Chapter

I Overview of Developments and Key Issues

Author(s):
International Monetary Fund
Published Date:
January 1988
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This study assesses recent trends in international capital markets. It reviews, in particular, the forces currently reshaping the markets of industrial countries and confronting financial institutions with major challenges.1 Against this background, the study reports on private sector financing flows to developing countries and discusses factors likely to influence future flows.2 More broadly, it discusses prospects for the management of financial risks at the systemic level on the basis of an analysis of macroeconomic, structural, and regulatory developments currently influencing those markets. The study concludes with a detailed discussion of the transmission mechanisms and policy reactions associated with the October 1987 instability in global equity markets.

The international financial markets have shown themselves to be quite resilient over the last year. This reflected somewhat more settled market conditions, with market participants having generally higher expectations of stability in the main economic variables, partly because of some progress in reducing imbalances between major industrial countries. Banks showed restraint in acquiring more cross-border assets; bank claims on developing countries, in particular, were reduced during 1988.

The nature of international intermediation has changed since the 1970s, with the driving force now being the need to provide investors in surplus industrial countries with the sort of claims they want to acquire on borrowers in deficit industrial countries. The liberalization of capital markets and the spread of innovative techniques have increased the scope for matching investors’ preferences and debtors’ needs. However, developments over the last two years underline the importance of maintaining macroeconomic policies that generate market confidence, if the increased scope for intermediation through international capital markets is to facilitate the necessary transfer of funds, rather than to lead to sudden shifts in flows with adverse consequences for exchange and interest rate stability.

The regulatory requirements for higher capital bases, the recent and prospective erosion of geographical barriers to financial activity, and the growing integration of different kinds of financial business have led to considerable rethinking of corporate strategies by financial institutions throughout the world. Banks are paying particular attention to improving the structure of their balance sheets and their returns on assets and are positioning themselves to take advantage of emerging market opportunities or to preserve existing niches from new competitors. The securities industry’s inroads into banks’ business with major corporate clients is leading many banks to reassess the potential of retail and other markets, to attempt to capture more fee-generating business, and possibly to move into lending activities that are riskier and have higher returns. In this environment, many banks have taken steps to reduce their exposure to indebted developing countries, actions which often benefited their stock prices.

Financial liberalization has made the financial system more competitive. At the same time, the process has involved changes in the nature, and possibly in the extent, of risk in the international financial system, with a pyramiding of financial transactions on a relatively small base of real transactions. As a result, authorities are reconsidering the regulatory and supervisory environment for financial institutions and markets. The problem is to manage the risk inherent in an expanding international financial system without losing the advantages of increased competition and without an excessive use of explicit or implicit guarantees that shift the burden of risk to the public sector.

Financial Market Trends

For the international capital markets, 1988 was generally a year of recovery. The international securities markets, depressed during the second and third quarters of 1987 and badly shaken by the October market break, rebounded in 1988. Activity in the international banking market, on the other hand, was substantially below that recorded in 1987, although it remained well above the levels of earlier years.

General Activity

A number of factors underlie these developments, including macroeconomic changes, regulatory reform, and significant market-specific events. On the macro-economic side, the increase in current account imbalances among the major industrial countries in 1987 heightened uncertainty about exchange and interest rates, with investors concerned about a further fall in the U.S. dollar and rising interest rates (Chart 1). This led investors to avoid the somewhat illiquid securities of the Eurobond market in favor of domestic bond markets and bank deposits and Eurobond investors to become reluctant to acquire U.S. dollar-denominated debt. This development was also reflected in a relative reduction of private sector financing of the U.S. current account deficit and an increase in official intervention aimed at supporting the dollar. Uncertainty concerning macroeconomic policies was a cause of, and was in turn exacerbated by, the stock market break of October 1987.

Chart 1.Five Major Industrial Countries’ Nominal Interest Rates, January 1982–December 1988

(In percent)

Sources: International Monetary Fund, World Economic Outlook; and Fund staff estimates.

1 Monthly averages of daily rates on money market instruments of about 90 days’ maturity.

2 France, the Federal Republic of Germany, Japan, the United Kingdom, and the United States; using three-year moving average, GNP-based weights.

3 Monthly averages of daily or weekly yields on government bonds, with maturities ranging from 7 years for Japan to 20 years for the United Kingdom and the United States.

In 1988, there was a striking improvement in world trade and economic activity, a reduction in current account imbalances, and a perception of greater exchange rate stability (Table 1). Market participants therefore felt less need to lay off foreign exchange exposure, and the demand for U.S. dollar-denominated securities increased somewhat. In response to the higher level of confidence in the stability of exchange rates, the Eurobond market recovered faster than expected at the time of the market break. It remains to be seen, however, how permanent this shift in sentiment is, as external and internal imbalances in the major countries of the Organization for Economic Cooperation and Development (OECD) remain large, and fears of an acceleration of inflation and of rising interest rates remain widespread. Activity in international capital markets also continued to reflect an underlying trend toward international liberalization of capital controls and domestic liberalization of restrictions on financial market activities. Such a trend continues to promote the integration and deepening of domestic and international capital markets, as intermediaries operate on a global basis and investors’ portfolios are more broadly diversified across markets.

Table 1.Selected Economic Indicators, 1982–88(In billions of U.S. dollars; or in percent)
1988
198219831984198519861987Estimate
Total of identified current account deficits1175159194202252245268
Industrial countries5265124137168191203
Of which:
Seven major2751110121147171179
Developing countries123947065845465
Total of identified fiscal deficits for seven major industrial countries
Central government306370367380412367372
General government259286250256309248204
Overall current account balances of developing countries2-83.4-62.4-31.4-26.0-42.21.4-19.1
Reserve accumulation of developing countries (accumulation +)-35.91.712.318.74.156.97.2
Growth rate in value of world trade-6.2-2.06.10.89.616.814.5
Growth rate of real GNP of industrial countries-0.32.84.93.42.63.44.1
Inflation rate of industrial countries (GNP deflators)7.25.04.43.53.42.93.1
Interest rates (six-month Eurodollar deposit rate)13.69.911.38.66.87.38.1
Sources: International Monetary Fund, World Economic Outlook, April 1989: A Survey by the Staff of the International Monetary Fund, World Economic and Financial Surveys (Washington, 1989); and Fund staff estimates.

Finally, the markets were influenced by a number of specific events. The collapse of the perpetual floating rate note market at the end of 1986, and the resulting concern of investors about the liquidity of instruments, contributed to the depression of the bond market during 1987. Fears were heightened by the October 1987 market break, which led for a few months to a virtual halt in the issue of new equity-linked bonds and more generally to an increased awareness of systemic risks. Similarly, a movement to higher capital adequacy standards in many countries has made banks more cautious about building up assets, either on or off their balance sheets, and this may have exerted a depressing effect on international banking activity during 1988.

Following two years of sustained growth, the expansion of international bank claims slowed during the first three quarters of 1988, with claims on industrial countries down by 3 percent and liabilities to those countries down by 23 percent, compared with the levels recorded during the same period of 1987 (Table A1).3 The slowdown in deposit-taking from nonbanks reflected the strong revival of the bond markets as a major source of international financial intermediation, particularly for sovereign borrowers and first-class names. Much of the decline in bank activity was accounted for by reduced cross-border lending and deposit-taking by banks in European countries. Conversely, the high level of activity registered in the market for syndicated credits since the beginning of 1987 has been maintained. A major factor has been the continued large demand for credits associated with mergers, acquisitions, and leveraged buy-outs. Moreover, the syndicated credit market remains an attractive source of financing for second-tier borrowers who have found it more difficult to raise funds in the Eurobond market since last year’s shake-up. During the past year, there has also been a resurgence of new Eurocommercial paper programs, as well as marked growth in markets for interest and exchange rate hedging instruments.

International bond markets recovered strongly during 1988 (Table A2). The gross issuance of straight fixed rate bonds during the year exceeded that for 1987, and the issuance of equity-related fixed rate bonds is approaching the high levels reached prior to that year’s stock market break. While scheduled amortization payments continued to increase and early repayments remained substantial, net bond issuance during 1988 was above the year. The share of dollar-denominated issues has increased in 1988, although it remains well below the levels prevailing prior to 1987 (Chart 2). Investors’ expectations of higher interest rates have led to a revival of the market for floating rate notes, although the activity remains well below the levels observed in 1984–86, prior to the collapse of the perpetual note market. The recovery in the issuance of fixed rate bonds in 1988 occurred amid considerable uncertainty among investors about interest rate trends. Although the revival of the equity-related bond market was led by issues for Japanese companies, which benefited from an increase in stock market prices in Japan, it also showed the underlying strength of sentiment in the bond market, as prices on most equity markets remained below levels prevailing prior to October 1987.

Chart 2.Currency Composition of International Bond Issues, 1984–881

(In percent)

Source: Organization for Economic Cooperation and Development, Financial Statistics Monthly.

1 Based on exchange rates prevailing at time of bond issue.

Claims on Developing Countries

International banks’ net claims on developing countries, as measured by the Fund’s International Banking Statistics (IBS), declined by $11 billion during the first three quarters of 1988, compared with an increase of $19 billion in all of 1987 (Table A3).4 Increases in bank claims have mainly been on countries without debt-servicing problems, as have noteworthy increases in bond issues by developing countries (Table A4); substantial decreases, conversely, occurred in claims on the 15 heavily indebted countries. On the basis of data adjustments detailed in Chapter III of this study, the estimated cash flow from banks to the 15 heavily indebted countries during the period 1985 to September 1988 amounted to about $14 billion, compared with a net repayment of $15 billion measured by the exchange rate adjusted change in stocks as reported in the Fund’s International Banking Statistics. The former number, however, should be interpreted cautiously since debt conversions often involve partial repayments to banks. During the first three quarters of 1988, bank claims on the 15 heavily indebted countries declined by an estimated $11.3 billion. This occurred despite a slight increase in disbursements under concerted lending arrangements. Total disbursements under such arrangements during 1988 reached $6.0 billion, compared with $5.7 billion in 1987 (Table A5). New commitments under concerted lending arrangements amounted to $5.7 billion during 1988 ($2.4 billion 1987), mainly as a result of agreements in principle with Brazil amounting to $5.2 billion.

The process of restructuring commercial bank debt continued throughout 1987 and 1988. The average terms of reschedulings agreed to in 1988 were generally more favorable to the debtor countries, with average maturities now reaching 18 years, and spreads above the London interbank offered rate (LIBOR) down to 83 basis points (Table A6). Among the interesting features of recent restructuring packages has been the increased use of exit bonds. These proved to be more acceptable to banks in the case of Brazil than they had in the earlier case of Argentina. A number of banks attributed this to the more attractive pricing of the Brazilian bonds (6 percent compared with 4 percent for Argentina); some 100 banks subscribed to more than $1 billion’s worth of the higher priced bonds. Also attractive in the Brazilian package were bonds permitting conversion into cruzado-denominated Brazilian Government debt at par. Two other noteworthy developments in the last year were the agreement of Bolivia with its banks to buy back a portion of its bank debt using funds donated from official sources and Mexico’s issuance of a collateralized 20-year bond in exchange for part of its debt. Finally, the amendment of the Chilean restructuring agreement contained a number of innovative features, including the waiver by banks of some clauses in loan agreements in order to allow Chile to use some $500 million of its excess copper earnings to buy back its own debt, to collateralize some of its borrowing, and to hedge the interest rate exposure on its external debt.

Banks have been making a considerable effort to reduce their overall exposure to developing countries with debt-servicing problems. The rate of disposing of claims on developing countries seems to have accelerated during 1988. Over this period, U.S. banks’ claims on all developing countries declined by $12.7 billion after a decline of $10 billion in 1987. This decline was particularly marked among the smaller and regional U.S. banks. Similar trends were evident in the rest of the world, with the possible exceptions of the Federal Republic of Germany and Japan. The decline in claims on developing countries combined with a strengthening of bank capital bases has resulted in a marked improvement in the ratio of developing country debt to bank capital in all major banking systems, leaving banks much less vulnerable to problems originating in this sector. While the position of U.S. money-center banks has also strengthened considerably (Chart 3), their levels of exposure in relation to capital generally remain among the highest in the world, in part because the decline in the U.S. dollar since 1985 has reduced the ratio of claims on developing countries to bank capital in most other industrial countries.

Chart 3.Selected Balance Sheet Data for U.S. Banks, 1977–Third Quarter 1988

(In percent)

Source: Federal Financial Institutions Examination Council, Country Exposure Lending Survey.

1 Twelve-month growth rates.

2 Excluding offshore centers.

Although bank provisions against developing country exposure continued to increase in 1988, this increase was much smaller than in 1987. Japanese banks were permitted to raise their provisioning levels from 5 percent to 10 percent (15 percent at the start of 1989) of exposure to troubled debtor countries; mandatory provisioning standards in Canada were raised from a range of 30–40 percent to a range of 35–45 percent; and some other countries also increased provisioning levels. The provisioning levels of U.S. and, especially, Japanese banks remained below those elsewhere in the world. In the case of Japan, this is probably related to differences in tax treatment and to large unrealized profits in the banks’ securities holdings. In the case of the United States, tax policies, combined with low bank profitability, have probably contributed to the outcome.

Current provisioning levels in major banks, except for some German and Swiss banks, remain well below the discounts implied by current secondary market prices for developing country debt, even before the sharp general decline in prices in this market that took place between July 1988 and March 1989 (Chart 4). In that period the weighted average price for the debt of 15 heavily indebted countries declined by 14 percentage points, bringing the average price for such claims to about 33 cents per dollar of face value. Particularly large declines were registered in the prices of claims on Venezuela (21 percentage points), Brazil (22 percentage points), Colombia and Mexico (15 percentage points each), and Ecuador (14 percentage points). More moderate declines were registered for Argentina (7 percentage points), Chile (2 percentage points), and Yugoslavia (2 percentage points), while Uruguay (at about 60 percent of face value) was among the few that steadily resisted the downward trend.

Chart 4.Secondary Market Prices for Developing Country Loans1

(In percent of face value)

Source: Salomon Brothers.

1 Weighted average for 15 heavily indebted countries.

The across-the-board decline in 1988 in secondary market prices for developing country debt may have been indicative of the market’s tendency to respond sharply to changes in perceptions of the general outlook for the debt strategy—possibly a sign of a thin market. Whereas the sharp decline in prices in mid-1987 could be attributed to the combination of the introduction of a moratorium by Brazil and to a provisioning decision by Citibank, it is less clear what triggered the current decline. Possible factors include reconsideration of aspects of debt-equity swap programs in Brazil and Mexico, a new money request from Argentina, and further exposure reductions by some U.S. regional and Canadian banks that preferred to incur the associated losses at a time when they received extra income from Brazil’s clearance of arrears in the fourth quarter of 1988.

Market participants agreed that day-to-day movements in prices and transactions were fueled essentially by opportunities for debt-equity transactions. There remains little demand for developing country debt from the nonbank financial sector, and efforts to repackage developing country loans as marketable securities have so far been unsuccessful. It is estimated that the total volume of debt converted under officially recognized schemes in 1988 was $8.2 billion. This compares with the volume of $4.6 billion recorded in 1987. Total secondary market turnover, including unofficial debt conversions, is estimated by some participants to have more than doubled in 1988 from a base of about $20 billion in 1987. Many secondary market transactions involve exchanges of one form of debt for another, with the aim of accumulating a sufficient quantity of the right kind of debt to be eligible to participate in a given debt-equity swap arrangement. Demand for equity in developing countries by foreign investors may be limited by a number of factors. Some market participants noted that many corporations had left their subsidiaries in Latin America undercapitalized for some years and were now faced with the need to recapitalize them, which explained a good part of the current demand. Banks also stressed the need for countries to have appropriate privatization programs and a liberal attitude toward foreign investment.

Banks’ attitudes toward the secondary market have evolved in the last year. Its considerable increase in size has made banks, in general, more willing to recognize that prices in this market contain a certain amount of information and are prices at which some, though not all, of their claims could be liquidated. Banks have also become more aware of the possibilities that the secondary market offers them for reorganizing their portfolios. Several of the larger banks have accordingly reorganized their developing country debt operations to merge with asset-trading operations, with the aim of managing their developing country debt portfolios in a coordinated way. Such banks are actively seeking opportunities for reducing those portfolios, often through the secondary market. This has not, however, generally been the case for Japanese banks, which have rarely utilized the secondary market for their own account.

Challenges Facing Financial Institutions

Intensifying competition and changing regulatory requirements characterize contemporary financial markets. Competition has been fostered by the internationalization of institutions, the liberalization of domestic markets, technological advances in data processing and telecommunications, and financial product innovations that more extensively link traditional banking and securities markets. For their part, regulators have responded to changes in financial markets, albeit with a lag, with attempts to strike a balance between fostering competition, protecting investors and depositors, and safeguarding systemic stability. In particular, they have both tightened supervisory and capital adequacy standards and taken further steps to liberalize the banking environment, especially through the gradual relaxation of geographic and functional restrictions on banking activities.

With increasing competitive pressures on traditional lines of business, stiffer capital requirements and new opportunities stemming from the dismantling of functional and geographic barriers, profitability has become the prime concern of banks. Securities houses face similar challenges, especially after the events of October 1987 brought home the need for larger capital bases. Financial institutions are thus pressed to achieve operational efficiency backed by strong balance sheets. A major restructuring is already under way among internationally active institutions, a restructuring evidenced by a proliferation of closures, mergers, acquisitions, substantial cuts in staffing, sales of certain types of low-yielding assets, and reductions in holdings of developing country debt.5 For banks in particular, continued liberalization will bring a further strengthening of competitive pressures, especially through the breakdown of geographic barriers to financial activity within the United States and Europe. Similarly, the phenomenon of securitization, which contributes to the erosion of remaining functional barriers, is expected to increase in importance. As regulators allow the scope of the operations of financial institutions to expand, however, they themselves face pressure to safeguard certain public interests through more comprehensive supervision, to extend appropriate capital adequacy standards beyond banks, and to develop common standards for other activities of competing financial institutions. Those institutions, therefore, confront an environment characterized not only by greater competition, but also by uncertainty as to the emerging regulatory structure. Since changes in that structure are occurring at a time when the debt problem of developing countries is becoming more manageable from the viewpoint of the creditors, banks in particular increasingly appear to be focusing their strategic plans on the capital markets of industrial countries.

Capital Adequacy Standards

As discussed in detail in Chapter IV, the initiative of the Committee on Banking Regulation and Supervisory Practices of the Bank for International Settlement (BIS), which was endorsed by the Group of Ten in July 1988, specifies minimum capital bases for international banks of 8 percent of risk-weighted assets and off-balance sheet commitments, to be phased in over a five-year period ending in 1992. These are minimum capital requirements and leave national authorities the flexibility to impose more stringent requirements. Other countries, including some OECD countries and major offshore banking centers, have expressed intentions to adhere to the Basle standards. Initial indications are that most banks in most countries of the Group of Ten will be able to meet the 1992 standards. Major regional banks in the United States, British clearing banks, and major Swiss banks, for example, already generally meet the 1992 standards. Moreover, the transition for large German and Japanese banks is expected to be eased, inter alia, by large undisclosed reserves. Some French, Italian, Belgian, and U.S. money-center banks, as well as various smaller banks elsewhere, will, on the other hand, have to make some significant balance sheet adjustments.

Bank strategies to meet the new capital standards will depend in part on the flexibility provided by the authorities during the transition period. In the United States, for instance, the Federal Reserve has attempted to ease the transition of relatively undercapitalized banks by utilizing its latitude to broaden the types of preferred share issues qualifying as core capital. By contrast, British authorities felt justified in advancing the deadline for compliance to June 1989. And in Japan, the authorities are expected to provide a wide range of options for banks to raise needed capital at home. Banks have generally responded to the new capital requirements in three ways: by raising more capital, by shedding or restructuring assets, and by generating higher returns by improving margins. Raising more capital has already led banks all over the world to increase their raising of primary or secondary capital. The ability to do so successfully, however, depends on market assessments of the prospects for individual banks. In this process, a rising share price both lowers the cost of capital for banks and reassures the market. The shedding of developing country debt by banks recently has been met by positive market reaction. Encouraged by this response, a growing number of banks, especially in North America, are reducing further their exposures to developing countries and are considering “menu” items in restructuring packages that involve debt reduction. This effect is less marked in countries with less stringent disclosure requirements.

Sales of developing country debt in the secondary loan market is just one technique used to help meet the new capital adequacy standards. Other techniques include the securitization of claims and their sale to nonbank investors, a process that was under way even before the pressure for higher capital ratios. The new standards have also led some banks to slow the growth of their assets. In addition, the new standards require banks to allot capital to various off-balance sheet activities, particularly in the swap and options areas. This has resulted in a reconsideration of pricing for these products. Banks have also started to adjust their balance sheets to switch the relative weight of capital absorbing assets in favor of those with low-risk weights. This is a process that will mainly benefit sovereign borrowers from advanced industrial regions. The quest to raise returns on assets, with the aims of generating more funds internally and enhancing access to cost-efficient sources of capital, has encouraged banks to focus more on fee income, as margins on traditional banking business have been squeezed by what many participants regard as excess capacity in the industry. This may have led banks into more risky areas of activity. In this regard, an expansion of bank involvement in leveraged buy-outs is frequently cited as an example.

Geographic Integration

The removal of restrictions on cross-border banking and on the establishment of banks and other financial institutions outside their home countries has been proceeding for many years. In the United States, the movement toward interstate banking is growing and is widely expected to culminate by 1992; the United States and Canada have concluded a free trade agreement, which provides, inter alia, for the removal of barriers to trade in financial services between the two countries. In the European Community (EC), measures have been adopted that aim at creating a single European market by the end of 1992, including a single market for banking and investment services. Such policy developments are forcing banks and other financial institutions to reconsider how to position themselves in newly integrating markets as well as how to defend their traditional strengths from new competitors.

U.S. banks, many of which have long operated internationally, are now confronting the challenges and opportunities of a truly national banking market at home. Expanding reciprocal agreements among states have gradually been eroding statutory and customary bans on interstate retail banking, leading to the emergence of new “super-regional” banks based outside the traditional financial centers. These banks, less constrained by the burden of developing country debt, have become formidable competitors for the often less profitable money-center banks. Indications are that movement toward effective nationwide banking in the United States is accelerating. An increasing number of states have now passed, or are planning to pass, laws to permit the reciprocal entry of out-of-state banks after specific “trigger” dates. Federal and state regulators have often encouraged the removal of geographic barriers, not least because of desires to facilitate cross-state mergers of ailing banks and thrift institutions.

The Canada-U.S. Free Trade Agreement (FTA), implemented on January 1, 1989, provides for a further opening of North American financial markets. Under the Agreement, Canada is committed to removing a number of constraints on U.S. financial institutions operating in Canada—such as restrictions on ownership, asset growth, and market share. In turn, Canadian banks are guaranteed the same treatment in the United States as U.S. banks, even in the event of future limitations on the activities of other foreign institutions. The potential impact of the FTA on North American capital and credit markets is difficult to gauge, given the substantial degree of freedom that already exists in this area, but it may increase competition, as has been the case following the opening up of Canadian securities markets. It is not clear whether, as a direct result of the FTA, U.S. or Canadian financial institutions will gain an enduring competitive advantage over financial institutions from other countries. Such a gain may in fact not be forthcoming, especially considering that, on the U.S. side, the argument on financial services implicitly endorses equality of competitive opportunity, the U.S. Treasury notion of national treatment, and judging by the recent opening of Canadian securities markets to foreign firms, it appears that Canadian authorities may be prepared to grant similar benefits to financial institutions of third countries. Nevertheless, the demand for U.S. financial assets by Canadian institutions should increase, and vice versa, with the general increase in economic activity expected to result from the FTA. Some Canadian banks consider that their experience with retail banking across several time zones, and the proprietary technology that makes this possible, might give them a competitive edge when interstate retail banking barriers are eliminated in the United States.

The European Community is aiming to create a full-fledged common market among its 12 member countries by the end of 1992. The prospect of an integrated Europe, with free movement of goods, services, capital, and people, opens opportunities for EC residents and raises challenges for the rest of the world. European companies and foreign companies resident in the European Community are considering how best to organize their manufacturing and distribution activities to take advantage of the single market. It is expected that the level of merger, acquisition, and financial restructuring activity in the EC will intensify substantially. Banks too are considering how to adapt their activities in response to their customers’ moves and to take advantage of the single European market in financial services. The Community’s proposed Second Banking Coordination Directive promises major changes in markets for financial services. On the supply side, by virtue of a “single banking license,” a bank authorized to operate in one member country will automatically be entitled to offer a wide range of listed services, including leasing, securities underwriting and trading, and funds management, throughout the Community, provided only that the service is permitted by home-country rules. While primary banking supervision will be exercised by the authorities in the country of incorporation, such a harmonization will necessarily imply Community-wide minimum standards on such matters as deposit guarantee schemes and capital requirements; it should also be accompanied by an effective competition policy. On the demand side, with the abolition of remaining capital controls, the single market will give consumers of financial services the freedom to decide where, by whom, and how their investment and borrowing needs are met.

In the field of investment services, preparatory work is less advanced than in banking. The intention, however, is again to establish a single European market by 1992. This should involve granting securities houses established anywhere in the Community the freedom to operate freely throughout the region. Securities prospectuses acceptable to one country would have to be acceptable in all. To meet this goal, the Community is attempting to reach agreement on common minimum standards in the securities area so as to permit the mutual recognition of regulations. Uncertainty remains, of course, as to whether the schedule of financial liberalization will be fully implemented by 12 countries where, in many instances, financial structures, as well as supervisory and tax policies, have differed greatly. Nevertheless, concrete steps taken to date and agreements reached on various proposed directives, including the directive on the liberalization of capital movements adopted in June 1988, have already changed the competitive environment for financial institutions in Europe.

Banks resident in the EC are now pondering and experimenting with varying strategies aimed at exploiting forthcoming freedoms, including the freedom to open branches without the need for prior host-country authorization; the freedom to broaden the range of services, and thus take advantage of opportunities such as those offered by the internationalization of securities markets and of funds management; and the freedom to provide services directly from their home countries, without the need to maintain expensive physical operations in host countries. In maneuvering for position in 1992, European banks face a complex set of challenges, including those related to decisions on appropriate product lines, scales of operations, methods of expansion, and defenses against takeover. The implications of 1992 for financial institutions based outside the Community are no less challenging. Internationally minded banks aspiring to retain or expand their market share within Europe do not, of course, want to be left out of the potential benefits of a unified European market. Their strategic plans, however, are complicated by uncertainty about the Community’s policy toward institutions based outside the EC. Under the proposed directive on banking, branches of non-EC banks will remain under the jurisdiction of the countries in which they are established, while existing subsidiaries of non-EC banks will be treated as Community undertakings, that is, subject to the “single license” scheme. This differentiation in treatment could put pressure on non-EC banks to open subsidiaries, with the attendant competitive disadvantage associated with the need for subsidiaries to hold their own capital instead of effectively relying on the full resources of their parents. As for the entry of non-EC banks after 1992, uncertainty appears to be greater. In effect, the proposed directives authorize the Commission of the EC to deny entry to banks from a non-EC country that fails to offer reciprocal treatment to the banks of any EC member country. The precise interpretation of “reciprocal treatment” is still taking shape. The Commission has, nevertheless, attempted to dispel notions that the policy of reciprocal treatment will be applied retroactively or that it will seek “mirror image” rules of access from non-EC countries. Instead, the less stringent requirement of “global, comparable access” has been publicly emphasized. For their part, many banks appear to be intent on pre-empting any problems arising from the final interpretation by exploring various methods of expansion, including friendly alliances, joint ventures, mergers, acquisitions, and new establishments.

Functional Integration

Technological developments and regulatory relaxation are gradually dismantling functional barriers between different kinds of financial markets. Perhaps the most obvious development under this heading has been the gradual spread of universal banking-type structures from the Federal Republic of Germany, Switzerland, and other European countries to various parts of the world. Recent measures adopted in the United Kingdom, Australia, and Canada, for example, have permitted banks to own securities houses. As discussed further in Chapter IV, only Japan and the United States among the major countries still have barriers between commercial banks and investment houses, but, even there, pressure to break down the barriers is evident. Indeed, outside their national frontiers, U.S. and Japanese financial institutions frequently practice some form of universal banking.

This development partly reflects pressure from regulators as well as from the banking community. Regulators have often seemed willing to relax functional constraints on financial institutions in order to make new profit opportunities available, to strengthen balance sheets, and to reduce competitive disadvantages in domestic financial markets vis-à-vis foreign markets. With banks’ major corporate customers frequently finding it cheaper to issue securities in their own names than to take on bank debt, commercial banks have pressed for new powers in order to retain important clients. At the same time, securities houses are attempting to expand into more traditional commercial banking areas. The eventual removal of the restrictions on commercial banking activity in the United States and Japan (imposed, respectively, by the Glass-Steagall Act and Article 65 of the Securities and Exchange Act) appears possible. Particularly in the United States, the erosion of those restrictions appears well advanced, with federal and state regulators already allowing commercial banks to engage in limited underwriting of commercial paper, municipal bonds, and securities backed by mortgages or consumer-related receivables. In the face of protracted debates in the U.S. Congress and in the courts, pressure for regulatory reform continues to rise.

The erosion of other functional barriers is no less significant. Barriers between banks and building societies have been largely eliminated in the United Kingdom. Limitations on the activities of some of the specialized Japanese banks are being relaxed. And the creation of a single market promises to erode further the remaining functional barriers in Europe. In many countries, a redrawing of boundaries between insurance and banking activities is under consideration. As discussed in more detail in Chapter IV, however, functional integration can involve significant new risks as institutions enter fields outside their normal experience. In the United States, for example, regulators relaxed the traditional limits on the activities of savings and loan associations in part to allow them to diversify their portfolios and take advantage of more profitable activities. This led some, bolstered by a government-insured deposit base, into particularly risky activities at a time when competitive conditions made it difficult to ensure positive interest rate spreads between traditional assets and liabilities. Widespread insolvencies, resulting in the necessity of official support to the deposit insurance fund, resulted. Estimates of the ultimate cost of making the deposit insurance fund whole exceed $100 billion.

Debt and the Financing of Developing Countries

A bank’s attitude to the current debt situation of developing countries is heavily influenced by the factors described above, particularly by the market’s perception of the bank’s portfolio, the role that lending to developing countries plays in the bank’s strategic plans, and the tax and prudential environment. As already noted, bank share prices, particularly in North America, have responded sharply to indications that individual banks have significantly reduced or eliminated their exposure to developing country debt. This was evident in early 1987, for example, when Citibank’s announcement of large provisions for cross-border risk was immediately reflected in an increase in the market valuation of its shares.

For strategic reasons, many small and some larger international banks have been redirecting their operations away from lending to developing countries. Other banks still see profit opportunities in cross-border business with developing countries, but primarily in support of their established domestic customers in need of trade or project financing. Some major banks, however, still see themselves as having permanent interests in developing countries, interests sometimes embodied in branch networks that remain or promise again to become profitable. The divergence in bank strategies implies that banks may respond differently to the same opportunities. Some may be prepared to pay a premium for the liquidity gained by eliminating their assets in developing countries and for the possibility of utilizing the resources thus freed to pursue other strategies; such banks can be expected to resist future involuntary lending. By the same token, others may consider that their claims on developing countries are worth more than the current general market valuation and therefore may be not only reluctant to sell those claims but also prepared to lend new money in the hope of raising their value. In such circumstances, a menu approach to the debt situation represents the only feasible way to accommodate the disparate interests of the creditors. Banks generally welcome the further development of such an approach, while stressing the lack of realism in generalized proposals intended to appeal to all banks within creditor groups.

In discussing the regulatory environment as it affects lending to developing countries, banks note that the new capital adequacy standards made sovereign lending to developing countries, regardless of their creditworthiness, more costly than sovereign lending to advanced industrial countries. National regulators in the Group of Ten countries maintain that while the underlying rationale for such a distinction remains under review, in practice they expect it to introduce no new distortions into the market. Common capital adequacy standards were not meant to replace the exercise of judgment by banks on credit risk. Regulators also point out that bank lending to developing countries carries the same risk weight as for lending to the world’s most creditworthy nonbank corporations. While these standards may, for example, theoretically lead to a difference between the profitability of loans to the least developed members of the OECD and to the most advanced non-OECD countries, industry observers commonly view provisioning policies as the more important determinant of the cost and availability of loans.

The provisioning standards set by regulators for potential losses on loans to developing countries are generally regarded as appropriate by banks, although Japanese banks would like to be able to set aside reserves comparable with those of banks elsewhere in the world. Relatively profitable banks often express a willingness to establish higher reserve levels, provided that they receive associated tax credits. Some banks are using secondary market prices as one of the elements in determining appropriate provisioning levels. Others believe that the potential recoverability of many claims on countries with debt-servicing problems is greater than secondary market discounts imply and that reserves should therefore remain well below these levels. Some banks feel certain types of lending to developing countries would be profitable if they did not entail the same degree of provisioning as is required for medium-term balance of payments loans. In their view, relatively less provisioning should be required for short-term trade credit when extended to countries with a good record of servicing claims of this type. Others suggest that banks might be more willing to engage in new lending if it was given seniority over other claims, thus justifying lower provisioning levels.

Most tax authorities in industrial countries consider provisioning to be a tax-deductible expense; the major exceptions are Belgium, Japan, and the United States, where a bank must in general realize a loss before it can receive a tax credit. For the time being, in the United States general transfer risk provisions form part of regulatory capital, as do non-tax-deductible provisions in Japan. One issue is whether the tax credit associated with provisioning encourages banks to reach accommodation with their debtors, or instead, by giving them a fiscal advantage early, reduces the incentive to reach such an accommodation. Banks in countries with tax deductibility for provisioning usually have higher provisioning levels than do banks from other countries. In general, highly provisioned banks report less pressure from the developing country debt situation and express a greater willingness to consider a wider range of possible approaches to its resolution. The fact that a bank had already received the advantage of tax credits does not seem to make it less willing to consider reaching accommodation with the debtor, but the incentives for such banks to reduce their exposure through secondary market sales seem to be less. Banks that need to realize a loss before receiving tax credit appear to be more assiduous in seeking reductions in their developing country portfolios. While this might lead them to accommodate the interests of debtor countries, such reductions might also be achieved through transactions on the secondary market with no benefit for the debtor country.

Management of Risk in the International Financial System

A fundamental task of financial intermediaries is to appraise and assume risk and to charge for it appropriately. As a result of regulatory change, the growth of derivative product markets, and technological innovation, competitive pressure appears to be increasing the general level of risk assumed by intermediaries, while only partially providing the tools needed to manage that risk. To many market participants, the need for better risk control has become clearer, in particular after the stock market events of October 1987. Regulators welcome the positive effects of liberalization on the efficiency of financial markets but wish to ensure that those markets remain sound and supportive of growth in the real economy. They are concerned that confidence be maintained, and for this reason have always sought to ensure that banks and other financial institutions have proper risk management systems in place. They are also typically concerned to safeguard the interests of depositors and investors who rely on the sound and honest management of those institutions. In this process, to the extent that they provide explicit or implicit guarantees, regulators need to be sure that they are not encouraging intermediaries to take on excessive risk; the current crisis of the savings and loan industry in the United States underscores the danger inherent in such guarantees. The increasing complexity and volume of contemporary financial intermediation, its international scope, the speed with which disturbances spread, and the breakdown of geographic and functional barriers that potentially insulate markets, are now leading supervisory authorities in a number of countries to reassess the adequacy of prudential arrangements both nationally and internationally.6

Risks for Financial Intermediaries

The most important single source of risk in banking has been and remains credit risk, that of a counterparty being unable to reimburse the bank when an obligation falls due. For an intermediary, credit risk can be increased by the maintenance of large exposures to single entities, particular sectors, or geographic areas. For cross-border credits, such risks are exacerbated by the possibility that local authorities will not make the foreign exchange available to settle claims. There are indications that an increasing level of credit risk is now being incurred by the international banking system. Market participants frequently express the concern that, in an effort to raise rates of return on assets to help raise stock prices and needed capital, banks are moving into riskier fields in search of higher rates of return. Consequent effects on the quality of bank portfolios are seen by many observers as exacerbated by the movement of the most creditworthy borrowers to commercial paper and other direct financing markets. Finally, the degree of credit risk is also connected to the level of uncertainty about the stability of developments in the world economy. It is worth noting here that the number of bank failures in the United States has been high in the last five years, despite the strong performance of the economy; a downturn in economic activity could worsen the situation significantly.

A second traditional source of risk in banking is liquidity risk, the risk that a bank would not have on hand or be able to obtain from the market sufficient liquid assets to meet current demands. In this area too, there is evidence that risks are increasing. A number of innovative products in recent years have shown themselves to be less liquid than originally envisaged. In addition, as banks move into securities businesses or extend more credit to underwriting houses, sudden changes in securities market conditions can quickly transform growing short-term credits into illiquid assets. This has led some banks to examine more carefully the credit ratings of other intermediaries and to seek new mechanisms for limiting exposure.

A third type of risk to which banks are exposed is interest rate risk. With the gradual elimination of interest rate controls and consequent reductions in sources of low-cost funding, banks could become more exposed to interest rate risk to the extent that the interest structure of their liabilities is not matched with that of their assets. With much of their funding raised on a floating rate basis in the wholesale money markets, banks have tended to put their lending on a similar basis. This reduces interest rate risk, but only by effectively turning it into increased credit risk, especially in an era marked by significant interest rate volatility. A similar additional risk can be encountered by banks when they mismatch the currency composition of their assets and liabilities, thus exposing themselves to the possibility of adverse changes in exchange rates.

Financial institutions have followed a variety of strategies in seeking to control the risks they assume. One has been to improve their internal risk management systems. While credit risk continues to be dealt with through traditional procedures for screening the credentials of customers, control of other market-related risks has sometimes involved the development of extensive data-processing systems that allow traders to check that their transactions are within the limits set by internal guidelines and allow senior management to keep track of exposures in real time. Some major banks continue to decentralize exposure limits branch by branch, allowing the possibility of branches taking positions against one another; others have developed systems for controlling exposure on a global basis. In a few cases where an institution has extensive operations on the major markets around the world, the “book” is formally passed from New York to Tokyo to London and back to New York during each 24-hour period, allowing a continuous monitoring and adjusting of worldwide exposure. Reliance on associated data-processing systems, while allowing the better control of some risks, carries with it a number of additional risks. Such systems are only as good as the data entered and are vulnerable to hardware and software failure.7 Expertise that allows such systems to be properly checked and to make communications linkages fully secure is scarce.

The growth of derivative product markets, such as financial futures, options, and swaps, partly reflects the desire of market participants to control risks through various hedging techniques. Such new instruments are not without their own risk characteristics, which cannot be appreciated until experience has been gained of how they function over the long term or during an economic downturn. With many institutions turning to innovative products to generate more fee income, concern has been expressed that, on occasion, such risks may be incurred without a full appreciation of their extent or without adequate compensation. This may be because of the arcane nature of some of the new instruments, the computerized strategies that often drive their use, or an inadequate understanding of their implications on the part of senior management. By requiring banks to take their off-balance sheet exposures into account when deciding on appropriate levels of capital, the Basle capital adequacy standards have begun to address such concerns. Multilateral agreement on those standards testifies to the longstanding priority supervisory authorities have themselves given to the control of financial risks at both the institutional and systemic levels.

Multilateral Coordination of Supervision

The new capital adequacy standards for banks were, in fact, designed to achieve three main objectives: to harmonize the competitive conditions under which international banks operate, to bring indirect financial commitments within a general prudential framework, and to inject more capital into the banking system. Early moves by banks to raise capital, restructure balance sheets, and change the pricing of certain products may be seen as consistent with these objectives. But in the overarching effort to foster the prudent management of financial institutions, supervisors have never limited themselves to looking solely at capital adequacy standards. Nor, indeed, have high levels of capital in the past prevented bank failures. Other items that supervisors typically consider include the composition and diversification of bank loan portfolios, accounting standards, the level and severity of problem and classified assets, the quality, trend, and variability of earnings, dividend payout ratios, the level and trend of retained earnings, the liquidity and structure of liabilities, the degree of interest and maturity mismatch between assets and liabilities, the effectiveness of loan and investment policies, and the overall ability of management to monitor and control risks. Although multilateral discussion on such matters continues, the need for common international standards is considered less pressing by most supervisors, except within the EC where coordinated supervision is a precondition to the creation of a single market for financial services.

While multilateral coordination efforts are well advanced in the banking sector, work has just begun on coordinating the supervision of securities houses, on delineating relative responsibilities of the supervisor of the parent company and that of branches or subsidiaries, and on other measures to give markets confidence that all participants are appropriately regulated. Whereas the Basle Concordat of 1975 established the principle that supervision of banks would be done on a consolidated basis, with the parent bank being liable for the quality of subsidiary operations, supervision in the securities business is typically carried out on the basis of physical location. Complicating the problem are differences in organization of national supervisory authorities in this sector. In some countries, supervisory responsibility rests with the central bank, in some with the ministry of finance, and in some with regional or nongovernmental agencies. There are also considerable differences between countries in the structures of securities businesses, with various approaches taken to the joining of securities and banking functions. Furthermore, the focus and objectives of securities market regulation have differed from country to country.8 In most, however, the primary rationale for official oversight has been investor protection. This has led to regulations concerning financial disclosure, the transparency, openness, and liquidity of markets, and the discouragement of fraud. As financial markets become more fully integrated across borders, the need for a more comprehensive and internationally consistent approach to protecting investors, and ultimately the payments system, is becoming apparent.

Work under way within the International Organization of Securities Commissions (IOSCO), the OECD, and other forums is attempting to clarify the various issues involved and elaborate appropriate responses. In the meantime, the Draft Directive on Investment Services of the EC proposes to lay down certain minimum standards in this area for the member countries of the Community. There has also been considerable bilateral contact between national securities regulators on related matters. Increasing attention is also being paid nationally and internationally to the safety and efficiency of clearance and settlement systems for both banking and securities transactions and to the coordination of official responses to emergencies. The main issues in this area are limiting credit risk in settlement systems, expanding their capacity, and reducing their vulnerability to external shocks without impeding efficient cross-border linkages. The time taken to effect a transfer of funds or to complete a change in ownership of a security varies widely across different systems. During this settlement period, a counterparty is exposed to the risk that the other party may go out of business. Information on the creditworthiness of the counterparty may be hard to obtain. For this reason, much effort is being put into shortening settlement periods, with many countries moving toward overnight settlement (and those with overnight settlement considering same-day settlement), and into considering limitations on the size of overdraft a participant can run at any one time.

The integrity of clearing systems themselves is of considerable concern to monetary and regulatory authorities because their failure could set off a chain reaction of defaults. Central banks have usually been unwilling to take on the job of formally guaranteeing such systems, for fear that this would lead to the inadequate evaluation of counterparty risks by participants. They have, however, often taken pains to encourage participants in these systems to protect themselves adequately against undue risks. For example, they have supported efforts to preserve the physical security of the computerized systems that lie at the heart of counterparty settlement procedures and have encouraged the establishment of reserve funds to insure systems against widespread counterparty failure. Private settlement systems have also recently been making efforts to improve their self-insurance schemes.

The gradual breakdown of functional barriers within the financial services industry poses new challenges for regulatory authorities. While the most obvious trend is the gradual integration of the banking and securities business, there are also trends toward the integration of banking, insurance, and other types of financial services. Regulators are increasingly concerned, therefore, about the supervision of diversified financial conglomerates, the possibility that problems can spread quickly from one sector to another, and the danger of extending implicit guarantees. To many observers, the case for functional rather than institutional regulation is becoming more persuasive. This is the approach taken in the Financial Services Act of the United Kingdom, which makes no attempt to define, say, a bank or a securities house, but regulates in a consistent fashion all participants in specific lines of business. Such approaches have been stimulated by concern that the regulation of financial activities should be uniform regardless of who conducts them. Up to the present, most attention has been paid in this respect to the relationship between banking and securities activities. The regulatory reforms that have recently taken place, for example, in the United Kingdom, Australia, France, and Canada, had among their objectives the elimination of restrictive practices in securities markets, the enhancement of competitive efficiency, and the injection of capital into securities firms.

In countries with universal banking systems, together with those where regulatory changes have meant that securities houses are often subsidiaries of banks, the issue of preventing problems in securities operations from spilling over into banks has been important. Under the capital adequacy standards of the Basle Committee, the capital of subsidiaries dedicated to the securities business is netted out of total capital. While this is helpful, it does not guarantee that banks will not have explicitly or implicitly committed themselves to their securities affiliates for far greater amounts. Indeed, those affiliates can be expected to trade on the name of the parent bank, and it is widely presumed that a parent bank will not risk damage to its reputation by letting its affiliate default. As functional barriers erode in the United States and other traditionally segmented markets, supervisors appear to be encouraging the establishment of structures, often referred to as internal “firewalls,” which would attempt to keep parent banks’ liability from securities operations strictly limited. Such barriers would ideally prevent the transfer of increased risk from securities affiliates to the parent, protect impartiality in credit approval procedures, and limit the scope of central bank safety nets. Supervisors are aware, however, of the temptation to breach such firewalls, especially during times of crisis. The gradual integration of securities and other financial markets both nationally and internationally and the now-evident possibility of the rapid transmission of shocks from one market to another are prompting supervisors to review their controls over the risks to the entire financial system that may originate in securities markets. This is quite a new area, and the conceptual and practical understanding of the problems involved remains less well developed than in the banking sector.

The October 1987 Stock Market Break

The need for deeper understanding and for attendant policy development was underscored when an important sector of the securities business, the equity market, experienced a serious shock in October 1987. As detailed in Chapter V, the rapid spread of price declines from one market to another made it clear that the integration of markets had become more extensive than many observers realized. Countries with short settlement periods reported exceptional pressure from foreign market participants seeking to utilize the liquidity of their markets to meet obligations elsewhere. There was evidence during October 1987 of the effects of trading halts or price limits in one market spilling over into other markets. With the multiple listings of stocks and instruments on a number of exchanges growing, such phenomena are expected to become more widespread. These events have stimulated new international efforts to coordinate the regulation of securities markets.

The strains on the markets evident during the October 1987 events have also led market participants and regulators to focus on a number of weaknesses in the functioning of equity markets. The first involves the performance of trading systems under atypical conditions. Problems arose on some markets in handling an overwhelming volume of sell orders; price quotes became unreliable and spreads fluctuated erratically, creating doubt about fundamental market liquidity. There were also strains in clearing and settlement systems, and delays in confirming payment of margin calls. In response, several major markets took steps to increase the capacity of their systems to handle substantially larger volumes of transactions as well as to clarify and adapt rules governing the behavior of market makers and other market participants. The suddenness of the fall in equity prices and the volumes experienced also led to fears about the adequacy of the capital base of some brokers. In general, fear about the solvency of counterparties was probably less in countries where brokers usually form part of financial conglomerates or universal banks. In some countries, however, a tendency toward tiering emerged on inter-broker-dealer markets, which had hitherto relied on anonymity, as market participants sought information about the credit ratings of their counterparties. In New York and Hong Kong, minimum capital requirements for brokers were subsequently raised substantially and supervisors since then have generally been reassessing capital standards for firms under their jurisdiction. The stock market break also brought to light the need for better coordination between cash and derivative product markets. The rules and clearing procedures established for the derivative markets, such as price limits and margin requirements in futures markets, appeared during the break to be inadequately integrated with those for the cash equity markets. This led to discussions on mechanisms for ensuring greater uniformity of regulatory approach.

The full extent and nature of official intervention during the market break is unclear. In the United States, the authorities provided liquidity to the financial system through open market operations and counseled banks on the need to meet the large but legitimate funding needs of major market participants. Rules on collateralization were also eased. In Japan, regulations on margin requirements were relaxed, while in Hong Kong, emergency assistance was arranged to allow some participants to meet their liabilities. It is likely that analogous interventions occurred in other countries.

Systemic Risk

Supervisory authorities generally face the problem of establishing a level of regulation that maximizes competition in financial markets without jeopardizing safety, soundness, and effectiveness. As international linkages deepen, the problem of striking the right balance between these objectives becomes more complex. Thus regulators across the world are currently reconsidering whether changes in the nature and scope of their activities are required to ensure the soundness of their national financial systems and the emerging international system. The key issue appears to be finding the appropriate level of prudential supervision in a liberalized regulatory environment. There is evidence that, as a result of recent developments, some countries are already tightening the rules governing certain financial activities. In the United Kingdom, the market liberalization fostered by the Financial Services Act has been complemented by the establishment of a new, more comprehensive, supervisory framework. Within the EC, the movement toward a single market for financial services has been associated with the steps toward the mutual recognition of national regulatory standards. In the United States, the market break has led to an appreciation of the need for increased collaboration among the various bodies supervising financial markets. The role of governmental guarantees is also under reconsideration in a number of countries, most prominently in the United States in the wake of widespread intermediary failures.

While the explicit guarantees given by deposit insurance organizations by now have long histories in many countries, the implications of implicit guarantees are more difficult to assess. Moreover, payments to depositors in bankrupt intermediaries have often extended beyond those required by statute, for example, to cover foreign depositors. There seems an increasing likelihood that no industrial country is prepared to let a major bank fail outright, leaving the loss to fall to some extent on shareholders but mainly on uninsured creditors. In the light of actions and expectations of market participants during the October 1987 stock market break, questions have been raised as to whether such guarantees effectively extend to major securities houses, since the failure of any of these could have a systemic impact similar to the failure of a major bank. This, again, may threaten to lead some market participants to undertake excessively risky behavior. To the extent that such implicit guarantees have spread, many observers are calling for closer surveillance on the part of supervisory authorities to ensure that markets remain efficient and stable.

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