DecemBER 2016 Adrian BlundellWignall Special Advisor on Financial Markets to the OECD Secretary General for Financial amp Enterprise Affairs Directorate The World Economy The Key Moving Parts ID: 585320
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Slide1
Finance & New Risk Scenarios, rome DecemBER 2016
Adrian Blundell-Wignall
Special Advisor on Financial Markets to the OECD Secretary General, for Financial & Enterprise Affairs Directorate.Slide2
The World Economy: The Key Moving Parts
2
World growth came to depend on commodity super cycle an related investment: China a major driver, and now in reversal as excess capacity emerges globally.
The return on equity driven down below the cost of capital – low inflation, absence of investment & productivity.
7
major risks
interacting with this:
(1) Political—the rapid hollowing out of the middle class.
(2) Financial markets—low interest rates & asset prices.
(3) Europe’s failure to deal with the banking crisis.
(4) Pushing Risk into shadow banking
(5) Emerging market risk: US tightening, a rising dollar and China and debt.
(6) Fintech risks to the traditional financial institution model.
(7) Brexit risk for Europe.Slide3
Political: Hollowing Out%; Changes in Shares of Employment by Pay Category 1997-2015
3Slide4
Global Capital Expenditure: Dependence on Energy & Materials (now reversing)
4Slide5
Sector Investment Misallocation
: ROE-COK in
Emerging Economies
, 2002-2015
5Slide6
Low rates hurt banks (there is a banking crisis in Europe) and they may bankrupt pension & insurance companies. So why? To save lame-duck companies from adding to NPL’s? To boost asset prices?? To weaken the exchange rate???
Asset price bubble emerge—not supported by productivity growth.
Funds chase yield and alternative products, in order to catch up.
Redemption risk on asset price reversal with illiquid assets—disorderly markets.
6
Low Interest ratesSlide7
1 Month Major Interbank Rates
7Slide8
Evolution of Selected Financial Prices
8Slide9
9
Evolution of REITSSlide10
The 4% Real Target of Many Pension Funds is not Realistic: Low Interest R
ates
C
ould P
ersist
for a
Long
T
ime
10Slide11
Drop in interest rates increases exposure to longevity risk of mortality tables across countries – average shortfall for females, age 65
11Slide12
Corporate Bond Issuance
and
Declining Quality
, 2000-2015
12Slide13
OECD 2008 View on Dealing with the Bank Crisis. Did Europe Measure up?
13
OECD publications consistently recommended three key elements of banking reform:
Deal with any troubled assets first
.
Recapitalise banks.
Regulatory focus
on a simple leverage ratio of at least 5% of the un-weighted (IFRS) balance sheet, and not to rely on the Basel risk weighting approach to capital rules.
Separate derivatives and other high-risk investment banking activities from insured deposit balance sheets that subsidises these activities and leads to an under-pricing of
risk. Maintain liquid assets. Reduce wholesale funding.Slide14
Non-Performing Loans (in % of Total Loans)
14Slide15
15
Core Tier 1: Basel Risk-Weighted versus the Simple Leverage RatioSlide16
16
Business Model Features That Drive Risk in GSIB BanksSlide17
17
Distance-To-Default: BanksSlide18
Distance-To-Default of Large Banks by Region
18Slide19
Credit Default Swap of Large Banks by Region
19Slide20
Pushing Risk Into Shadow Banks
20
Risky assets transferring to shadow banks as bank regulation proceeds.
US & UK banking and finance centres de-globalising much less than Europe and Japan.
OECD research shows that the problem of rising inter-connectedness is worst in Asia.
Chinese and Japanese institutions are moving into where European banks and non-banks are moving out.
Banks are more interconnected with shadow banks in Asia than before the crisis. Things improved in the USA. But they stayed the same in Europe.Slide21
21
Holdings of Derivatives:
Banks vs Shadow Banks
(gross market value)Slide22
22
Cross-Border Claims by Nationality or Residence:
Banks versus Shadow BanksSlide23
Emerging Markets & EU Debt & Bank Risks Building Up
23
Low interest rates are contributing to build up of debt globally in the company sector. (China especially. Early warning sign).
US and other advanced countries own $-denominated Emerging Market financial and non-financial debt.
NPLs in China are hard to compare with advanced countries – maybe close to 6%.
USA rates set to rise and the $ moving up—with much non-investment grade debt in dollars and a lot from banks and non-banks.Slide24
Government, Household & Company Debt: Advanced and Emerging
24Slide25
Global Non-Investment Grade EME Issuance
25Slide26
26
PBOC New Exchange Rate Basket & Some ComponentsSlide27
International Reserves of Major Emerging Countries
27Slide28
Fintech Threats: Distributed Ledgers
28
Distributed
ledgers are much more transformative than
sharing
economy disruptions
(Uber, AirBnB) which
still involve hierarchical intermediaries
Could make society unrecognisable
Distributed
ledger technology is a shift towards a different underlying philosophy of economic organisation based on: distributed consensus, open source, transparency, and technological
communities
Technology threatens
all intermediaries under pressure from globalisation, information intensity, and connectivity.
Avoids
duplication and inefficiency.
Gets
rid of cross checking between individual ledgers and
databases.Slide29
29
Distributed versus CentralisedSlide30
Blocks and Blockchain
30
Blockchain is a
list of “blocks” and a “block” is typically a list of
transactions or records (first
developed for
Bitcoin). A new
block is “chained” to the previous block, using a cryptographic
signature.
Used
like a ledger shared and corroborated by anyone with
right
permissions.
Changes
in the ledger
reflected
in all copies quickly. Keys and cryptology determine who can do what within the
ledger.
Un-permissioned ledgers:
blockchain can be
un-permissioned, so
anyone
can add a
block,
but
consensus
is needed on what is
added including the code.
Older blocks cannot be
rewritten.
Permissioned ledgers
: consensus
achieved
by a set of trusted nodes and may have a
proprietor
(e.g. Ripple, the Estonian government, etc.).
Code
itself is developed and updated by the
proprietor.Slide31
Transformative vision
31
Transformative
vision of the world is to have citizens participate in smart contract applications that work with the blockchain
database
Legacy contracts are typically archived signed
contracts
Smart contracts
contain the computer code that executes the contract—2 users sign and it is executed by the contract on the blockchain.
Problem
with
legacy
system
– it is located
in single institutions, with an array of networking and messaging—there is a single point of failure and
subject
to
cyber-attack
Smart
contracts
in distributed
ledger are hard to
attack.
Care required in regulation—distributed ledgers can help reduce the cost of finance; help in the fight against cyber crime; reduce bribery and corruption; reduce tax avoidance; and fight terrorism financing.Slide32
Brexit & Financial Services
32
Will UK
financial
institutions
lose their Europe “passports
”?
US
and other non-EU banks that meet European regulatory standards are able to be licenced on an individual basis to provide services in
Europe
LCH
Clearnet Ltd (owned by LSEG), ICE Clear Europe, LME Clear Limited and CME Clearing Europe
Limited
operate in London.
UK
is
largest
market for OTC
euro
foreign exchange transactions and
largest
interest rate derivatives market in the world.
There
are other non-euro countries that clear euro-denominated instruments as well (i.e. the US and Singapore
)
EU lost a case against the UK in the General Court of the EU over the ECB claiming that euro contracts need to be cleared in euro countries (for supervision reasons). Treaty change required to do it.Slide33
33UK Services vs Total Goods and Services Balance of Payments with EuropeSlide34
34
UK
Exports to
Region
in percent of
UK
Exports
to the OECD 22Slide35
35
Number of
Institutions Included
in the United Kingdom
Banking Sector
by
Nationality in 2016