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Analysts are poring over new statistics on debt exposure from the Bank for International Settlements released today. As has become customary with each quarterly release of this data, the report’s (virtual) pages are flipped directly to the section detailing the size of banks’ portfolio of bonds issued by governments on the euro area’s troubled periphery.
French and German banks are the most exposed, by far, to troubled government debt. Although banks have been reducing their exposure—the value of debt from Greece, Ireland, Portugal and Spain held by foreign banks fell by 35% last year—significant holdings remain. German banks, for example, were sitting on more than 40% of the US$54bn in foreign-held Greek government debt at the end of 2010.
The inevitable restructuring of Greek debt will be painful for lenders, although the severity will vary according to the method employed. In the meantime, attempts to cajole banks into a voluntary refinancing of Greece’s daunting debt pile (along the lines of the “Vienna Initiative” in central and eastern Europe) will continue, despite a glaring lack of incentives for lenders to take part.
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For the last three years, global finance has been rocked by sub-prime mortgages, bank failures and sovereign-debt scares. But the world’s foreign exchange markets have nonetheless grown by leaps and bounds. That is the surprising conclusion of a survey of the market published on December 1st.
The study, the Triennial Central Bank Survey for the Bank for International Settlements (BIS), shows that the foreign exchange market expanded by 20% to average daily trading of US$3.98trn in April 2010 from three years before. It also documents the increasing role of non-traditional financial traders. Finally, it provides evidence of the continued domination of the market by traders in the UK, US and a handful of other established centres.
Read more at Financial Services Briefing: “Resilient forex” (December 1st)
Every three years, the Bank for International Settlements surveys the global currency market. Its latest report shows that the average daily turnover in the foreign exchange market reached a whopping US$4trn in April 2010, up 20% from April 2007. The most popular currencies remain the US dollar, euro and Japanese yen, which largely maintained their overall share of trading over the past three years.
Deeper digging into the results uncovers some interesting trends in certain currency pairs. Facing moribund growth at home, investors from the largest developed economies are looking to emerging markets for returns, fuelling rapid growth in, for example, the exchange of American dollars for Brazilian reais and Chinese yuan. Another particularly fast-growing pair, the yen-Australian dollar, reflects a growing appetite for commodities. By contrast, one of the only pairs to see trading volumes fall in recent years is the august “cable”, or trade between US dollars and British pounds.
A Reuters story suggests that German government officials are taking steps to “identify speculators in Greek debt to try to prevent them from profiting unduly from any bailout.” The measures that could be taken to prevent such profits are unclear, and the article somewhat conflates investors in sovereign debt with those who invest in credit default swaps linked to sovereign debt.
If the purported goal of the investigation is to crack down on CDS speculators, new data from the Bank for International Settlements should give officials pause. In its latest quarterly banking review, published today, the organisation notes that the net exposure of investors to the sovereign CDS of beleaguered euro area economies is a tiny fraction of the actual sovereign debt of those countries. Thus, assuming CDS traders are largely to blame for pushing up the cost of countries’ refinancing is a rather heroic assumption.
Concerns about derivatives markets’ growing influence over the underlying securities upon which they are based have been around for a while. In the context of CDS, these concerns generally surface when a scarcity of corporate debt threatens the settlement of linked derivatives during credit events (defaults, restructurings and the like). But the notional amount of CDS written on sovereign issues pales in comparison to the value of the underlying debt, so attacking derivatives “speculators” on this front seems misguided.
What’s more, a recent Moody’s report suggests that banks may be buying more protection against sovereign default by Greece, Portugal and other teetering economies for reasons not directly related to growing worries about sovereign default. Derivatives linked to some corporate and sub-sovereign borrowers may not exist, so lenders choose instead to buy “protection on the sovereign on the assumption (hope?) of strong correlation between it and the entity to which they have the long credit exposure,” Moody’s writes. Of course, such correlation could be spurious, leaving banks with imperfect hedges and government officials with misguided conspiracy theories.
In the latest quarterly review from the Bank for International Settlements, researchers backtest the “stress tests” employed by regulators and supervisors to gauge the solidity of banks during financial crises.
After studying tests conducted around 43 banking crises in 30 countries since 1974—including those immediately preceding the latest crash—the research finds that the “overwhelming majority [of countries] concluded that their banking systems were robust even in the face of very severe adverse scenarios.” In fact, nearly 70% of the “very severe” macroeconomic scenarios envisioned by the tests proved milder than subsequent events.
Economic growth preceding the crisis is an important factor in determining the accuracy of assumptions. High growth in the run-up to a crisis tends to result in overly mild stress-test scenarios, for example. And as Nassim Nicholas Taleb was probably thrilled to read, stress testers often find it hard to imagine conditions “beyond the realm of anything that has been experienced.”
Stress testing, as traditionally practiced, is likely to “lull users into a false sense of security” by continuing to underestimate the dangers of extreme events, the research concludes. Put another way, the Alea blog answers the hypothetical question in the paper’s title—Macro stress tests and crises: what can we learn?—with a simple rejoinder: “That they don’t work.”