finance & new risk scenarios, rome december 2016...finance & new risk scenarios, rome...
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FINANCE & NEW RISK
SCENARIOS, ROME
DECEMBER 2016
Adrian Blundell-WignallSpecial Advisor on Financial Markets to the OECD Secretary General, for Financial & Enterprise Affairs Directorate.
The World Economy: The Key
Moving Parts
2
• World growth came to depend on commodity super cycle an related investment: China a major driver, and now in reversal as excess capacity emerges globally.
• The return on equity driven down below the cost of capital – low inflation, absence of investment & productivity.
• 7 major risks interacting with this:
(1) Political—the rapid hollowing out of the middle class.
(2) Financial markets—low interest rates & asset prices.
(3) Europe’s failure to deal with the banking crisis.
(4) Pushing Risk into shadow banking
(5) Emerging market risk: US tightening, a rising dollar and China and debt.
(6) Fintech risks to the traditional financial institution model.
(7) Brexit risk for Europe.
Political: Hollowing Out%; Changes in Shares of
Employment by Pay Category 1997-2015
3
Global Capital Expenditure: Dependence
on Energy & Materials (now reversing)
4
0
500
1000
1500
2000
2500
3000
3500
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
US$, bn
Energy Materials Industrials Consumer Discretionary Consumer Staples
Healthcare Information Technology Telecom. Services Utilities
Sector Investment Misallocation: ROE-
COK in Emerging Economies, 2002-2015
5
-10
-5
0
5
10
15
20
25
%
EMEs Worst Performers
Materials Energy Softw. & Services
-10
-5
0
5
10
15
20
25%
EMEs Bottom MidCons. Services Tech Hardware & Equip
Capital Goods Retailing
Utilities Transport
Pharma. & Biotech.
-10
-5
0
5
10
15
20
25
%
EMEs Upper Mid
Media Com. & Prof. ServicesTelecom. Services H-care Equip & ServAuto. & Compo. Food Bev. & Tobacco
-10
-5
0
5
10
15
20
25
%
EMEs Best Performers
Consumer Dur. & Apprl. Food & Staples Retail
H-H & Pers. Products Semiconductors
Low rates hurt banks (there is a banking crisis in Europe) and they may bankrupt pension & insurance companies. So why? To save lame-duck companies from adding to NPL’s? To boost asset prices?? To weaken the exchange rate???
Asset price bubble emerge—not supported by productivity growth.
Funds chase yield and alternative products, in order to catch up.
Redemption risk on asset price reversal with illiquid assets—disorderly markets.
6
Low Interest rates
1 Month Major Interbank Rates
7
-18
-15
-12
-9
-6
-3
0
3
6
9
12
-1.2
-1
-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
0.6
0.8%%
EURIBOR LIBOR CHF LIBOR JPY LIBOR GBP LIBOR USD HIBOR (RHS)
Evolution of Selected Financial Prices
8
30
80
130
180
230
280
330
Index (100 = Jan-2008)
US Tsy Tot Ret 10y GBI $ Tot Ret EMEs
MSCI World Tot Ret S&P 500 Tot Ret
HFRI Weighted Index Tot Ret US Private Equity
US Real Estate Shanghai Equity Composite Index
9
Evolution of REITS
0
50
100
150
200
250
300
350
400
Price index100=Q2 2009
Japan Australia United States United Kingdom China Europe
The 4% Real Target of Many Pension Funds is not Realistic:
Low Interest Rates Could Persist for a Long Time
10
Drop in interest rates increases exposure to longevity
risk of mortality tables across countries – average
shortfall for females, age 65
11
Corporate Bond Issuance and Declining Quality,
2000-2015
12
0
500
1000
1500
2000
2500
3000
3500
4000
14
14.5
15
15.5
16
16.5
17
17.5
18
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
USD blnRating Index
New Supply of Corp. Bonds Value Weighted Avg. rating
0
10
20
30
40
50
60
70
80
90
100
2000 2000-2007 2015
%
C Grade - Non-investment B Grade - Non-invesment B Grade - Investment A Grade - Investment
OECD 2008 View on Dealing with the Bank
Crisis. Did Europe Measure up?
13
OECD publications consistently recommended three key elements of banking reform:
• Deal with any troubled assets first.
• Recapitalise banks.
• Regulatory focus on a simple leverage ratio of at least 5% of the un-weighted (IFRS) balance sheet, and not to rely on the Basel risk weighting approach to capital rules.
• Separate derivatives and other high-risk investment banking activities from insured deposit balance sheets that subsidises these activities and leads to an under-pricing of risk. Maintain liquid assets. Reduce wholesale funding.
Non-Performing Loans (in % of Total Loans)
14
0
2
4
6
8
10
12
2008 2009 2010 2011 2012 2013 2014 2015 2016
% Total loans
United States Europe Switzerland United Kingdom
Japan Australia Latin America Asia
0
5
10
15
20
25
30
35
40
45
50
2008 2009 2010 2011 2012 2013 2014 2015 2016
% Total loans
Greece Ireland Italy Portugal Spain
15
Core Tier 1: Basel Risk-Weighted versus the
Simple Leverage Ratio
0
1
2
3
4
5
6
7
8
9
2008 2009 2010 2011 2012 2013 2014 2015 2016
% TA ifrs
0
2
4
6
8
10
12
14
16
18
2008 2009 2010 2011 2012 2013 2014 2015 2016
% RWA
United States Europe Switzerland United Kingdom JapanAustralia Latin America Asia Basel III
16
Business Model Features That Drive Risk in
GSIB Banks
0
5
10
15
20
25
30
35
2008 2009 2010 2011 2012 2013 2014 2015 2016
% TA ifrs
Wholesale Funding
United States Europe Switzerland United KingdomJapan Australia Latin America Asia
0
10
20
30
40
50
60
2008 2009 2010 2011 2012 2013 2014 2015 2016
% TA ifrs
Trading AssetsUnited States Europe Switzerland United Kingdom
Japan Australia Latin America Asia
0
10
20
30
40
50
2008 2009 2010 2011 2012 2013 2014 2015 2016
% TA ifrs
GMV Derivatives
United States Europe Switzerland United KingdomJapan Australia Latin America Asia
17
Distance-To-Default: Banks
0
10
20
30
40
50
60
70
80
90
0
1
2
3
4
5
6
7
8
9IndexStd dev
VIX (RHS) United States United Kingdom Europe Japan Australia Latin America Asia
Distance-To-Default of Large Banks by Region
18
0
1
2
3
4
5
6
Europe NorthAmerica
Asia PacificG-SIBs US G-SIBsNon-US
OL BanksUS
OL BanksNon-US
DSI BanksEurope
Standard dev iation
Pre-crisis Crisis Post-crisis
Credit Default Swap of Large Banks by Region
19
0
50
100
150
200
250
Europe NorthAmerica
AsiaPacific
G-SIBs US G-SIBsNon-US
OL BanksUS
OL BanksNon-US
DSI BanksEurope
Basis point
Pre-crisis Crisis Post-crisis
586
Pushing Risk Into Shadow Banks
20
• Risky assets transferring to shadow banks as bank regulation proceeds.
• US & UK banking and finance centres de-globalising much less than Europe and Japan.
• OECD research shows that the problem of rising inter-connectedness is worst in Asia.
• Chinese and Japanese institutions are moving into where European banks and non-banks are moving out.
• Banks are more interconnected with shadow banks in Asia than before the crisis. Things improved in the USA. But they stayed the same in Europe.
21
Holdings of Derivatives: Banks vs Shadow
Banks (gross market value)
0
5000
10000
15000
20000
25000
30000
$US bn, Outstanding
GMV
Non-financial customers Shadow-banking institutions Reporting dealers
22
Cross-Border Claims by Nationality or
Residence: Banks versus Shadow Banks
0
20
40
60
80
100
120
140
160
180
200
%GDP
United KingdomBanks, by residence Non-banks, by residenceBanks, by nationality Non-banks, by nationality
0
20
40
60
80
100
120
%GDP
Europe 15Banks, by residence Non-banks, by residenceBanks, by nationality Non-banks, by nationality
0
10
20
30
40
50
60
70
%GDP
Japan
Banks, by residence Non-banks, by residenceBanks, by nationality Non-banks, by nationality
0
5
10
15
20
25%GDP
United States
Banks, by residence Non-banks, by residenceBanks, by nationality Non-banks, by nationality
Emerging Markets & EU Debt &
Bank Risks Building Up
23
• Low interest rates are contributing to build up of debt globally in the company sector. (China especially. Early warning sign).
• US and other advanced countries own $-denominated Emerging Market financial and non-financial debt.
• NPLs in China are hard to compare with advanced countries – maybe close to 6%.
• USA rates set to rise and the $ moving up—with much non-investment grade debt in dollars and a lot from banks and non-banks.
Government, Household & Company
Debt: Advanced and Emerging
24
0
50
100
150
200
250
300 GDP (%)
EMERGING TOTAL
Non-financial corporations Households and NPISHs General government
0
50
100
150
200
250
300 GDP (%)
CHINA
Non-financial corporations Households and NPISHs General government
0
50
100
150
200
250
300 GDP (%)
ADVANCED
Non-financial corporations Households and NPISHs General government
Global Non-Investment Grade EME Issuance
25
0
5000
10000
15000
20000
25000
30000
35000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Aug-16
$US mn EME Financial Issuance
Others Korean Won British Pound Chinese Yuan Japanese Yen US Dollar Euro
0
5000
10000
15000
20000
25000
30000
35000
40000
45000
50000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Aug-16
$US mn EME Non-Financial Issuance
Others Korean Won British Pound Chinese Yuan Japanese Yen US Dollar Euro
26
PBOC New Exchange Rate Basket & Some
Components
60
65
70
75
80
85
90
95
100
105
110Index 100=Jan2016
Basket 100 = Jan-2016 USD Index Euro Index Yen Index
92
94
96
98
100
102
104Index 100=Dec2014 CFETS RMB Index
International Reserves of Major Emerging
Countries
27
50
60
70
80
90
100
110
120
130
140
Index(100 = Jan 2012)
Brazil Argentina South Africa ChinaIndia Russia Turkey Indonesia
Fintech Threats: Distributed Ledgers
28
• Distributed ledgers are much more transformative than sharing economy disruptions (Uber, AirBnB) which still involve hierarchical intermediaries
• Could make society unrecognisable
• Distributed ledger technology is a shift towards a different underlying philosophy of economic organisation based on: distributed consensus, open source, transparency, and technological communities
• Technology threatens all intermediaries under pressure from globalisation, information intensity, and connectivity. Avoids duplication and inefficiency. Gets rid of cross checking between individual ledgers and databases.
29
Distributed versus Centralised
Blocks and Blockchain
30
• Blockchain is a list of “blocks” and a “block” is typically a list of transactions or records (first developed for Bitcoin). A new block is “chained” to the previous block, using a cryptographic signature.
• Used like a ledger shared and corroborated by anyone with right permissions. Changes in the ledger reflected in all copies quickly. Keys and cryptology determine who can do what within the ledger.
• Un-permissioned ledgers: blockchain can be un-permissioned, so anyone can add a block, but consensus is needed on what is added including the code. Older blocks cannot be rewritten.
• Permissioned ledgers: consensus achieved by a set of trusted nodes and may have a proprietor (e.g. Ripple, the Estonian government, etc.). Code itself is developed and updated by the proprietor.
Transformative vision
31
• Transformative vision of the world is to have citizens participate in smart contract applications that work with the blockchain database
• Legacy contracts are typically archived signed contracts
• Smart contracts contain the computer code that executes the contract—2 users sign and it is executed by the contract on the blockchain. Problem with legacy system – it is located in single institutions, with an array of networking and messaging—there is a single point of failure and subject to cyber-attack
• Smart contracts in distributed ledger are hard to attack.
• Care required in regulation—distributed ledgers can help reduce the cost of finance; help in the fight against cyber crime; reduce bribery and corruption; reduce tax avoidance; and fight terrorism financing.
Brexit & Financial Services
32
• Will UK financial institutions lose their Europe “passports”?
• US and other non-EU banks that meet European regulatory standards are able to be licenced on an individual basis to provide services in Europe
• LCH Clearnet Ltd (owned by LSEG), ICE Clear Europe, LME Clear Limited and CME Clearing Europe Limited operate in London. UK is largest market for OTC euro foreign exchange transactions and largest interest rate derivatives market in the world. There are other non-euro countries that clear euro-denominated instruments as well (i.e. the US and Singapore)
• EU lost a case against the UK in the General Court of the EU over the ECB claiming that euro contracts need to be cleared in euro countries (for supervision reasons). Treaty change required to do it.
33
UK Services vs Total Goods and Services
Balance of Payments with Europe
-80,000
-60,000
-40,000
-20,000
0
20,000
40,000
60,000
80,000
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
GBP mln
Trade in Services with Europe
Trade in G&S with Europe
34
UK Exports to Region in percent of UK
Exports to the OECD 22
35
Number of Institutions Included in the United
Kingdom Banking Sector by Nationality in 2016
116
80239
45
86
United Kingdom Other EU
United States Japan
Other developed countries Other nationalities