rates.

Emerging market assets also experienced broad-based price declines, as depressed levels of risk appetite and associated pressures in the industrialised world spilled over into emerging financial markets. With confidence in the continued viability of key parts of the international banking system plunging, the authorities in several countries embarked on an unprecedented wave of policy initiatives to arrest the ongoing collapse in asset prices and contain systemic risks.

Market developments over the period under review went through four more or less distinct stages. Stage one, which led into the Lehman bankruptcy in mid-September, was marked by the takeover by the US authorities of the government-sponsored housing finance agencies Fannie Mae and Freddie Mac. Stage two encompassed the immediate implications of the Lehman bankruptcy and the crisis of confidence it triggered. Stage three, starting in late September, was characterised by fast-paced and increasingly broad policy actions, as the response to the crisis evolved from case by case reactions to a more international, system-wide approach. In the fourth stage, from mid-October, pricing patterns were increasingly dominated by recession fears, while markets continued to struggle with the uncertainties surrounding the large number of newly announced policy initiatives.

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Highlights of international banking and financial market activity

Trading on the international derivatives exchanges retreated in the third quarter of 2008. Total turnover based on notional amounts decreased to $542 trillion from $600 trillion in the second quarter. Most of the contraction took place in derivatives on short-term interest rates.

In the global over-the-counter (OTC) derivatives markets, notional amounts outstanding continued to expand in the first half of 2008. Notional amounts of all types of OTC contracts stood at $863.0 trillion at the end of June, 21% higher than six months before. By volume, credit default swap (CDS) contracts registered their first ever decline (-1%), compared with an average six-month growth rate for outstanding CDS contracts over the last three years of 45%.

Borrowing in the international debt securities market lessened sharply in the third quarter of 2008 amid the continued turmoil in financial markets. Net issuance of bonds and notes decreased to $247 billion, down substantially from $1,086 billion in the second quarter.

Outstanding claims in the international banking market diminished sharply during the second quarter of 2008. BIS reporting banks' international claims fell by an unprecedented $1.1 trillion, with sizeable declines recorded across claims in most currencies of denomination. While a significant decrease in interbank claims (-$812 billion) accounted for most of that decline, international claims on non-banks also fell for the first time since 1998, mainly vis-à-vis the United States, the United Kingdom and Japan. At the same time, residents of emerging markets and many central banks around the world reduced their placements of funds with BIS reporting banks.

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This BIS Quarterly Review presents four special features:

Developments in repo markets during the financial turmoil

Commodity prices and inflation dynamics

Bank health and lending to emerging markets

How many in negative equity? The role of mortgage contract characteristics

Press release

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