Global Financial Stability Research Articles

The Size and the Main Determinants of China’s Official Currency Reserves in the Period 1990-2019

Purpose: This paper aims to analyze the size of China's Central Bank's foreign exchange reserves and the main determinants of changes in China's foreign reserves. The publication attempts to prove two theses. According to the first thesis, the current foreign exchange reserves level in China has been higher than the optimal level suggested by the foreign exchange reserves adequacy ratios. However, in line with the second thesis, the most important factors determining China's foreign exchange reserves were changes in the value of imports and changes in the level of China's short-term foreign debt. Design/Methodology/Approach: The study uses a research method based on literature studies in the field of banking and international finance and econometric methods (the classic least squares method). The selection of these research methods and their use are elements of the author's approach to the problem of the optimal level of foreign exchange reserves in China. Findings: Research revealed that for almost the entire period 1990-2019, the value of China's foreign exchange reserves was higher than the optimal values, as suggested by the adequacy ratios of currency reserves. The exceptions were the ratio of the optimal level of foreign exchange reserves, calculated as 20% of the M2 money supply, and the ratio calculated by the IMF methodology for countries with constant exchange rates. China's relatively high foreign exchange reserves were adequately hedged against the possible effects of economic crises, while the relatively high level of these reserves led to their low profitability. The analysis results indicated that changes in the value of China's foreign exchange reserves were, to the greatest extent, determined by the inflow of foreign direct investment and changes in import expenditure. Practical Implications: The discussion on the accumulation of foreign reserves should have practical implications and be set to eliminate threats, not to individual economies but to maintain global financial stability in the world. On the other hand, the currency reserves adequacy indicators themselves should be used flexibly and should reflect individual countries' economic specificities. Originality: So far, no such comprehensive research has been carried out on the magnitude and determinants of China's foreign reserves changes. What is more, the analysis covers a long period of research (1990-2019) and is based on the proprietary model, estimated with the use of econometric tools.

The COVID-19 Pandemic and Sovereign Credit Risk

This study examines the effects of the COVID-19 pandemic on sovereign CDS spreads using a large sample of countries. We show how sovereign CDS spreads have widened significantly in response to the COVID-19 pandemic. Based on the most conservative estimate, a 1% increase in COVID-19 infections leads to a 0.17% increase in sovereign CDS spreads. Furthermore, this effect is stronger for developing countries and countries with worse healthcare systems. Government policies partially offset the impact of the COVID-19 pandemic, although these same policies also lead to widening sovereign CDS spreads. Sovereign CDS spreads narrow dramatically several months after the outbreak of the COVID-19 pandemic. Overall, our results suggest that the ongoing COVID-19 pandemic has been a massive shock to the global financial stability.

THE COVID-19 PANDEMIC AND THE GLOBAL ECONOMY :A SYNOPSIS

Several countries are affected by the coronavirus, causing panic across the globe. The coronavirus originated during late December,2019 and spread across borders in few months. The pandemic caused by the virus has resulted in intense social and economic disruptions. It has caused a severe global recession. Social distancing measures are undertaken to reduce the spread of the virus. According to the recent Global Financial Stability Report, further aggravation of the virus will affect global nancial security and if nancial conditions are tightened even further, the global nancial system will suffer more “cracks”. The prices of commodities and risk assets have begun to fall sharply, volatility of assets has increased, corporate credit markets are crumbling, and market liquidity is seen to be deteriorating. Country authorities are taking several scal measures, implementing social distancing and self-quarantine, supporting the corporate sector and providing unemployment benets for those affected. Few countries that have been hugely affected by the crisis are USA, Spain, Italy, Germany, France, United Kingdom, Turkey, Iran and China. The countries have been implementing various policies for the same. The following article briefs on the measures taken by countries to minimize the spread of the virus and its economic repercussions, the countries most affected and policies implemented in order to tackle COVID-19 repercussions.

FORMATION OF THE SYSTEM OF FINANCIAL-INFORMATION SUPPORT OF ENVIRONMENTALLY-ORIENTED MANAGEMENT OF THE ENTERPRISE

The relevance of the study is due to the need for changes in the methodology and organization of financial and information support for the activities of business entities taking into account modern socio-economic transformations.
 It has been established that awareness of limited resources and the introduction of programs for their conservation, ensuring the harmonious development of mankind has an impact on the conduct of economic activity. In addition, the need for systematic research aimed at creating modern information support for an environmentally-oriented enterprise management system is maximally connected with the need for close cooperation with international financial organizations, among which are comparability and objectivity of indicators. This confirms the importance of reflecting the above trends in the accounting methodology — a system that generates information about the results of an enterprise.
 The article substantiates that the formation of a modern system of financial and information support for business activities aimed at the conservation and rational use of natural resource potential at the micro level will minimize financial risks associated with environmental changes, and at the macro level it will help to achieve the goals of environmentally sustainable development and implementation of state programs environmental safety of Ukraine. The main global forms of non-financial reporting are analyzed, as well as the domestic Management Report for the publication of information on environmental aspects of economic activity. Given the recommendations of the International Federation of Accountants on the dissemination of the use of integrated reporting, considerable attention is focused on the study of the reflection in it of the environmental components of the enterprise. It was found that based on integrated reporting, not only climate change strategies are formed, but also information on how climate change affects the enterprise’s business strategy and its ability to create value. Thus, integrated reporting formalizes the process of building strategies. Building an enterprise management system based on long-term strategies will not only reduce climate risks, but also create better models for building business structures, increase the stability of capital markets and global financial stability.
 It is proved that the development of modernization tools for the domestic financial accounting system, the introduction of environmentally oriented accounting systems will, in addition to increasing the quality of accounting and analytical information, achieve global sustainable development goals and ensure environmental safety, stimulate the subjects of the domestic economy to protect, reproduce and rational use of natural resources.

Impact of the ECB Quantitative Easing on the International Investment Position

This paper aims at estimating the impact of Quantitative Easing (QE) implemented by the ECB on external assets and liabilities recorded in the International Investment Position (IIP). Indeed, monetary policy affects the prices of securities and exchange rates, as well as international capital flows. These movements affect the IIP and can trigger important global imbalances and financial stability issues. Our analysis focuses on France. We find that QE affected all the items composing its IIP. Announcements played a stronger role compared to amounts purchased. We also decompose changes in the IIP into flows and valuation effects and show that the latter was the most reactive to the programme. Finally, we quantify the overall effect by establishing counterfactual scenarios in the absence of QE. The strong impact observed initially was rapidly counterbalanced; suggesting an over-adjustment phenomenon at the beginning of the programme.

Uwarunkowania i wyzwania kreacji safe assets – szczególna rola długu publicznego

Przedmiot badań: Aktywa bezpieczne (safe assets) są definiowane na różne sposoby, w zależ­ności od ich atrybutów i funkcji. Najczęściej przyjmuje się, że są to płynne instrumenty finanso­we, głównie dłużne, które gwarantują inwestorom zachowanie wartości w trakcie niekorzystnych zjawisk gospodarczych. Podkreśla się, że dług publiczny ze względu na jego cechy charaktery­styczne, najlepiej może wypełnić tę funkcję. Jednakże, ze względu na oddziaływanie czynników popytowych i podażowych, w gospodarce światowej powstaje problem niedoboru aktywów bez­piecznych. Możliwość uzupełniania podaży jest ograniczona zdolnością głównego globalnego dostawcy aktywów bezpiecznych – USA do zwiększania skali długu publicznego.
 Cel badawczy: Celem artykułu jest odpowiedź na kluczowe pytanie, jak dostarczać gospodarce globalnej wymaganą ilość aktywów bezpiecznych, zachowując stabilność zadłużenia publiczne­go emitentów oraz wymagany poziom bezpieczeństwa. 1
 Metoda badawcza: Artykuł stanowi syntezę studiów teoretycznych podejmowanych w litera­turze światowej i jednocześnie próbę wprowadzenia do polskiej literatury zakresu pojęciowego związanego z aktywami bezpiecznymi. Rozważania teoretyczne opierają się na założeniu, że dług publiczny jest kluczowym czynnikiem determinującym wielkość ich emisji. W konsekwencji, w artykule wyodrębniono zestaw ekonomicznych i pozaekonomicznych czynników kreacji pu­blicznych aktywów bezpiecznych. Na podstawie analizy opisowej wskaźników makroekonomicznych (fiskalnych) podjęto ocenę zdolności emitentów walut rezerwowych, w tym głównie USA, do dostarczania safe assets.
 Wyniki: Wyniki badań pozwalają wyciągnąć trzy kluczowe wnioski. Po pierwsze, w procesach kreacji safe assets, ze względu na ich specyficzne funkcje i atrybuty, dominującą rolę odgrywa sektor publiczny. Z tego powodu głównymi dostawcami safe assets są kraje emitujące waluty rezerwowe, w szczególności USA, ze względu na ich monopolistyczną pozycję w międzynaro­dowym systemie walutowym. Po drugie, potencjał tych krajów do emisji aktywów bezpiecznych jest ograniczony. Świadczą o tym zarówno rozważania teoretyczne (krzywa Laffera dla safe as­sets, dylemat Triffina), jak i rosnące poziomy zadłużenia publicznego. Po trzecie, dla utrzymania globalnej stabilności finansowej, konieczne jest uzupełnienie puli aktywów bezpiecznych. Poten­cjalnie rolę tę mogłyby odgrywać Chiny i UGiW.

The Causes of Trade Tensions and their Consequences for Financial Stability

This paper was first delivered as a keynote address to the G20 Conference on Global Financial Stability in Seoul in November 2019; all mistakes are mine alone.

The multiplex nature of global financial contagions

As illustrated by the 2008 global financial crisis, the financial distress of one country can trigger financial distress in other countries. We examine the problem of identifying such “systemically important” countries (i.e., countries whose financial distress can trigger further distress), which is important for assessing global financial stability. Using data on bilateral financial positions that are split by asset type, we build a multiplex global financial network in which nodes represent countries, edges encode cross-country financial assets of various types, and layers represent asset types. We examine the temporal evolution of a measure of node importance known as MultiRank centrality, and we find that several major European countries decrease in rank and that several major Asian countries increase in rank since 2008. We then develop a multiplex threshold model of financial contagions in which a shock can propagate either within a layer or between layers. We find that the number of systemically important countries can be twice as large when we take into account the heterogeneity of financial exposures (i.e., when using a multiplex network) than in a contagion on an associated aggregate global financial network (i.e., on a monolayer network), as is often examined in other studies. We also study the extent to which buffers can reduce the propagation of financial distress. Our analysis suggests that accounting for both intralayer and interlayer propagation of contagions in a multiplex structure of financial assets is important for understanding interconnected financial systems of countries.

Treacherous Landscape For Foreign G-Sibs


 
 
 In 2010, the Dodd-Frank Wall Street Reform and Con- sumer Protection Act restructured the regulatory regime for fi- nancial institutions in the United States by mandating corpo- rate governance reforms and requiring that firms maintain high levels of high-quality capital reserves in their U.S. legal entities. Likely the most consequential of the statute’s provi- sions was that which authorized Regulation YY, a landmark regulation that transformed capital planning and risk man- agement processes among financial institutions in the United States. Along with implementing enhanced prudential stand- ards for the U.S. operations of large, complex financial insti- tutions, Regulation YY altered the corporate structure of for- eign banking organizations (“FBOs”) by requiring large foreign banking institutions to establish a new legal entity, called an intermediate holding company (“IHC”). Put simply, IHCs were created to reorganize and capture, in one umbrella legal entity, all non-branch U.S. operations of FBOs. Further, to ensure robust, localized oversight of U.S. operations, each IHC is required to establish their own board of directors and risk committee, separate and apart from the board and com- mittees of the broader organization. IHCs are also required to comply with both the capital and leverage ratio requirements applied to similarly large domestic financial institutions, and the programmatic requirements associated with firms of that size (resolution planning, CCAR, CLAR).
 
 
 
 There is another regulation, though, that when coupled with the far-reaching implications of Regulation YY has dis- parately impacted foreign banking organizations. That regu- lation is Regulation W, a longstanding regulation that limits the amount of intracompany transactions banking organiza- tions can engage in. Following the enactment of Dodd-Frank, Regulation W was amended in several ways which limited spe- cifically the types of transactions that FBOs often engage in with their affiliates to manage their liquidity risk and to ab- sorb liquidity shocks. The post-crisis changes made to Regula- tion W have already begun to be rolled back by U.S. regulators, however there has not yet been a detailed analysis of how spe- cifically the interaction between Regulation YY and Regulation W undermines global financial stability.
 The specific aim of this Note is to evaluate whether Regu- lation YY and Regulation W have destabilized the global fi- nancial system. Institutions’ 2018 and 2019 CCAR results will be the lens through which the impact of the regulations is eval- uated. Specifically, we look at both institutions’ Tier 1 capital ratios and Tier 1 leverage ratios to assess how specifically the IHCs have positioned their liquid capital and adjusted their business model in response to Regulation YY reorganization. Ultimately, we conclude that the interaction between Regula- tion YY and the revised Regulation W has dramatically frag- mented the global flow of capital among FBOs. Regulation YY’s IHC reorganization mandate largely cabins foreign banks’ ability to absorb liquidity shocks through their organi- zations—a result that may pose a serious threat to global fi- nancial stability. That is, the fundamental disruption of insti- tutions’ ability to funnel liquidity to their network of legal entities around the world raises a significant concern regard- ing their resiliency during periods of stress, particularly for those systemically important firms who experienced pervasive liquidity issues in the most recent crisis.
 
 
 
 
 
 

Does US-China Trade War Matter on ASEAN Stock Market: Event-study Approach

The trade war between the US and China by imposing tariffs has the potential to affect global financial stability. As the largest economy in the world, the US and China had been trading goods and services globally. Then, when these countries have retaliated, the tariff war will affect the global supply chain, international trade, economy, and the stock market. This research examined the effect of the US-China trade war on ASEAN stock prices using an event-study approach. The result shows that the ASEAN stock market has positive abnormal returns during pre-event period (12%). In contrast, ASEAN stock markets shifted to negative abnormal return (-7.4%) in the short-term window, indicating that the stock market is efficient. Stock price reflects the information from the market quickly. However, the impact of the trade war on the ASEAN stock market is insignificant.

A Bayesian panel stochastic volatility measure of financial stability

AbstractWe propose to model financial stability, opting for an alternative bank profit function whose volatility is measured within a framework of panel stochastic volatility. Within this model financial stability and volatility are latent variables. To observe financial stability and volatility we employ Bayesian inference procedures organized around Sequential Monte Carlo (SMC) technique and particle filtering. We do so in a single stage that controls also for non‐linearities, while we also allow for some key bank and country‐specific variables to impact upon financial stability and volatility. Thus, we provide a new measure of financial stability by country, over time and also at a global level. In an empirical application, we derive financial stability indexes for a plethora of countries, as well as the global financial stability index that acts as an early warning index. Our results suggest that the financial cycle is subject to non‐linearities. We argue that the global financial system should closely monitor large, systemic, banks as key to support financial stability.

Monitoring market participants, externals and financial transactions in a global financial stability environment

Monitoring market participants, externals and financial transactions in a global financial stability environment

Global Financial Stability Notes: The Strains in Offshore US Dollar Funding during the COVID-19 Crisis: Some Observations

Global Financial Stability Notes: The Strains in Offshore US Dollar Funding during the COVID-19 Crisis: Some Observations

Strains in Offshore US Dollar Funding during the COVID-19 Crisis

This note analyzes recent trends in offshore US dollar funding markets and explores the drivers of dollar funding costs during the COVID-19 pandemic crisis. Preliminary evidence suggests that only part of the sharp increase in observed dollar funding costs can be attributed to the standard supply- and demand-side factors analyzed in the October 2019 Global Financial Stability Report (GFSR), including the dollar funding fragility of non-US global banks. Changes in market structure since the global financial crisis, as well as heightened uncertainty and tensions in the commercial paper market, may provide further explanations for the movements in dollar funding costs in late March 2020. The US Federal Reserve’s swap line arrangements have helped lessen strains in dollar funding markets, but funding pressure remains significant for some emerging market economies, notably those with-out access to the swap lines. Furthermore, tighter dollar funding conditions appear to have accompanied increases in financial stress in the home economies of affected non-US global banks and to have generated adverse spill-over effects in the form of cutbacks in cross-border lending.

A Model of Fickle Capital Flows and Retrenchment

We develop a model of gross capital flows and analyze their role in global financial stability. In our model, consistent with the data, when a country experiences asset fire sales, foreign investments exit (fickleness) while domestic investments abroad return home (retrenchment). When countries have symmetric expected returns and financial development, the benefits of retrenchment dominate the costs of fickleness and gross flows increase fire-sale prices. Fickleness, however, creates a coordination problem since it encourages local policymakers to restrict capital inflows. When countries are asymmetric, capital flows are driven by additional mechanisms, reach-for-safety and reach-for-yield, that can destabilize the receiving country.

MODELING OF ECONOMIC SAFETY OF SUSTAINABLE NATURE MANAGEMENT FINANCIAL SUPPORT

The study systematizes mutual influences and connections of the economic safety of bank sector functioning as a whole, bank activity (state and commercial) at the fund market and financial support of sustainable nature management, taking into account bank strategies “threading” by Sustainable development aims of UNO till 2030 of both own activity (concrete examples are given) and one of market agents of the nature-resource sector of the national economy, for which a financial-credit institution acts as a specific financial provider in the world of sustainable nature management and comprehensive development, taking into account the global ecologic initiative. There are given parallels in aim setting of supranational and national regulators in two opposite and at the same time complementary conceptions: “green economy” and “financial globalism”, expecting dynamism of unpredictability and inertia of global financial stability absence on the ecologically influenced stability of the economic dynamics. There are constructed correspondent econometric dependence models of a triad “financial safety of the bank sector – financial support stability – nature management sustainability” on variables – corporative equity and bond issue, using special methods and program environment Eviews and Statistica. It has been revealed, that the market of bonds and the one of equities differently react on changes of the economic dynamics – the equity issue volume, as opposite to corporative bond issue, doesn’t depend on nature management sustainability indices, and its financial support stability is not in the sphere of financial-economic parametrization, but in the political conjuncture, socio-psychological and mental transformation in the direction of economic subjects’ readiness to conducting ecologically and at the same time socially responsible business that needs modernization of the purpose orientation of safe bank strategies, taking correspondent anti-crisis arrangements by them for providing safety of their activity at the fund market under conditions of intensification of the COVID-19 pandemic influence. Obtained modeling results may be used by the National bank of Ukraine for actualizing the macroprudential policy, directed on elimination of system risks for preventing crises or diminution of losses from them by the system of financial stimulation of rational nature management.

Money Market Funds Reforms in the US and the EU: The Quest for Financial Stability

This article considers the impact of money market funds (MMFs) reforms in the US and the EU on the money market fund industry and global financial stability. The 2008 financial crisis proved that MMFs are a source of considerable instability to the global financial system, and highlighted their susceptibility to runs. The shareholders’ incentive to redeem their shares before others do when there is a perception that the MMFs might suffer a loss makes MMFs vulnerable to runs. Given this reality, the article argues that the emphasis of the financial regulators on achieving the stability of the entire financial system after the 2008 financial crisis necessitates the strictness of the new reforms. Divided into six parts, the article outlines the attributes and classification of MMFs, the definition of financial stability, and the run and systemic risk posed by MMFs during the financial crisis, before assessing the MMFs’ reforms in the US and the EU and the impacts of these reforms on the MMFs industry and global financial stability system. The major component of the US reform is the introduction of the floating net asset value (FNAV), where an MMF’s share price will fluctuate to reflect the daily market value of the fund assets. In the EU the new regulation provides investors with a high degree of optionality for investing by introducing Low Volatility Net Asset Value (LVNAV) MMFs. The article concludes that despite that, the reforms are likely to jeopardize the viability of some categories of MMFs, they enhance global financial stability, and the complexity of the reforms has made MMFs more appropriate products to financial institutions’ investors than retail investors. Money market funds, financial stability, the UK, the US, macro-prudential policy

Challenges to global financial stability: Interconnections, credit risk, business cycle and the role of market participants

The worldwide financial crisis (WFC) of 2007-09 has shown the importance of cross-sectional dependencies of assets, credit exposures and volatility, which can threaten domestic and global financial stability through cascades in financial networks. A correct assessment of company-specific risk has to account for the potential risk spillover effects from other firms (Hautsch et al. 2014). This is because of the intertwined nature of financial markets, which allow the spread of risk throughout the system (Acemoglu et al., 2015). The potential impact of interconnected financial institutions on the entire financial system has been a financial stability concern for central banks and regulators. The need for economic foundations for a systemic risk measure is more than an academic concern since it involves regulators, supervisory authorities and policy-makers (Acharya et al. 2017). This special issue provides a substantial contribution to the systemic risk literature

Risks on Global Financial Stability Induced by Climate Change

There is increasing concern among financial regulators that changes in the distribution and frequency of extreme weather events induced by climate change could pose a threat to global financial stability. In order to assess this risk, we develop a simple model of the propagation of climate-induced shocks through financial networks. Weshow that the magnitude of global risks is determined by the interplay between the exposure of countries to climate-related natural hazards and their financial leverage. Climate change induces a shift in the distribution of impacts towards high-income countries and a thus larger amplification of impacts as the financial sectors of high-income countries are more leveraged. Conversely, high-income countries are more exposed to financial shocks. In high-end climate scenarios, this could lead to the emergence of systemic risk as total impacts become commensurate with the capital of the banking sectors of countries that are hubs of the global financial network. Adaptation policy, or the lack thereof, appears to be one of the key risk drivers as it determines the future exposure of high-income countries.

CDS Central Counterparty Clearing Default Measures: Road to Recovery or Invitation to Predation?

Following the 2008 financial crisis, regulation mandates the clearing of the CDS market through Central Clearing Counter-parties (CCPs). Large CCPs are now designated as ’Global Systemically Important Institutions’ (GSIIs), whose unlikely-but-plausible failure threatens global financial market stability. This work examines CCP resilience following a large dealer member’s default and the ensuing default contagion. In unwinding the defaulter’s positions, the CCP faces the price impact of constrained member liquidations and unconstrained members’ predatory selling. The variation margin captures the effect of price-mediated contagion and its amplification. A novel spatial measure captures the covariance between members’ CDS holdings and the CDS being unwound. Key results show: Liquidations by constrained members lower the CCP’s profits and make cds-spreads less informative. There exists a strong conflict between predatory competition and dealer distress, which inadvertently makes dealers prey on themselves. In turn, the adoption of a risk-sharing guarantee fund structure would provide a natural disciplinary mechanism for predation – minimizing overall CCP and member losses. A dynamic simulation, calibrated to OTC market data, supports these theoretical results with parameter magnitudes and sensitivities. Examination of three market liquidity scenarios provides intuition for effective liquidity injection by a Lender of Last Resort.