Asian money markets survive financial crisis

The underdevelopment of Asia’s money markets has insulated it, to some degree, from the shocks that disrupted more developed money markets, according to a study made by the Bank of International Settlements (BIS).

It likewise stressed that the problems arising from 2007 US sub-prime fiasco, provides authorities and market participants in Asia with an opportunity to learn from experiences elsewhere in their efforts to realize the full benefits offered by well functioning money markets.

The BIS study said that the lack of sophistication and connectivity of the Asian markets to the global money community cushioned it from the negative effects to the US and European markets.

The BIS is an international organization closely relating exclusively and extensively with the world’s central banks and financial institutions. It is often referred to as the central bank of central banks.

Money markets in much of Asia were not significantly affected by the events that disrupted US dollar and euro money markets beginning in mid-2007. In contrast to the situation in North America and Europe, money markets in Asia functioned normally in the second half of 2007 and first half of 2008, and monetary authorities in Asia had no cause to take special actions to stabilize them.

“The relative stability of the region’s markets was clearly welcome, it stemmed however in part from structural weaknesses,” the BIS study said.

An indication of the lack of depth of the Asian markets is the use of short-term or even swap-implied interest rates as the reference floating rate leg in interest rate swap (RS) contracts, instead of the three- or six-month interbank rates typically employed in the US dollar, euro and yen markets.

The Philippine peso IRS for instance is referenced to interest rates implied by foreign exchange (FX) swaps.

Likewise, the low credit rating of locally headquartered foreign banks limited their participation to the global community versus their principal. Thus in the turmoil such as what is presently occurring, the disadvantage of the locally headquartered foreign bank or insurer unexpectedly turned into a buffer.

Most Asian financial institutions likewise tend to deposit surplus cash with their central banks or buy government securities rather than lend it out to interbank markets.

The BIS study points to the backwardness or underdevelopment of the collaterized markets in Asia as among the “weaknesses” that turned into an advantage during the present turmoil.

“Repo markets, where loans are secured against securities, are among the most important markets for collaterized short-term financing, particularly for securities dealers, which tend to hold large stock of eligible collateral,” the study said. “Yet many of the region’s money markets remain characterized by segmentation and a low degree of cross border integration.”

Nonetheless, the report said that money markets in Asia have improved over the past decade.

Money markets are defined as the markets for short-term debt funding of financial and non-financial corporations, which perform a number of vital economic functions.

It helps banks to match short-term assets and liabilities, securities dealers to finance their positions and non-financial corporations to smooth fluctuations in their working capital needs.

The report said that the availability of benchmark money markets rates is required for the functioning of a wide range of derivatives markets, including interest rate swap markets.

Well-developed money markets also facilitate central banks’ task of implementing their monetary policy objectives, regardless of whether they have formal interest rate targets.

“Therefore, money markets are integral to the maintenance of macroeconomic and financial stability,” the international organization of central banks said.

It is still in the long-term interest of the Asian markets to promote further development of its money markets, including closer integration with foreign markets.

“If accompanied by appropriate policy and market reforms, integration need not increase Asian money markets’ vulnerability to external shocks. The continued development of repo and FX swap markets is especially important, considering that activity in collaterized funding markets is usually the most resilient in the face of disruptions to other segments of the financial system. The turmoil has, however, demonstrated that even collateralized markets can be vulnerable to disruptions when trading conditions in related markets deteriorate. This highlights the dependence of money markets on the proper functioning of other segments of financial markets, including bond, equity and foreign exchange markets,” it said.

The Committee on the Global Financial System under the BIS made several recommendations for central banks to modify monetary policy to cope with episodes of impaired money market functioning.

Among the suggestions was for the inclusion of systems that allow central banks to conduct operations with an extensive set of counterparties and against a broad range of collateral, redesigning standing facilities in ways that reduce the stigma associated with borrowing directly from a central bank, facilitate the international distribution of funds, and enhancing communications with market participants and the media.

“The resilience of money markets everywhere, Asia included, would be enhanced through the implementation of these recommendations,” the BIS report said.