Transcript Adrian Blundell-Wignall

FINANCE & NEW RISK
SCENARIOS, ROME
DECEMBER 2016
Adrian Blundell-Wignall
Special Advisor on Financial Markets to the OECD
Secretary General, for Financial & Enterprise Affairs
Directorate.
The World Economy: The Key
Moving Parts
• 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.
2
Political: Hollowing Out%; Changes in Shares of
Employment by Pay Category 1997-2015
3
Global Capital Expenditure: Dependence
on Energy & Materials (now reversing)
Energy
Healthcare
Materials
Industrials
Information Technology
Consumer Discretionary
Telecom. Services
Consumer Staples
Utilities
US$, bn
3500
3000
2500
2000
1500
1000
500
0
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
4
Sector Investment Misallocation: ROECOK in Emerging Economies, 2002-2015
EMEs Bottom Mid
Cons. Services
Tech Hardware & Equip
Capital Goods
Retailing
Utilities
Transport
Pharma. & Biotech.
EMEs Worst Performers
Materials
Energy
Softw. & Services
%
%
25
20
15
10
5
0
-5
-10
25
20
15
10
5
0
-5
-10
EMEs Best Performers
EMEs Upper Mid
%
25
20
15
10
5
0
-5
-10
Media
Telecom. Services
Auto. & Compo.
Com. & Prof. Servic es
H-care Equip & Serv
Food Bev. & Tobacco
Consumer Dur. & Apprl.
H-H & Pers. Products
%
25
20
15
10
5
0
-5
-10
Food & Staples Retail
Semiconductors
5
Low Interest rates
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
1 Month Major Interbank Rates
EURIBOR
0.8
0.6
0.4
0.2
0
-0.2
-0.4
-0.6
-0.8
-1
-1.2
%
LIBOR CHF
LIBOR JPY
LIBOR GBP
LIBOR USD
HIBOR (RHS)
%
12
9
6
3
0
-3
-6
-9
-12
-15
-18
7
Evolution of Selected Financial Prices
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
Index
(100 = Jan-2008)
330
280
230
180
130
80
30
8
Evolution of REITS
Japan
400
Australia
United States
United Kingdom
China
Europe
Price index
100=Q2 2009
350
300
250
200
150
100
50
0
9
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
New Supply of Corp. Bonds
Value Weighted Avg. rating
Rating Index
18
USD bln
4000
17.5
3500
17
3000
16.5
2500
16
2000
15.5
1500
15
1000
14.5
14
500
2000
2001
2002
2003
2004
C Grade - Non-investment
2005
2006
2007
2008
B Grade - Non-invesment
2009
2010
2011
2012
B Grade - Investment
2013
2014
2015
0
A Grade - Investment
%
100
90
80
70
60
50
40
30
20
10
0
12
2000
2000-2007
2015
OECD 2008 View on Dealing with the Bank
Crisis. Did Europe Measure up?
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 underpricing of risk. Maintain liquid assets. Reduce wholesale
funding.
13
Non-Performing Loans (in % of Total Loans)
United States
Japan
12
Europe
Australia
Switzerland
Latin America
United Kingdom
Asia
% Total loans
10
8
6
4
2
0
2008
2009
2010
Greece
50
45
40
35
30
25
20
15
10
5
0
2011
Ireland
2012
2013
Italy
2014
2015
Portugal
2016
Spain
% Total loans
2008
2009
2010
2011
2012
2013
2014
2015
2016
14
Core Tier 1: Basel Risk-Weighted versus the
Simple Leverage Ratio
United States Europe
Switzerland
Australia
Latin America Asia
18 % RWA
16
14
12
10
8
6
4
2
0
2008
2009
2010
2011
2012
9 % TA ifrs
8
7
6
5
4
3
2
1
0
2008
2009
2010
2011
2012
United Kingdom
Basel III
2013
2013
2014
2014
Japan
2015
2015
2016
2016
15
Business Model Features That Drive Risk in
GSIB Banks
Trading Assets
Wholesale Funding
United States
Japan
35 % TA ifrs
30
25
20
15
10
5
0
2008 2009
Europe
Australia
Switzerland
Latin America
United States
Japan
United Kingdom
Asia
Europe
Australia
Switzerland
Latin America
United Kingdom
Asia
60 % TA ifrs
50
40
30
20
10
0
2010
2011
2012
2013
2014
2015
2016
2008
2009
2010
2011
2012
2013
2014
2015
2016
GMV Derivatives
United States
Japan
Europe
Australia
Switzerland
Latin America
United Kingdom
Asia
50 % TA ifrs
40
30
20
10
0
2008
2009
2010
2011
2012
2013
2014
2015
2016
16
Distance-To-Default: Banks
VIX (RHS)
9
Std dev
United States
United Kingdom
Europe
Japan
Australia
Latin America
Asia
Index
90
8
80
7
70
6
60
5
50
4
40
3
30
2
20
1
10
0
0
17
Distance-To-Default of Large Banks by Region
Pre-crisis
6
Crisis
Post-crisis
Standard
dev iation
5
4
3
2
1
0
Europe
North Asia Pacif icG-SIBs US G-SIBs OL Banks OL Banks DSI Banks
America
Non-US
US
Non-US Europe
18
Credit Default Swap of Large Banks by Region
Pre-crisis
Basis point
Crisis
Post-crisis
586
250
200
150
100
50
0
Europe
North
America
Asia G-SIBs US G-SIBs OL Banks OL Banks DSI Banks
Pacific
Non-US
US
Non-US Europe
19
Pushing Risk Into Shadow Banks
• 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 interconnectedness 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.
20
Holdings of Derivatives: Banks vs Shadow
Banks (gross market value)
Non-financial customers
30000
Shadow-banking institutions
Reporting dealers
$US bn, Outstanding
GMV
25000
20000
15000
10000
5000
0
21
Cross-Border Claims by Nationality or
Residence: Banks versus Shadow Banks
United States
25
%GDP
Banks, by residence
Banks, by nationality
Banks, by residence
Banks, by nationality
Non-banks, by residence
Non-banks, by nationality
15
10
5
0
%GDP
Japan
%GDP
Banks, by residence
Banks, by nationality
Banks, by residence
Banks, by nationality
Non-banks, by residence
Non-banks, by nationality
120
60
100
30
20
Europe 15
Non-banks, by residence
Non-banks, by nationality
%GDP
70
40
Non-banks, by residence
Non-banks, by nationality
200
180
160
140
120
100
80
60
40
20
0
20
50
United Kingdom
80
60
40
10
20
0
0
22
Emerging Markets & EU Debt &
Bank Risks Building Up
• 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.
23
Government, Household & Company
Debt: Advanced and Emerging
Non-financial corporations
300
Households and NPISHs
GDP (%)
General government
300
Non-financial corporations
150
150
100
100
50
50
0
0
Non-financial corporations
300
CHINA
200
ADVANCED
200
General government
GDP (%)
250
250
Households and NPISHs
Households and NPISHs
General government
GDP (%)
250
EMERGING TOTAL
200
150
100
50
0
24
Global Non-Investment Grade EME Issuance
Others
35000
Korean Won
British Pound
Chinese Yuan
Japanese Yen
US Dollar
Euro
EME Financial Issuance
$US mn
30000
25000
20000
15000
10000
5000
0
2000
2001
2002
Others
50000
2003
2004
Korean Won
2005
2006
2007
British Pound
2008
2009
2010
Chinese Yuan
2011
2012
Japanese Yen
2013
2014
US Dollar
2015 Aug-16
Euro
EME Non-Financial Issuance
$US mn
45000
40000
35000
30000
25000
20000
15000
10000
5000
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015 Aug-16
25
PBOC New Exchange Rate Basket & Some
Components
Basket 100 = Jan-2016
USD Index
Euro Index
Yen Index
Index 100=Jan2016
110
105
100
95
90
85
80
75
70
65
60
104
Index 100=Dec2014
CFETS RMB Index
102
100
98
96
94
92
26
International Reserves of Major Emerging
Countries
140
Brazil
India
Index
(100 = Jan 2012)
Argentina
Russia
South Africa
Turkey
China
Indonesia
130
120
110
100
90
80
70
60
50
27
Fintech Threats: Distributed Ledgers
• 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.
28
Distributed versus Centralised
29
Blocks and Blockchain
• 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.
30
Transformative vision
• 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;
31
and fight terrorism financing.
Brexit & Financial Services
• 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.
32
UK Services vs Total Goods and Services
Balance of Payments with Europe
80,000
GBP mln
Trade in Services with Europe
60,000
Trade in G&S with Europe
40,000
20,000
0
-20,000
-40,000
-60,000
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
-80,000
33
UK Exports to Region in percent of UK
Exports to the OECD 22
34
Number of Institutions Included in the United
Kingdom Banking Sector by Nationality in 2016
United Kingdom
United States
Other developed countries
Other EU
Japan
Other nationalities
86
116
45
9
23
80
35