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 June 2008 issue tackles the crisis in financial markets in industrial countries from a number of angles. Articles look at the origins of the crisis in the subprime mortgage market in the United States and track its spillover into other markets. Then authors examine what can be done to prevent future crises. Other articles look at bank capital adequacy rules and Basel II, whether emerging markets and industrial economies are decoupling or converging, capital flows to low-income countries, efforts to achieve the MDGs, and currency intervention. Back to Basics looks at over-the-counter (OTC) markets and the People in Economics column profiles Jacques Polak. Picture This is on the digital divide.
The need to develop domestic securities markets has, following the recent international financial crises, increasingly attracted the attention of national and international policymakers.1 This has resulted in the issuance of a number of policy recommendations by various organizations, such as the Asia-Pacific Economic Cooperation (APEC) collaborative Initiative on Development of Domestic Bond Markets. The issue of government debt management is intrinsically linked to government securities market development. Work is currently under way on this issue at the International Monetary Fund (IMF) and the World Bank, where guidelines have been developed to guide government actions as an issuer, thereby steering development of the government securities market.2 This handbook on government securities market development seeks to fill an existing gap between specific technical studies about securities market microstructure and publications that offer general policy recommendations about securities market development. The handbook integrates these two perspectives by outlining important issues confronting senior strategic policymakers or those implementing policies to support development of a government securities market.
Tax policy has significant impact on financial decisions of investors and firms. Certain tax policies, such as transaction tax, can stifle the development of capital markets. New financial products, such as mutual funds and asset-backed securities, will have difficulty in competing against traditional substitutes without proper tax treatment. Thus, a well-developed financial system requires a well-designed tax policy.
Decentralization of some governmental functions is taking place in many developing and transition countries. Decentralized entities are becoming responsible for undertaking various infrastructure investments required to meet basic needs at the local level, including utilities, water and sanitation, transportation, health and education, and environmental protection. Owing to fiscal constraints at the center, decentralized entities can rely only partly on capital grants from the center to fund these investments. To meet their funding needs, decentralized entities, therefore, need to broaden their own resource base, access subnational bond markets, and increase the efficiency of resource use. In emerging-market countries, these funding needs must be weighed against the prospect that multiple issuers of securities with varying claims to sovereign creditworthiness will fragment a nascent market and thereby reduce its liquidity and efficiency. On the other hand, properly managed subnational bond market can complement the national bond market.
The issuance of debt securities by private sector entities has considerable public policy benefits. Such securities help the private sector contribute to economic development through more efficient reallocation of capital. In particular, they improve access to capital for housing and infrastructure at a time when privatization and deregulation in many developing countries are shifting the financing of these projects from public to private hands. Private sector securities also help diffuse stresses on the banking system by matching long-term investments with long-term capital. There is thus a strong public interest in a viable bond market for private sector issuers. Authorities can support private sector bond market development by maintaining a well-functioning market for government securities and by helping to establish disclosure procedures and a credit-rating system for private sector securities, bankruptcy laws, avoiding public sector crowding out, and limiting statutory restrictions on the issuance of private sector debt securities.