Capital Flows and the Risk-Taking Channel of Monetary Policy - PowerPoint PPT Presentation

Capital Flows and the Risk-Taking Channel of Monetary Policy Valentina Bruno Hyun Song Shin Central Bank of Turkey Conference October 8-9, 2012

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 1 Two Questions • What con fi guration of exchange rates are consistent with rebalancing of global demand? • To what extent will exchange rate appreciation stem capital in fl ows? — What are the fi nancial stability implications of exchange rate appreciation? — What are the feedback e ff ects between leverage and exchange rate appreciation? — How do the answers depend on stance of advanced economy monetary policy?

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 2 A Popular Narrative • “Low interest rates maintained by advanced economy central banks are key drivers of — Cross-border capital fl ows to emerging economies — Credit booms and overheating for capital recipient economies — Overshooting of real exchange rates” • Are these claims true? • What are the mechanisms?

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 3 Borrowers in A Banks in A Borrowers Banks Global Wholesale in B in B Banks Funding Market Banks in C Borrowers in C Figure 1. Topography of global liquidity

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 4 Borrowers in A Banks in A Borrowers Banks Global Wholesale in B in B Banks Funding Market Banks in C Borrowers in C Figure 2. Topography of global liquidity

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 5 Net interoffice assets Large time deposits Borrowings from banks in U.S. Borrowings from others Securities Loans and leases Cash assets 2.0 Trillion dollars 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 06-Jan-99 21-Jul-99 02-Feb-00 16-Aug-00 28-Feb-01 12-Sep-01 27-Mar-02 09-Oct-02 23-Apr-03 05-Nov-03 19-May-04 01-Dec-04 15-Jun-05 28-Dec-05 12-Jul-06 24-Jan-07 08-Aug-07 20-Feb-08 03-Sep-08 18-Mar-09 30-Sep-09 14-Apr-10 27-Oct-10 11-May-11 23-Nov-11 Figure 3. Assets and liabilities of foreign banks in the U.S. (Source: Federal Reserve H8 weekly series on assets and liabilities of foreign-related institutions)

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 6 Billion dollars 800 600 400 Net interoffice assets of foreign banks in US 200 0 -200 -400 20-Apr-88 17-May-89 13-Jun-90 10-Jul-91 05-Aug-92 01-Sep-93 28-Sep-94 25-Oct-95 20-Nov-96 17-Dec-97 13-Jan-99 09-Feb-00 07-Mar-01 03-Apr-02 30-Apr-03 26-May-04 22-Jun-05 19-Jul-06 15-Aug-07 10-Sep-08 07-Oct-09 03-Nov-10 30-Nov-11 Figure 4. Net intero ffi ce assets of foreign banks in U.S. given by negative of Federal Reserve weekly H8 series on “net due to related foreign o ffi ces of foreign-related institutions”

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 7 90 (%) 80 Asia 70 60 United States 50 40 Other Europe 30 20 Other euro area 10 0 Belgium, Italy, 2006 H2 2007 H1 2007 H2 2008 H1 2008 H2 2009 H1 2009 H2 2010 H1 2010 H2 2011 H1 Spain, Portugal, Ireland, Greece Figure 5. Amount owed by banks to US prime money market funds (% of total), based on top 10 prime MMFs, representing $755 bn of $1.66 trn total prime MMF assets (Source: IMF GFSR Sept 2011, data from Fitch).

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 8 500 450 Ireland Spain 400 Turkey 350 Australia 300 South Korea 250 Chile 200 Brazil 150 Egypt 100 100 South Africa 50 0 Mar.1999 Mar.2000 Mar.2001 Mar.2002 Mar.2003 Mar.2004 Mar.2005 Mar.2006 Mar.2007 Mar.2008 Mar.2009 Mar.2010 Figure 6. External claims (loans and deposits) of BIS reporting banks on counterparties listed on right (Source: BIS locational banking statistics Table 7A)

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 9 350 Australia 300 South Korea 250 Indonesia 200 Malaysia 150 Thailand 100 100 50 0 Mar.1999 Mar.2000 Mar.2001 Mar.2002 Mar.2003 Mar.2004 Mar.2005 Mar.2006 Mar.2007 Mar.2008 Mar.2009 Mar.2010 Figure 7. External claims (loans and deposits) of BIS reporting banks on counterparties listed on right (Source: BIS locational banking statistics Table 7A)

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 10 800 Slovakia 700 600 Poland 500 Ireland 400 Spain 300 Turkey 200 100 100 0 Mar.1999 Mar.2000 Mar.2001 Mar.2002 Mar.2003 Mar.2004 Mar.2005 Mar.2006 Mar.2007 Mar.2008 Mar.2009 Mar.2010 Figure 8. External claims (loans and deposits) of BIS reporting banks on counterparties listed on right (Source: BIS locational banking statistics Table 7A)

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 11 3,000 2,500 2,000 Latvia 1,500 Lithuania 1,000 Estonia Iceland 500 100 0 Mar.1999 Mar.2000 Mar.2001 Mar.2002 Mar.2003 Mar.2004 Mar.2005 Mar.2006 Mar.2007 Mar.2008 Mar.2009 Mar.2010 Figure 9. External claims (loans and deposits) of BIS reporting banks on counterparties listed on right (Source: BIS locational banking statistics Table 7A)

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 12 Risk-Taking Channel Borio and Zhu (2008) • Pivotal role of banking sector — Short-term interest rates and term premium • Leverage cycle — Expansion phase driven by low measured risks — Measured risks are dampened during expansions — “Excess elasticity” (Borio and Disyatat (2011)) • Global liquidity — US dollar wholesale bank funding market — European global banks

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 13 1.4 Trillion pounds 1.2 1.0 Equity 0.8 Other Liabilities 0.6 Total MMF funding 0.4 Customer 0.2 Deposits 0.0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Figure 10. Total Liabilities of Barclays (1992 - 2007) (Source: Bankscope)

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 14 1.4 Trillion pounds 1.2 1.0 Total Assets 0.8 Risk-Weighted 0.6 Assets 0.4 0.2 0.0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Figure 11. Barclays, risk-weighted assets and total assets (Source: Bankscope)

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 15 Barclays: 2 year change in assets, equity, debt and risk-weighted assets (1992 -2010) 1,000 800 risk-weighted assets (billion pounds) 2 year change in equity, debt and y = 0.9974x - 0.175 R 2 = 0.9998 600 2yr RWA 400 Change 200 2yr Equity 0 Change -200 2yr Debt -400 Change -600 -800 -1,000 -1,000 -500 0 500 1,000 2 year asset change (billion pounds) Figure 12. Barclays: 2 year change in assets, equity and debt (1992-2010) (Source: Bankscope)

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 16 Credit Supply Model • Vasicek credit risk model (backbone of Basel II) • Turn on its head as credit supply model — Given sticky equity, credit supply is determined by risk-taking decision   = 1+    ∈ (0  1) 1 − 1+   is ratio of notional debt to notional assets

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 17 Ampli fi cation Channel Decline in Increased Bank funding cost risk-taking Capital inflows and Decline in currency appreciation measured risks Dampened volatility Figure 13. Risk-taking channel of monetary policy in the cross-border context

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 18 Banking sector capital flows VIX 0.25 70 Banking Sector Capital Flows (year on year growth of 0.20 60 external claims of BIS-reporting banks) 0.15 50 (average over quarter) 0.10 VIX Index 40 0.05 0.00 30 -0.05 20 -0.10 10 -0.15 -0.20 0 Sep-96 Jun-97 Mar-98 Dec-98 Sep-99 Jun-00 Mar-01 Dec-01 Sep-02 Jun-03 Mar-04 Dec-04 Sep-05 Jun-06 Mar-07 Dec-07 Sep-08 Jun-09 Mar-10 Dec-10 Sep-11 Figure 14. This fi gure plots cross-border banking sector capital fl ows as year-on-year growth in external claims of BIS-reporting banks (Table 7A). The VIX series is the quarterly average of CBOE VIX index.

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 19 Model Sketch Foreign bank Local borrower branch A L L A Parent bank   or 1 f 1 r Local US US US wholesale currency dollars dollars dollars funding market border Figure 15. This fi gure depicts the lending relationships examined in the model. A foreign bank branch lends to local borrowers in dollars and fi nances its lending from the wholesale dollar funding market.

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 20 Credit Supply Notation for balance sheet of bank Bank E   1 f 1 r C L

Bruno and Shin: Capital Flows and the Risk-Taking Channel of Monetary Policy 21 Borrowers  is debt with dollar face value  , maturing at date  . Value of the borrower’s project (in local currency) at date  is ½µ ¶ ¾ √  −  2   =  0 exp  +   2   is a standard normal Borrower defaults when         is value of local currency against dollars