Comments on Session I

1. Comments on Session I Paul Mizen University of Nottingham

2. I congratulate the authors on a very detailed, well-focused set of studies. • The key theme shows the importance of capital flows and non-core liabilities in the banking sector. • I expect the papers to be highly informative for regulatory and macro-prudential policy.

3. Why this is important research • A common feature of all these papers is the view that it is unhelpful to consider EM and DM economies separately. I agree! • Many elements of DM crisis resembled EM crisis experiences e.g. IR and ES housing bubbles, withdrawal of capital etc • Did we forget the self-fulfilling nature of crises and become complacent about DM debt and bubbly asset markets? • Capital flows and growth of non-core liabilities are critical to both EM and DM economies.

4. Three Measures of Crisis • First three papers explore the usefulness of three types of financial indicators: • Market indicators of spreads, prices etc • Ratios and gaps of balance sheet variables • Liabilities, and their components Let me discuss these papers first.

5. Three Measures of Crisis Market indicators of spreads, prices etc tend to tell us about current conjuncture, not future. True, some indicators are better forward-looking variables than others. VIX, CDS tend to be current, but corporate bond spreads more forward looking. Consider nature of contracts • bonds are nominal, with fixed coupons – hence investors explore future with care • CDS written contracts that can be neutralised or reversed with another contract What about information in these spreads? • CDS-fin v non-fin reveal exposure to sovr. Debt • VIX may be a proxy for capital flows (direction and reversal)

6. Three Measures of Crisis Ratios of credit to GDP, core or non-core liabilities to total liabilities offer indication of stage of the cycle. Agreed. Perhaps worth looking at imbalances more generally. • savings v. investment flows between EM and DM • “uphill” flows of capital towards EMs • Net foreign assets to GDP • CA balance • Core tier 1 capital ratio • Private sector debt to income ratios, LTVs etc Could these act as controls, corroboration, compl. Info?

7. Three Measures of Crisis Liabilities and the definition of core v. non-core helpful. Key contribution of these papers in looking at • centralised lending decisions by global banks in USD may lead to ‘supply push’ and rapid growth in FCY liabilities of the banks. • Non-financial firms acting as borrowers and the rise of M2 deposit claims on banks in closed economies. Essentially these show the actions of global banks or non-banks on the liabilities of the banking system, creating systemic risk. Might further consider the possibility that banks can create large gross positions against each other. John Moore calls these leverage stacks, and these can also increase systemic risk.

8. Paper 1 Good to see evidence of • Procyclicality of bank liability elasticities and core-non-core ratio with GDP • very useful contributions to our understanding of crises and may help us develop early warning systems • What about alternative sources of funds? US $ loans v. dom LCY loans? What about bond and equity funding? Swaps market?

9. Paper 2 Specifically on prediction of crises: • Role for contagion, therefore consider neighbours, close trading partners, countries with similar financial characteristics • Crises can jump between sectors e.g. currency crisis to banking crisis, or vice versa. Can you find a causal relationship between these different crisis measures?

10. Paper 3 Specifically on non-financial corporates: • Changing relationship between USD loans and RMB deposits in Hong Kong very significant • Similarly, the development of the ‘dim sum’ bond market is important for Chinese banks, FC Chinese corporates e.g. property developers. Explore how replaces expensive onshore funding for weaker borrowers. • Agree that non-financial corporates play a role in transmission of funding. Two concerns: not through banking system, firm to firm lending, and very short term.

11. Papers 1,2 and 3 Some suggestions to consider: • Financial development is likely to change the relationships between these variables. For example, greater use of RMB assets, and invoicing, will reduce the significance of USD loans by global banks. • Emergence of new (unregulated) areas of borrowing and lending will create wider non-core definitions of liabilities. • Development of market finance might shift the focus of concern away from banks and monetary aggregates towards marketable debt instruments or equity.

12. Papers 1,2 and 3 Some suggestions to consider: • Lower bank dependence (disintermediation) over time may reduce importance of banks. • Greater emphasis on foreign investor participation in onshore and offshore markets may alter financial structure. • Lengthening of maturity by firms may alter sensitivity of firms to capital outflows/withdrawal of non-core claims.

13. Paper 4 Questions whether there is a decline in equity home bias for EM countries. Evidence suggests that higher home bias in EM than in DM countries. But Japan is the exception, raising the possibility that Asia has high home bias. Can you test this hypothesis? Clearly some countries are not financially open e.g. China, should you drop these from your sample? Perhaps you could refine your pooled probit by allowing country fixed effects and an interaction term between the home bias ratio and the country dummy. Test equality of coefficients within groups (Asia, EM Asia etc) using F tests.

14. Conclusions Some very worthwhile work on the nature and causes of financial instability. The papers were impressive in their scope and novelty. Should provide a knowledge base on which to base recommendations for regulatory reform and macro-prudential policy.