BIS: markets return to the new normal

The international financial markets are returning to a 'new normal', with activity stabilising at significantly lower levels than before the crisis, according to the latest quarterly survey from the Bank for International Settlements (BIS), published today.

The third quarter of 2009 saw total notional turnover of exchange-traded derivatives remain constant at $425 trillion; a slight fall in interest rate derivatives from $376 trillion to $368 trillion, linked to continued low and stable interest rates worldwide, was balanced by a rise in equity derivatives from $43 trillion to $50 trillion, as equity prices remained high. Improved investor confidence, the BIS said, also led to an increase in forex derivatives trade, from $5.9 trillion to $7.2 trillion worldwide.

The BIS also released figures for the over-the-counter derivatives markets as of June 30; overall notional outstanding value rose 10% from the start of the year to $605 trillion, although gross credit exposures fell 18% to $3.7 trillion and gross market values fell 21% to $25 trillion.

Aggressive capital raising by European and US banks in the second quarter of the year meant  capital raised had finally caught up with write-downs, the BIS noted, although bank balance sheets continued to contract. The $477 billion gross total contraction was a reduction on the preceding two quarters, though still high by historical standards. China stood out, with banks continuing to expand credit significantly – 7.4 trillion yuan ($1.1 trillion) of new lending in the first six months of 2009 alone – though the BIS warned this could mean lower credit standards, leading to poor asset quality emerging in the years ahead.

The bank also reviewed the general failure of macroeconomic stress tests before the crisis, with BIS economists Rodrigo Alfaro and Mathias Drehmann warning that system-wide tests were unlikely ever to become reliable enough for prudential use: "For the foreseeable future, the challenges in modelling crises appropriately seem enormous. And as we have argued, it is doubtful the statistical models will be free of structural breaks once crises emerge. As a consequence, it is likely that stress tests will continue to underestimate the risks to the economy, as they did prior to the current crisis. There is, therefore, a real danger that stress testing results will continue to lull users into a false sense of security".

And another paper, by the BIS' Leonardo Gambacorta, warned that continued low interest rates would drive banks to riskier behaviour in an attempt to improve their yield, saying regulators should be "especially vigilant during periods of unusually low interest rates, particularly if they are accompanied by other signs of risk-taking, such as rapid credit and asset price increases".

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