Transcript Part 4 Monetary policy transmission

Review of the current financial crisis
Adalbert Winkler
Centre for Development Finance
Frankfurt School of Finance & Management
European Fund for Southeast Europe
Financial Crisis Workshop
Sarajevo, 23 April 2009
©Frankfurt–School.de
Outline
1) The financial crisis: origins, phases and latest trends /
developments around the world
2) The origins of financial crises
3) Impact on Southeast Europe
4) Conclusions
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The financial crisis:
origins, phases and
latest trends / developments around the world
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The financial crisis: origins, phases and latest trends /
developments around the world
emerging economies
(4) Post-Lehman
(4) Post-Lehman
(2) August 07:
Money market
(1) Subprime crisis
turbulences
(3) September 08:
Lehman Brothers
US
Europe
financial integration in developed countries
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The financial crisis: origins and phases
Origin: US subprime mortgage market
• Credit-constrained borrowers
• Low income households, minorities, low-income
neighborhoods
• High(er) interest rates
• Followed financial liberalisation
• Government support for mortgage lending and
homeownership
 Similarities with development / microfinance
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The financial crisis: origins and phases
Differences: subprime lending and development finance
• Subprime lending is lending with elevated credit risk
• Credit risk is a function of house price developments
• Lending methodology relies on collateral (house)
• Lending beneficial to borrowers and lenders under the
expectation of rising house prices
• Subprime borrowing also by middle and higher income
households (not only poor, low-income households)
• Subprime borrowers have had access to financial
services of the formal financial sector
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The financial crisis: origins and phases
• Via securitization subprime lending was spread through
markets and SIVs to the banking sector on a global scale
(IMF 2009)
• Solvency shock of falling US house prices: Credit risk
materialised
• Securities became illiquid due to asymmetric information
about severity of losses of individual borrowers / portfolios
• Market panicked and everybody wanted to sell
• Market collapsed
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The financial crisis: origins and phases
Different explanations how this could happen
 “originate and distribute” (Krahnen 2006,
Franke/Krahnen 2008)
 “plausible denial” (Calomiris 2008)
 “loss” of information (Gorton 2008)
•
But all agree:
Incentive and information problems at the very heart of
the crisis
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The financial crisis: origins and phases
• Spill-over to the interbank markets of mature economies
(Step 2), as banks had been key investors in subprime
instruments (direct and – via SIVs – indirect)
• Asymmetric information in the interbank market: How big
are possible losses of my counterpart? No reliable
assessment possible
• Banks refused to lend to each other
• Interbank market in mature economies collapsed
• Lender of last resort interventions of central banks
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The financial crisis: origins and phases
• Current financial crisis is a classical financial crisis seen
regularly in
today’s advanced economies before WW II, in
particular before 1913
many emerging market economies and developing
countries
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The financial crisis: origins and phases
• Step 3: Collapse of Lehman brothers
• Step 4: Liquidity crisis in global financial markets
• Another solvency shock causing illiquidity of financial
assets worldwide
• “If Lehman can fail, how can my borrower / investment be
safe?”
• Flight to quality, liquidity: US treasury bills and German
government bonds
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Trends: spreads
Emerging market bonds spreads (JP Morgan)
basis points over US treasuries
1000
900
800
Latin
Europe
Asia
Africa
EMBI Global
700
Lehman Brothers
9 August 2007
600
500
400
300
200
100
31.12.08
30.09.08
30.06.08
31.03.08
31.12.07
30.09.07
30.06.07
31.03.07
31.12.06
30.09.06
30.06.06
31.03.06
31.12.05
30.09.05
30.06.05
31.03.05
31.12.04
30.09.04
30.06.04
31.03.04
31.12.03
30.09.03
30.06.03
31.03.03
31.12.02
0
Source: Bloomberg
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Trends: capital flows
Capital flow reversal: USD 2.5 trillion
Source: IMF (2009a)
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Trends: trade flows
Percentage change from a year earlier
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Source: IMF (2009a)
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Trends: growth
Source: IMF (2009a)
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Trends: inflation
Source: IMF (2009a)
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The origins of financial crises
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The origins of financial crises
Economic theory
•
Debt crisis
•
Currency crisis (currency crisis models beginning with
Krugman 1979)
•
Global liquidity crisis (Diamond/Dybvig 1983, Chang
and Velasco 2000)
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Debt crisis
•
Yes, for US subprime borrowers; but for the US as a
whole?
•
Practical definitons
 Debt to GDP ratio should not increase forever
(Roubini 2001)
 Country is being rated as in default
 Receives a large non-concessional IMF loan
defined in excess of 100 percent of quota (Nieto
Parra 2008)
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Debt crisis
Net investment position of the United States and other
selected coutries
0,0
-0,2
-0,4
-0,6
-0,8
-1,0
Greece
Portugal
Romania
Spain
Hungary
United States
Lithuania
-1,2
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Sources: Lane and Milesi-Ferretti (up to 2004), IMF Article IV reports, own compilation
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Debt crisis
General government gross debt
as a percentage of GDP
70
65
60
55
50
45
Germany
United States
40
35
30
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
Source: IMF
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Currency crisis
•
Crisis / speculative attacks occur because of
 unsustainable macroeconomic policies, leading to
large fiscal and current account deficits (firstgeneration models)
 Self-fulfilling prophecies due to trade-offs policy
makers face related to high output and
employment costs of using high interest rates to
defend the currency (second-generation models)
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Currency crisis
• US fiscal deficit
General government balance
2
Germany
Euro area
1
United States
0
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
-1
-2
-3
-4
-5
-6
Source: IMF
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Currency crisis
• Large and rising US current account deficit, global imbalances
USD billion
800
Emerging markets and
developing economies
Emerging and Developing Economies
600
Advanced Economies (excl. US)
United States
400
200
0
-200
-400
-600
United States
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
-800
Source: IMF
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Currency crisis
Standard emerging
market currency
crisis
United States 2007
– 2009
• Interest rates
• Interest rates
• Exchange rate
• Exchange rate
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Currency crisis
Exchange rates in Russia, the US and Thailand
month before the crisis = index 1; nominal effective exchange rate (Russia, US), against the
USD (Thailand)
1,2
1
0,8
Russia
United States
Thailand
0,6
0,4
Month before the crisis:
Thailand = June 1997
Russia= July 1998
United States= August 2007
0,2
0
-17
-15
-13
-11
-9
-7
-5
-3
-1
1
3
5
7
9
11
13
15
Source: IMF, own compilations
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Currency crisis
• No evidence that foreign investors triggered the crisis.
Capital inflows to the US have continued smoothly
• Financial crisis was caused within the US financial system
(as discussed) and transmitted to the global financial
system
• Currency crises symptoms now in emerging market
countries
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Currency crisis
Source: IMF (2009b)
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Liquidity crisis
Liquidity crisis in mature economies spread to emerging
markets
Problem for emerging markets: limited ablility to act as lender
of last resort as liabililites have been mainly accumulated in
foreign currencies
Example: banking systems
Assets
Short-term assets
in domestic currency
Long-term assets
Liabilities and Shareholder's Equity
Short-term liabilities
in domestic currency
in domestic currency
Short-term assets
in foreign currency
Long-term assets
Short-term liabilities
in foreign currency
National lender of last resort in case of fixed exchange rates:
internationaler lender of last resort
International lender of last resort
independent of exchange rates
in foreign currency
Total assets
Total liabilities
Source: Own collocation
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Liquidity crisis
Example: corporate borrowing
Source: IMF (2009a)
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Liquidity crisis
Without international lender of last resort:
• investors want to sell / withdraw at any price
• sudden stop / sudden reversal of capital flows
• global financial intermediation collapsed (Greenspan 2008)
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The financial crisis:
Impact on Southeast Europe
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The financial crisis: impact on Southeast Europe
The growth model of emerging Europe
•
Financial opening up and integration with the euro
area / EU
•
Euro-based exchange rate policies
•
Capital flows
•
Credit growth (private sector)
•
Consumption and investment (domestic demand)
 Strong growth
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The financial crisis: impact on Southeast Europe
The growth model of emerging Europe
But also
•
Overheating
•
Substantial current account deficits, external debt
(private sector)
•
Lack of counter-cyclical fiscal policies
•
Financial vulnerabilities
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Credit growth outstanding in the emerging market
universe …
Percentage change 2007/ 2006 versus 2000
550%
500%
450%
400%
350%
300%
250%
200%
150%
100%
50%
0%
Czech Republic
China, P.R. Mainland
Tunisia
Mexico
Malta
Chile
Malawi
Madagascar
Israel
Sri Lanka
Mali
Senegal
Cyprus
Indonesia
Togo
Pakistan
Korea
Mauritius
Morocco
Armenia
Burkina Faso
Jordan
Brazil
Bosnia & Herzegovina
Botswana
Poland
Honduras
Benin
Colombia
Turkey
India
Saudi Arabia
Niger
Slovenia
Costa Rica
Croatia
Hungary
FYR Macedonia
Venezuela
Estonia
Vietnam
Azerbaijan
Belarus
Russia
Cambodia
Moldova
Kyrgyz Republic
Lithuania
Latvia
Romannia
Bulgaria
Ukraine
Kazakhstan
Albania
Note: EFSE Countries are marked in red. The ranking and the respective percentage changes are sensitive to the choice of the base year. For
example, the percentage change of close to zero in the Czech Republic reflects the substantial restructuring and consolidation efforts in the banking
sector undertaken by the authorities in the first years of this decade. Over recent years, however, private sector credit as a percentage of GDP has
been rising at a pace similar to that observed in other Central and Eastern European countries.
Sources: IMF, author's compilations.
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Strong progress in income convergence
Convergence progress in selected EFSE countries
per capita GDP, as a percentage of US GDP per capita
12
2000
2007
10
8
6
4
2
0
FYR Macedonia
Albania
Bosnia and Herzegovina
Serbia
Source: IMF: own compilation
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Rising macroeconomic vulnerabilities
Inflation differential to the euro area
percentage points
10
2007
2008
8
6
4
2
0
-2
Serbia
Romania
Montenegro
Macedonia,
Former Yugoslav
Republic of
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Bulgaria
Bosnia and
Herzegovina
Albania
Note: 2008 figures are estimates.
Sources: IMF, author's calculations.
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Rising macroeconomic vulnerabilities
United States
-25
Maldives
Solomon Islands
Seychelles
Montenegro, Republic of
São Tomé and Príncipe
Kiribati
St. Kitts and Nevis
Liberia
St. Vincent and the Grenadines
Djibouti
Grenada
Latvia
Dominica
Lao People's Democratic Republic
Bahamas, The
Bulgaria
St. Lucia
Georgia
Congo, Republic of
Antigua and Barbuda
Guyana
Jordan
Nicaragua
Serbia
Estonia
Iceland
Madagascar
Fiji
Jamaica
Romania
Greece
Vanuatu
Lithuania
Bosnia and Herzegovina
Ghana
Burundi
Sudan
Lebanon
Gambia, The
Tonga
Spain
Cape Verde
Honduras
Burkina Faso
Moldova
Vietnam
Tajikistan
Mozambique
Portugal
Tanzania
Guinea
Croatia
Albania
Senegal
New Zealand
Panama
Mauritius
Niger
South Africa
Cyprus
Barbados
Mauritania
Zambia
Mali
Kazakhstan
Belarus
Kyrgyz Republic
Armenia
Togo
Malta
Australia
Samoa
Costa Rica
Syrian Arab Republic
Turkey
Benin
Dominican Republic
Hungary
United States
Slovak Republic
Guatemala
Pakistan
United Kingdom
Rwanda
El Salvador
Slovenia
Eritrea
Sri Lanka
Ethiopia
Ireland
Central African Republic
Yemen, Republic of
Chad
Ukraine
Belize
Congo, Democratic Republic of
Sierra Leone
Colombia
Poland
Kenya
Malawi
Macedonia, Former Yugoslav Republic of
Czech Republic
Tunisia
Italy
Uganda
India
Guinea-Bissau
France
Zimbabwe
Cambodia
Mexico
Uruguay
Afghanistan, Rep. of.
Mongolia
Morocco
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Albania
FYR Macedonia
Montenegro
Bulgaria
Serbia
B & H Romania
Current Account Balance of 2007 Deficit Countries
% of GDP
0
-5
-10
-15
-20
Moldova
-30
-35
-40
-45
Sources: IMF, own compilation.
Lack of counter-cyclical fiscal policy
General government balance of selected EFSE economies
(as a percentage of GDP)
2000
2002
2004
2005
2006
2007
FYR Macedonia
2.7
-5.4
0.7
0.3
-0.5
0.6
Albania
-8.3
-6.6
-5.2
-3.7
-3.2
-3.8
Bosnia and Herzegovina
-7.7
-3.0
-0.5
0.8
2.2
-0.1
Kosovo
n.a.
4.0
-5.9
-1.9
2.4
6.8
Montenegro
n.a.
n.a.
-2.6
-1.7
2.2
4.5
Serbia
-0.2
-3.3
0.0
0.8
-1.6
-1.9
Source: International Monetary Fund
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Rising financial vulnerabilities
Credit risk
Deterioration of credit quality
due to rapid growth
• banks: strain on banks‘
risk assessment and
management capabilities
• borrowers: rapidly rising
debt burden, lack of track
record and debt
management experience
Share of total non-performing loans of banks in total loans
percent
25
20
15
2005
2006
2007
10
5
0
ALBANIA
BOSNIA AND
HERZEGOVINA
BULGARIA
CROATIA
FYR MACEDONIA
MONTENEGRO
ROMANIA
Source: EBRD
(in particular households)
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Rising financial vulnerabilities
Market risk
- Exchange rate risk (Fx loans)
- Interest rate and liquidity risk
(maturity transformation)
©Frankfurt–School.de
Source: ECB (2007)
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From vulnerabilities to crisis?
The typical lending boom does not end in crisis, but with a
‘soft landing’, whereby credit growth gradually decelerates.
(Tornell/Westermann 2002)
But many crises have been preceeded by a credit boom
(Caprio/Klingebiel 1996 a,b)
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From vulnerabilities to crisis?
Two scenarios
„Asia“
Financial and currency crisis
(Sorsa et al 2007)
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„Portugal“
Protracted growth slowdown
due to adjustment needs
(Martin, Schuknecht, Vansteenkiste 2007)
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Peculiarity: Foreign, euro area, bank based
financial deepening in SEE
• Opening up to foreign banks after the failure of financial development based on state-owned and domestic private banks
• EU accession perspective and the associated reforms and growth
prospects raised interest of (mainly euro area) foreign banks to
enter the respective markets
• Timing of both factors largely determined the start of the financial
deepening process („early birds, late risers and sleeping beauties“
Vladkova Hollar et. al. 2003)
• SEE (and emerging Europe) the region with the by far largest
share of foreign banks in total assets in the world
• Financial deepening mainly driven by interbank (parent –
subsidiary) lending and investment
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Peculiarity: Foreign, euro area, bank based
financial deepening in SEE
Share of Foreign Banks in Total Banking Sector Assets, 2007
%
100
80
60
40
20
0
MOLDOVA
SERBIA
ROMANIA
MONTENEGRO
FYR
MACEDONIA
©Frankfurt–School.de
BULGARIA
BOSNIA AND
HERZEGOVINA
ALBANIA
Source: EBRD
45
Parent banks (triangles) and subsidiaries (circles), 2004
Source: De Haas and Lelyveld (2008)
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Foreign (euro area) bank based financial
deepening in SEE
Main „depositors“ of SEE banks: single parent bank with
excellent information about the long-term solvency of their
claims
Thus: risk of „sudden reversal” („ bank run”, Diamond/Dybvig 1983) is
low. Indeed, parent bank can be expected to support its
subsidiary if
• it has faith in the long-term solvency / profitability of its
subsidiary (De Haas/Lelyveld 2008),
• it has the financial means to do.
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Foreign (euro area) bank based financial
deepening in SEE
Global financial crisis invalidated main assumption the benign
scenario for SEE was based on:
stable and liquid parent banks
Parent banks face liquidity challenges in home market
But at least, they
• have access to an international lender of last resort (the
ECB)
• benefit from the banking sector rescue packages of their
home country governments
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Foreign (euro area) bank based financial
deepening in SEE
Foreign, euro area-based banking still a net benefit
for the region
This view is supported by the observation that liquidity issues
have been most pronounced
• at banks in the region that do not have a parent bank in the
euro area
• when doubts about the commitment of parent banks to
support their subsidiaries have been aired
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The financial crisis: impact on SEE
However, liquidity pressures have become strong in the region
Indicators:
• Strong increase in spreads and interest rates
• Depreciation and depreciation pressures
• Reduction of foreign exchange reserves
• Lifting and reversal of measures to contain and impede
capital infows
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Impact on SEE – financial
Bond spreads
basis points
1600
1400
Serbia
1200
Bulgaria
1000
Romania
800
Global Sovereign Spread
600
400
200
03.04.09
03.02.09
03.12.08
03.10.08
03.08.08
03.06.08
03.04.08
03.02.08
03.12.07
03.10.07
03.08.07
03.06.07
03.04.07
03.02.07
03.12.06
0
Source: Bloomberg
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Impact on SEE - financial
Exchange Rate Developments
National currency in:
FYR Macedonia
Albania
Bosnia and
Herzegovina
Serbia
$
€
$
€
$
€
$
€
01.01.2007
09.08.2007
-4.0
-0.4
-5.0
-1.4
-3.8
-0.2
-3.4
0.2
09.08.2007
15.09.2008
-3.3
0.3
-2.5
1.1
-3.4
0.2
-8.2
-4,0
15.09.2008
31.03.2009
7.6
0.2
13.5
5.8
7.0
-0.3
33.7
23.7
Source: Bloomberg
positive values: depreciation (in %)
negative values: appreciation (in %)
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Impact on SEE – financial
Central Bank and governmental measures since 15 September 2008
Measures to bolster liquidity
Other regulatory
measures
International
support
Goverment bank
bailouts
Foreign
exchange
reserves
no
yes
/
no
decline
constant
yes
no
/
no
constant*
decline
yes
no
/
no
decline*
constant
no
no
/
no
decline
Montenegro
decline
yes
no
/
yes
decline
Serbia
decline
yes
no
IMF: € 3 bn.
no
decline
Minimum
reserve
requirements
Other measures
FYR Macedonia
constant
Albania
Bosnia and
Herzegovina
Kosovo
Source: Own compilation
* by the end of 2008
Source: Vogel and Winkler (2009)
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Impact on SEE – real sector and portfolio quality
• Sharp shift in export and industrial production trends
from high growth rates to contraction
• Inflationary pressures strongly abating in countries
with a fixed exchange rate to the euro
• Fiscal policy largely unavailable to counter collapse in
exports, output and employment
• Severe impact of the downturn on portfolio quality in
the region
• Share of non-performing loans will rise to levels
unseen before
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The financial crisis: impact on SEE
• Thus, challenge for parent banks will become even more
daunting
 Refraining from a reversal of capital flows will not be
enough
 Subsidiaries in the region will need fresh capital
• Parent banks are increasingly needing support to meet this
challenge
• Thus, joint efforts under way to avoid the extreme scenario,
a parent bank withdrawal from the region
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The financial crisis: impact on SEE
Efforts include
• the national governments of parent banks and European
institutions
• international financial institutions supporting bank stability
and lending activity in the region (EIB, EBRD, World
Bank initiative of February 2009)
• coordination between IMF and parent banks in
supporting host economies
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Conclusion
• A global liquidity crisis
• SEE strongly effected due to high degree of financial
integration
• High degree of financial integration was key building block of
countries’ growth strategy
• Rested on stability and liquidity of parent banks
• Assumption does not hold anymore
• Financial and real effects of the crisis very strong
• Fiscal policy not available
• Challenge: avoiding financial meltdown
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Thank you for your attention
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References
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Economic Outlook, April 2009, Chapter 4, Washington DC.
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