International Capital Markets
Developments, Prospects, and Key Policy Issues
September 1997

Published by the International Monetary Fund
© 1997

Contents

Preface

1. Introduction

2. Developments and Trends in the Mature Markets
   1. Foreign Exchange Markets: Capital Flows and the Rise of the Dollar
   2. Credit Markets: Spread Compression and Increased Volumes
          Bond markets
          International bank loan markets
   3. Risks in Foreign Exchange and Credit Markets
   4. Equity Markets
   5. Expanding and Maturing Derivative Markets

3. EMU: Systemic Implications and Challenges
   1. Global Financial Adjustments After Introduction of Euro
   2. EMU and the Potential Benefits of European-wide Securities Markets
   3. Consolidation and Restructuring of European Banking Systems
   4. Systemic Risk Management in EMU

4. Developments and Prospects in Emerging Markets
   1. Capital Flows To Emerging Markets
          Private and official capital flows
          Financial instruments: bonds, equities, bank lending,
              and the use of derivative products
   2. Performance of Emerging Debt and Equity Markets
   3. Sustainability of Capital Flows and Speculative Attacks
          Speculative currency attacks

5. External Liability Management

6. Developments in International Banking
   1. Industrial Countries
   2. Banking System Developments in Emerging Markets
          Asian emerging markets
          Latin America
          Eastern Europe and Africa

7. Postscript: Emerging Market Currency Crisis of July 1997

8. Conclusions
   1. Mature Markets
   2. Structural Aspects of EMU
   3. Emerging Markets
          The role of the IMF
   4. External Liability Management
   5. Developments in International Banking

Appendices

1. Market Surprised by Yen's Appreciation in May 1997
2. Sovereign Ratings and Fundamentals
3. The Mechanics of Speculative Attacks
4. Building a Resilient Financial System in Hong Kong, China

References

Background Material—Part I: Recent Developments and Trends in Capital Markets and Banking Systems

1. Introduction

2. Recent Developments in Emerging Capital Markets
   1. Capital Flows, Reserves, and Foreign Exchange Markets
          Capital flows in the balance of payments
          Reserve accumulation
          Foreign exchange markets
   2. Bond Markets
          Secondary markets
          Primary issues
          Spread compression in emerging debt markets
   3. Equity Markets
          Secondary markets
          Primary markets
   4. Mutual Funds
   5. International Bank Lending
          Syndicated loans
          The interbank market

3. Developments and Trends in the Mature Capital Markets
   1. Introduction
   2. Exchange Rates
          Overview
          Interest differentials, capital flows, and the dollar's rise
          Volatility in foreign exchange markets
   3. Bond Markets
          Overview
          European Monetary Union and convergence plays
          Spreads in the dollar bloc countries and corporate markets
          Fundraising in fixed income markets
          Risks in fixed income markets
   4. International Syndicated Loan Markets
          Volumes and margins
          Structural developments
   5. Equity Markets
          Recent developments
          Risks to U.S. equity prices
   6. Derivative Markets
          Overview of recent developments
          Structural changes in derivative markets
   7. Developments in Systemic Risk Management

4. Developments in International Banking
   1. Restructuring and Consolidation of International Banking Systems
   2. Supervisory and Regulatory Developments
          Regulatory structure
          Capital requirements
          Supervision and regulation in emerging markets
   3. Developments in Profitability and Asset Quality in Selected Industrial Countries
          The next challenge: core profitability
   4. Banking System Developments in Emerging Markets
          Developments in Asian emerging markets
          Developments in Latin America
          Developments in European emerging markets

1. Extracting Information from Options Pricing
2. Have Securities Markets Become More Volatile?
3. A Comparison of U.S. Equity Prices to 1987 and Japan 1989
4. Trends in Fund Management
5. Circuit Breakers
6. Credit Derivatives
7. Accounting for Nonperforming Loans

Background Material—Part II: Selected Issues

1. Introduction

2. European Monetary Union: Institutional Framework for Financial Policies and Structural Implications
   1. Potential Size of EMU Financial Markets
   2. Institutional Framework for Financial Markets
          TARGET payments system
          The framework for EMU monetary policy
          Framework for general financial policies
   3. Euro as a Catalyst: Incentives for Continued Structural Change
   4. Structural Implications for Securities Markets: Further Securitization of European Finance
          EMU-wide repo and interbank markets
          EMU bond markets: a new focus on credit risk
          Equity markets
          Derivative markets
   5. Structural Implications for Banking Systems
          The EU banking system
          Single currency and restructuring of the EU banking system
          Financial institutions

3. Risk Management of Sovereign Liabilities
   1. Introduction
   2. Foreign Currency Exposure of Sovereign Liabilities
   3. Institutional Framework
          Separating debt management from monetary policy
          Debt management framework
   4. Strategic Management of Sovereign Liabilities
          Benchmarks for the foreign-currency debt portfolio
          Objectives
          Risks
          Macroeconomic constraints
          Institutional constraints
          Numéraire and horizon
          Analytical framework
          Selected examples of debt benchmarks
   5. Deviations from the Benchmark Portfolio
   6. Conclusion

4. Capital Flows to Emerging Markets—A Historical Perspective
   1. Earlier Periods of High Capital Mobility
   2. International Capital Flows after the First Oil Shock
          Capital flows in the 1973-89 period
          Capital flows in the 1990s
   3. Factors Stimulating Capital Flows and Renewed Market Access in the 1990s
          Structural changes
          Macroeconomic pull and push factors

1. ERM2
2. Remaining Impediments to Cross-Border Competition in Financial Services
3. Volatility and Correlation of Asset Returns in EMU
4. Remaining Impediments to Cross-Border Competition in Banking
5. Determinants of Balance of Payments and Banking Crises
6. Speculative Attacks in 1990s: Have Economic Models Got It Right Yet?
7. Liberalization of Capital Controls in Emerging Markets

Boxes

Background Material—Part I

1. The Brady Bond Market Comes of Age
2. Repackaged Brady Bonds
3. Emerging Market Currency Eurobonds: The Euro-rand Market

Tables

1. Net Foreign Purchases of U.S. Bonds, 1993-First Quarter 1997
2. Net Purchases of Domestic Bonds by Nonresidents, 1993-96
3. United States: International Transactions, 1990-96
4. One-Year Interest Differentials with Germany, February 28, 1995, January 30, 1997, and May 31, 1997
5. Domestic and International Debt Securities: Amounts Outstanding and Net Issues, 1995-First Quarter 1997
6. Announced International Syndicated Credit Facilities by Nationality of Borrowers, 1992-First Quarter 1997
7. Average Maturity and Spreads on Eurocredits, 1991-96
8. Major Industrial Countries: Equity Market Risk Adjusted Returns in Local Currency—Sharpe Ratios, 1990-94, 1991-95, and 1992-96
9. Markets for Selected Derivative Financial Instruments: Notional Principal Amounts Outstanding, 1986-96
10. Notional Principal Value of Outstanding Interest Rate and Currency Swaps Members of the International Swaps and Derivatives Association, 1987-June 1996
11. Total Foreign Exchange Reserves minus Gold in Selected Countries and Regions, 1995-96
12. European Union (EU), United States, and Japan: Selected Indicators on the Size of the Capital Markets, 1995
13. Private Capital Flows to Emerging Markets, 1990-96
14. Total Return Indices, 1990-First Quarter 1997

Background Material—Part I

1. Private Capital Flows to Emerging Markets, 1990-96
2. Secondary Market Transactions in Debt Instruments of Emerging Markets, 1993-First Quarter 1997
3. Bond Issues, Equity Issues, and Syndicated Loans, 1990-First Quarter 1997
4. Emerging Market Bond Issues: Fixed Rate, Floating Rate, and Call Options, 1990-First Quarter 1997
5. International Bond Issues by Emerging Markets by Currency of Denomination, 1990-First Quarter 1997
6. Stock Market Turnover Ratios and Value of New Equity Issues in Selected Countries and Regions, 1990-96
7. Medium and Long-Term Syndicated Loan Commitments: Interest Margins and Refinancings, 1990-1997Q1
8. Changes in Net Assets of BIS-Reporting Banks vis-à-vis Banks in Selected Countries and Regions, 1993-96
9. Merrill Lynch Global Investor Survey, 1992-97
10. Net Foreign Purchases of U.S. Bonds 1972-96
11. Net Purchases of Securities in Major Industrial Countries, 1986-96
12. United States: Selected External Account Variables, 1963-96
13. Major Industrial Countries: Bond and Equity Index Returns, 1995-97
14. One-Year and Seven-Year Interest Differentials with Germany, February 28, 1995, January 1, 1996, January 30, 1997, and May 31, 1997
15. Domestic and International Debt Securities: Amounts Outstanding and Net Issues, 1994-First Quarter 1997
16. Outstanding Amounts of International Debt Securities, 1993-First Quarter 1997
17. Outstanding Amounts and Net Issues of International Debt Securities by Currency of Issue, 1993-First Quarter 1997
18. Changes in Net Assets of BIS-Reporting Banks vis-à-vis Banks in Selected Countries and Regions, 1990-96
19. External Positions of Banks in Individual Reporting Countries, 1994-96
20. United States: Outstanding Repurchase Agreements (Repos), 1990-96
21. Equity Market Risk Adjustment Returns in Local Currency—Sharpe Ratios, 1983-96
22. United States: Net New Cash Flow To, and Total Assets of, Mutual Funds, 1984-May 1997
23. Annual Turnover in Derivative Financial Instruments Traded on Organized Exchanges Worldwide, 1986-96
24. New Interest Rate and Currency Swaps, 1987-95
25. Currency Composition of Notional Principal Value of Outstanding Interest Rate and Currency Swaps, 1987-June 1996
26. Bank Financial Strength Ratings for Selected Countries, June 2, 1997
27. Disintermediation in Selected Industrial Countries, 1985 and 1995
28. Japan and the United States: Summary of Prompt Corrective Action Provisions
29. Major Industrial Countries: Commercial Bank Profitability, 1985-94
30. Selected Asian Property Markets: Vacancy Rates and Changes in Rents, 1996-97
31. Loan Classification in Selected Emerging Markets

Background Material—Part II

1. European Union (EU), North America, and Japan: Selected Indicators on the Size of the Capital Markets, 1995
2. Amounts Outstanding of International Debt Securities by Currency and Country of Nationality, March 1997
3. Use of Selected Currencies on One Side of the Transaction, April 1989, April 1992, and April 1995
4. Notional Principal Value of Outstanding and New Interest Rate and Currency Swaps, 1995
5. European System of Central Banks: Open Market Operations and Standing Facilities
6. European System of Central Banks: Eligible Assets
7. Key Monetary Policy Operating Procedures in Industrial Countries and in the European Central Bank
8. Monetary and Supervisory Agencies
9. Deposit Insurance Schemes for Commercial Banks in the European Union and G-10 Countries, 1995
10. Permissible Banking Activities and Bank Ownership in the European Union and G-10 Countries, 1995
11. List of Bank Activities Subject to Mutual Recognition in the European Union
12. Components of Capital for Meeting the Capital Standards or Requirements in the European Union and G-10 Countries
13. Commercial Bank Supervisory Practices in the European Union and G-10 Countries, 1995
14. Mutual Funds, June 1996
15. European Union: Cross-Border Interbank Assets, 1992-96
16. Ratings of Foreign and Local Currency Debt of Sovereign Governments, May 29, 1997
17. European Union Countries, North America, and Japan: Foreign Currency Debt, 1996
18. Estimates of Credit Spreads for European Union Sovereigns, September 1996 and June 1997
19. Interest Rate Spreads of Canadian Provinces
20. The Euro Benchmark Yield Curve: Germany vs. France
21. Funds Raised in Capital Markets by Non-Financial Enterprises in Selected Industrial Countries, 1990-95
22. European Union (EU) Countries, United States, and Japan: Equity Markets, 1996
23. Banks' Restructuring: Number of Institutions and Size Concentration, 1980, 1990, and 1995
24. European Union Countries, North America, and Japan: Population per Bank Branch, 1985, 1992, and 1994
25. Mergers and Acquisition Activity in Banking, 1989-96
26. Net Interest Margins, 1989-95
27. Banks' Profitability
28. Long-Term Public and Publicly Guaranteed External Debt Outstanding and Reserves Excluding Gold in Selected Developing Countries, 1995
29. External Debt Profile of Selected Asian Countries, 1995
30. Institutional Structure of Debt Offices in OECD Countries: Debt Offices Within the Treasury
31. Institutional Structure of Debt Offices in OECD Countries: Autonomous Debt Offices
32. Institutional Structure of Debt Offices in OECD Countries: Debt Offices Within the Central Bank
33. Institutional Structure of Debt Offices in OECD Countries: Debt Offices Within the Ministry of Finance
34. Selected Crises, 1870-1914
35. External Financial Resources to Developing Countries
36. Moody's: Initial Ratings of Emerging Markets Countries, Prior to and Including 1989-First Quarter 1997
37. Implementation of the European Union Capital Adequacy and Investment Services Directives
38. Regulatory Constraints on Portfolio Investment of Institutional Investors in Selected Industrial Countries
39. Performance of Crises Indicators

Figures

1. Spot Exchange Rates, January 2, 1995-May 30, 1997
2. United States, Japan, and Germany: Interest Rate Differential, January 5, 1996-May 30, 1997
3. Major European Countries: Exchange Rates vs. Deutsche Mark, January 2, 1995-May 30, 1997
4. Implied Volatility: Japanese Yen and Deutsche Mark Three-Month Forwards, January 4, 1996-May 30, 1997
5. Selected European Long-Term Interest Rate Differentials with Germany, January 5, 1996-May, 30 1997
6. United States: Yield Spreads of Corporate Bonds over U.S. Treasuries, January 5, 1996-May 30, 1997
7. Yield Differential for the Ten-Year Government Bonds of Australia, Canada, and New Zealand, January 1, 1996-May 30, 1997
8. Stock Market Indices: Major Industrial Countries, January 1990-May 1997
9. Stock Market Indices: Smaller European Countries, January 1990-May 1997
10. United States: Equity Market Performance, 1926-May 1997
11. Composition of Private Market Financing for Emerging Markets, 1990-1996
12. Yield Spreads: Emerging Markets and High Yield U.S. Corporate Bonds, January 1992-May 1997
13. External Long-Term Public and Publicly Guaranteed Debt Outstanding, 1980-95
14. Thailand: Selected Financial Indicators, January 2-July 25, 1997
15. Financial Market Developments in Selected Asian Markets, January 2-July 25, 1997
16. Financial Market Developments in Selected Latin American Markets, January 2-July 25, 1997
17. Yield Curves in Selected Emerging Markets
18. Distribution for Japanese Yen/U.S. Dollar Exchange Rate in Early September 1997 Implied by Options Prices in May 1997
19. Emerging Markets: Sovereign Ratings and Fundamentals
20. Bank Receipts and Payments Arising from Forward Contract Operations

Background Material—Part I

1. Private Capital Flows to Emerging Markets, 1990-96
2. Total Reserves Minus Gold of Selected Emerging Markets, January 1990-May 1997
3. Exchange Rates of Selected Emerging Markets, January 1990-May 1997
4. Bond Markets: Selected Returns, Yields and Spreads, January 1992-May 1997
5. Yield Spreads for Selected Brady Bonds and U.S. Dollar-Denominated Eurobonds, January 1994-May 1997
6. Emerging Market Debt: Volatility and Correlation of Returns with Mature Markets, January 1993-May 1997
7. Brady and Eurobond Spreads
8. Composition of Private Market Financing for Emerging Markets, 1990-1996
9. Spreads and Maturities for Sovereign Borrowers, 1991-96
10. Equity Markets: Selected Returns, Price-Earnings Ratios, and Expected Returns, January 1993-May 1997
11. Equity Markets: Selected Volatilities, Return-Volatility Comparisons, and Correlations, January 1993-May 1997
12. Mutual Funds, 1990Q1-97Q1
13. Major Industrial Countries: Exchange Rates, 1994-May 1997
14. Major European Countries: Local Currency vs. Deutsche Mark, January 3, 1994-May 30, 1997
15. Major Industrial Countries: Real Growth in Broad Money Supply and Claims on Private Sector, 1980-First Quarter 1997
16. Major Industrial Countries: Short-Term Interest Rates, January 1994-May 1997
17. Major Industrial Countries: Long-Term Interest Rates, January 1994-May 1997
18. Bilateral Exchange Rates and Interest Differentials vis-à-vis the U.S. Dollar, January 1985-May 1997
19. United States: Foreign and International Holdings of Marketable Public Debt, 1980-96
20. RiskMetrics Daily Price Volatility for U.S. Dollar Spot Exchange Rates, January 19, 1995-May 30, 1997
21. Implied Volatility: Japanese Yen and Deutsche Mark Three-Month Forwards, December 5, 1995-May 30, 1997
22. Selected European Long-Term Interest Rate Differentials with Germany, January 7, 1994-May 30, 1997
23. Yield Differential for the Ten-Year Government Bonds of Australia, Canada, and New Zealand, January 4, 1994-May 30, 1997
24. United States: Yield Spreads of Corporate Bonds over U.S. Treasuries, 1962-May 1997
25. RiskMetrics Daily Price Volatility for Ten-Year Government Bonds, January 19, 1995-May 30, 1997
26. Spreads on Eurocredits, 1972-96
27. Major Industrial Countries: Stock Market Indices, January 1970-May 1997
28. United States: Corporate Profits and Market Capitalization, First Quarter 1965-First Quarter 1997
29. United States: Corporate Profits Volatility, First Quarter 1980-First Quarter 1997
30. Implied Volatility: S&P 500, Nikkei 225, and DAX Indices, January 7, 1994-May 30, 1997
31. Major Industrial Countries: Intermediation Spreads, 1990-96
32. Distribution for Japanese Yen/U.S. Dollar Exchange Rate in Early September 1997 Implied by Options Prices on May 20, 1997
33. Historical Stock and Bond Price Volatility in the United States, Japan, and Germany
34. United States and Japan: Developments in Equity, Bonds, and Money Markets Surrounding Significant Stock Market Increases

Background Material—Part II

1. Cross-Border Target Payment
2. Labor Costs and Productivity in Banking, 1994
3. External Long-Term Public and Publicly Guaranteed Debt Outstanding, 1975-95
4. Capital Mobility Index
5. Net Capital Outflows, 1880-1913
6. Net Capital Inflows, 1880-1913
7. Contribution of Capital Flows to Investment during 1870-1914
8. Capital Controls and Flows to Emerging Markets, 1982-96

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