This paper discusses systematic issues in international finance explained in the International Capital Markets report. The paper describes that the nature and extent of recent banking problems in several industrial countries along with the policy responses to those problems. It is observed that balance sheet problems in banking are widespread among the major industrial countries. The paper also analyses recent activity in the European currency unit bond and exchange markets, and reviews developments in the private financing of developing countries and discusses several issues raised by the recent experience, including the broadening of the investor base for developing country securities, the special role played by regional financial centers in East and Southeast Asia, and the systemic implications of the evolving pattern of developing country financing. A key influence on international capital movements in recent years was the rising international diversification of investment portfolios, which is generally believed to have increased in response to the liberalization of exchange and capital controls in many industrial countries in the 1970s and 1980s.
This paper focuses mainly on official bilateral and multilateral financing for countries that have rescheduled their debts to official bilateral creditors. In contrast to the approaches taken by private lenders, official creditors have continued to provide new financing on a large scale to countries with debt-servicing difficulties that implement adjustment and reform programs. Financial support bas been provided through a wide variety of instruments and channels. For the low-income rescheduling countries as a group, total financial assistance has been about as large as these countries' own export earnings in every year since 1986. The recent trends in official financing have important ramifications for developing countries. Access to external financing from official sources is likely to remain high for those countries whose adjustment and reform efforts provide assurances that resources will be used efficiently. Conversely, countries with uneven records of policy implementation (particularly as regards payments arrears) are likely to find difficulty in attracting financial support.
During most of the period under review, a favorable inflation outlook and reductions in official interest rates generally supported an environment of rising bond and equity prices and record levels of fund-raising. Against this background, the major currencies experienced a temporary misalignment beginning in March 1995 and lasting through the summer. The associated currency movements created substantial volatility in the major currency and related money and financial markets, but this volatility subsided as the major currencies became more aligned with economic fundamentals. Overall, the sharp currency movements had no discernible lasting effect on interest rates in the major industrial countries in 1995.
Despite the serious disruptions in early 1995 as a result of the Mexican crisis, total net capital flows to developing countries and countries in transition reached a record $228 billion in 1995. Notwithstanding early fears of widespread spillovers of Liquidity problems in Mexico, markets appeared relatively quickly to distinguish between those countries with sound fundamentals and those that seemed to share some features of the Mexican economy, which then saw at least temporary declines in market access and capital inflows. This regional differentiation is revealed by data on capital flows and securities issues. But even those countries that experienced the most serious contagion effects had almost fully regained access to international financial markets at precrisis spreads by the end of the year. Moreover, some countries that at first glance seem to have been relatively untouched by the crisis, particularly those with pegged or fixed exchange rates, were tested by international investors. In addition to the change in the regional nature of capital flows, there was a change in the composition of capital flows, with a decrease in portfolio investment and an increase in bank lending to developing countries and countries in transition.
This annex begins with a summary of recent developments in the foreign exchange market. Drawing on the BIS’s most recent foreign exchange and derivatives turnover reports.1 current trends in the types of instruments and currencies, trading locations, and market participants are reviewed. The remarkable growth of electronic broking for spot market transactions over the last three years is documented and examined in light of growing concerns about its effects on exchange rate volatility. Market characteristics, such as liquidity—and its components, breadth, and depth—are also examined, providing a broad picture of the current workings of this important 24-hour global market. The second main section of this annex deals with the potential systemic risk posed by the large and numerous cross-border settlements accompanying foreign exchange trading. An analysis of the issues underlying foreign exchange settlement risk is presented along with a discussion of the private and public initiatives designed to reduce it. The section pays particular attention to the advantages and disadvantages of multilateral netting systems and global clearing banks as possible risk-reducing measures.
This annex provides information on the framework for international cooperation in the supervision and regulation of financial institutions and describes cooperative efforts to regulate both international banks and securities firms on a global, regional, and bilateral basis. There are several motives for international cooperation in these areas. First, as suggested most recently by the failure of Barings Pic, the supervision and regulation of international financial institutions and their activities may be enhanced by better communication among regulators. Second, national policymakers are concerned about creating and maintaining a level playing field on which their firms can compete. In some instances, regulatory coordination has been a way to achieve parity. Third, there is a growing sense as evidenced by recent summit communiques from Halifax (May 1995) and Lyons (June 1996) of the potential systemic risk attendant to unregulated or underregulated financial activities. For these reasons, governments, central banks, and securities regulators have given a higher priority to international regulatory and supervisory cooperation in the 1990s than ever before.
The quantity and quality of statistics on international banking have improved substantially in recent years. In particular, the Fund introduced new tables on international banking statistics (IBS) in the January 1984 issue of International Financial Statistics (IFS) and expanded the coverage further in early 1985. The IBS series are a source of comprehensive data on a country’s gross liabilities to and claims on nonresident banks, as well as on its banks’ liabilities to and claims on nonresident nonbanks.
The typical interest rate swap is designed to arbitrage the different abilities of two borrowers (counterparties) to gain access to the fixed and floating interest rate markets. One counterparty generally has access to floating interest rate debt at relatively attractive rates but wants instead to secure fixed interest rate funds. The other counterparty has good access to the fixed interest rate markets but would prefer to have floating interest rate debt.