BIS Quarterly Review, March 2020 - media remarks

Claudio Borio's remarks | Hyun Song Shin's remarks

Head of the Monetary and Economic Department - Claudio Borio

Markets had a rude awakening last week. After an initial, short-lived shock in January, market participants had taken a rather benign view of the impact of the coronavirus on the global economy, finding comfort also in an accommodating global monetary policy stance. Everything changed as the week began and news hit the wires that the virus was spreading further and faster than anticipated. Acute concerns and uncertainty gripped market participants, as the expectation of a rapid V-shaped recovery now appeared grossly unrealistic. Markets in risk assets plunged as if no bottom was in sight: no one wants to catch a falling knife. And yet, for all the turmoil and anxiety, both market functioning and financial intermediation more generally proved resilient. The post-crisis regulatory reforms aimed at strengthening financial institutions are bearing fruit.

The tremors shook markets in successive waves as news unfolded and participants struggled to regain their footing. By Thursday's close in the United States, the more than 10% drop in global equity markets was the worst since the euro area crisis in 2011. The VIX soared, touching one of the highest levels in recent years. Safe haven sovereign yields sunk to all-time lows or thereabouts in several countries. High-yield corporate spreads jumped by roughly 100 basis points, returning to levels that had prevailed during the heightened trade tensions in early 2019. Fixed income assets in emerging market economies (EMEs) also experienced a sell-off, although the correction has been relatively more muted thus far. The US dollar appreciated against most currencies but not the euro or the yen or indeed the renminbi, which rose in value. Markets priced in considerable further monetary policy accommodation: the Federal Reserve's greater room for manoeuvre no doubt explains in part the dollar's relative weakness vis-à-vis the other major currencies.

The emergence of the first concerns about the virus outbreak in late January had reversed a prolonged risk-on phase triggered by the easing of trade tensions and that had taken a number of markets to frothy heights. Indeed, the US equity market had reached an all-time high. And while the risk-off phase had depressed bond yields substantially, on balance it had remained muted.

This was evident from the behaviour of risky assets. Before the sell-off last week, stock markets in advanced economies had largely recouped losses and some had again reached new peaks, although those in EMEs were still well below previous highs, especially in Asia. More to the point, risky fixed income as an asset class had proved surprisingly resilient throughout, showing all the hallmarks of a search for yield. Alongside buoyant issuance, corporate spreads in the United States had drifted down to comparatively low levels and those in the euro area were even tighter by historical norms. Indeed, sovereign spreads on high-yielding bonds in the euro area periphery, notably Italy and Greece, had actually narrowed. And the same was true of EME corporate and sovereign spreads, which had reached multi-year lows on the back of continued inflows into EME bond funds.

Signs of risk-taking were also evident in broader segments of corporate credit. This was true not just in the well known leveraged loan and collateralised loan obligation (CLO) markets, but also in the less familiar private credit market (Box A) - a market that involves loans to smaller, often risky firms originated mostly by non-bank financial institutions, notably private equity firms. This roughly $800 billion-large segment, which has grown rapidly in recent years, has also seen a deterioration in credit standards and the spread of illiquid and leveraged financing structures. Opaque and infrequent pricing, by artificially reducing the measured volatility of underlying returns, has further increased the appeal of the loans to investors and flattered recovery values. No doubt, the development of the private credit market has provided a welcome additional financing channel for those firms that may face difficulties, or find it too costly, to borrow from banks. Even so, it is also another reminder of how risks have been migrating outside the banking sector, sometimes towards less transparent corners of the financial system.

Now uncertainty rules globally. The situation remains fluid. The official community is monitoring developments closely. Where do we go from here? One thing is sure: financial markets will continue to dance to the tune of news about the virus, and of the authorities' response.

Economic Adviser and Head of Research - Hyun Song Shin

This special issue of the BIS Quarterly Review examines the fast-changing world of payments. Payments are the counterpart to the transactions underpinning the economy; safe and efficient payment systems are therefore vital. Technological innovations are shaking up these systems, disrupting the instruments (eg cash), institutions (eg banks) and processes involved.

The pace of change and potential for disruption have propelled payment systems to the top of policymakers' agenda. Indeed, the G20 made improving cross-border payments one of its priorities in 2020. The articles in this issue provide an overview of the strengths and weaknesses of the existing systems, describe how the rapid pace of technological change is impacting them, and assess emerging solutions.

In his introduction "Shaping the future of payments", BIS General Manager Agustín Carstens emphasises that central banks stand at the centre of payment systems and that, given the changes under way, they need to step up and play a more significant role in improving the safety and efficiency of those systems. The BIS Committee on Payments and Market Infrastructures (CPMI) is working with other relevant international bodies to develop a roadmap to enhance cross-border payments. Also, the BIS has established its Innovation Hub to foster international collaboration on innovative financial technology within the central banking community. The Hub aims to catalyse collaborative efforts among central banks, and cooperate, where appropriate, with academia, financial service providers and the broader private sector to develop public goods for the benefit of the global financial system.

Wholesale payment systems - for large-value transfers, mainly between banks - have experienced successive waves of innovation over the past few decades. Retail payment systems - for low-value but high-volume transfers between consumers and businesses - initially experienced slower innovation but are now changing rapidly. In "Fast retail payment systems", Morten Bech, Jenny Hancock and Wei Zhang trace the adoption of new systems for near instantaneous retail payments. Notably, early adopters were predominantly emerging market economies rather than advanced ones.

Notwithstanding the rapid pace of change, payment systems still suffer from shortcomings in at least two areas: access and cross-border payments. As discussed in "Innovations in payments" by Morten Bech and Jenny Hancock, large numbers of people have limited, if any, access to a bank or other type of account for making payments, especially in emerging market and developing economies (EMDEs). Furthermore, cross-border payments remain slow, expensive and cumbersome. In EMDEs, where remittances sometimes account for a substantial proportion of GDP, these two shortcomings feed off each other to magnify the inefficiencies.

A high share of cross-border payments is channelled through correspondent banks. Correspondent banking refers to an arrangement where a bank holds deposits owned by other banks, including those in another country, and plays the role of a payment intermediary as well as providing other services. The number of correspondent banks fell by about 20% between 2011 and 2018. In "On the global retreat of correspondent banks", Tara Rice, Goetz von Peter and Codruta Boar examine the drivers of this decline and assess its potential consequences for countries' access to the global financial system, the costs of cross-border payments and the use of less regulated payment networks.

Initiatives are under way to improve the infrastructure that links banks and other payment service providers in different countries. In "Payments without borders", Morten Bech, Umar Faruqui and Takeshi Shirakami review initiatives to build payment systems designed to operate across borders, link domestic systems or establish procedures for payment service providers to access systems remotely. While there are currently a small number of functioning examples, including in Mexico, South Africa and Switzerland, more such cross-border or multicurrency initiatives are being implemented or planned.

The most far-reaching option for improving payments is a peer-to-peer arrangement that links payers and payees directly and minimises the number of intermediaries. In "On the future of securities settlement", Morten Bech, Jenny Hancock, Tara Rice and Amber Wadsworth analyse how tokenisation - the process of converting assets into digital representations not recorded in accounts - could transform the clearing and settlement of securities. They conclude that tokenisation might reduce costs and complexity but does not eliminate the risks associated with one party failing to settle transactions.

Central bank digital currencies (CBDCs) have gained prominence in recent years in the broader debate on digital currencies. If a central bank were to decide to issue its own CBDC to general users, it would face several crucial technological design choices. In "The technology of retail central bank digital currency", Raphael Auer and Rainer Böhme identify a number of such design features, namely: whether the central bank issues digital currencies directly or through delegation; whether settlement follows decentralised consensus or takes place on a centralised ledger; and whether the CBDC is account-based or token-based. The challenge is to design a digital currency that balances the credibility of direct claims on the central bank with the convenience of using payment intermediaries.