Corporate Bond Markets - Robust Credit Cultures a Key to Development

Post the recent global economic crisis, there has been a significant shift in powers from developed nations to emerging market economies (EMEs). The sovereign crisis of European Countries, famously called as PIIGS (Portugal, Ireland, Italy, Greece and Spain) have questioned the dominance of emerging nations. In order to boost the economy growth, several developed nations have pledged to keep their interest rates at or near zero for an elongated period. The sovereign ratings of PIIGS have been cut and their fiscal deficits have reached to a record high.

The Asian story depicts a different perspective; the strong domestic consumption especially in India and China has led to the rally in the economy which has forced the central banks and governments to roll back their accommodative measures to tame the inflation. Out of these issues, it remains an important question how developed our bond markets – government bonds and corporate bonds are and it helps in measuring the pulse of the economy.

While the Asia-Pacific countries have made a good progress in developing local corporate bond market, they have a long way to go ahead. In India, Government Securities market are fairly developed on account of large quantum of government borrowings which have led to active trading and price discovery in securities of all tenures. However, in corporate bond market, we have a long way to go.

M. T. Raju, Upasana Bhutani and Anubhuti Sahay (2004) in their working paper “Corporate Debt Market in India – Key Issues and Policy Recommendations” have rightly pointed out for the need of “Single Trading Platform” instead of different platforms operated under NSE, BSE and FIMMDA. It tells that the different platforms allow liquidity bifurcated. They also emphasized the need of repo market in corporate debt. Recently, the RBI allowed the repo trading in corporate bond which might provide the liquidity in corporate bonds.

In another commentary report by Standard & Poors – “Fostering Robust Credit Cultures Is Key to Developing Deep and Liquid Corporate Bond Markets in Asia-Pacific”, Thomas G Schiller rightly pointed out that many Asia-Pacific seek to build market maturity and sophistication so as to attract many issuers to their countries. They have been emphasizing on robust credit cultures which are built on key elements such as transparency, independent and objective credit analysis, risk-based pricing, creditors’ rights and arm’s length relationships. In his commentary, he explained about the growing and maturing corporate bond markets in Australia, Hong Kong, Japan, Korea, Malaysia, New Zealand, Singapore, and Taiwan, and emerging markets in China, India and Thailand. About India, he mentions that India is a mostly sound credit culture that is still improving in some areas such as creditors’ rights. India’s corporate bond market is small but growing rapidly. Issuance grew by about 60 per cent over the two years to end-financial year March 31, 2010. However, the recent regulatory developments are enabling bond market development, including: the easing of issuance and listing requirements; the enhancement of disclosure requirements for issuers; the clearing of bonds through stock exchanges; and the introduction of credit default swaps (CDS) and interest rate swaps. He concluded that the process of building capital markets in banking dominated environment is a long and laborious one because it involves changing of a country’s business culture.

Read more about other countries here.
Happing Reading!

- Amar Ranu

(Permission sought from S&P to post their articles on this blog)

Policy Tools post Global Financial Crisis – US Perspective

Since 2008, the world economy is in bad shape! Post the Lehman fall in Wall Street in 2008, the contagion effect ran scathe through the entire global economy. The governments in conjugation with their respective Central Banks announced a series of monetary and fiscal policies which helped in containing the reversal in growth and boost the economy. Also many countries announced bail out programs for many of its big institutions who had over leveraged themselves and became a victim of sub-prime crisis.

It is largely considered that the world biggest economy, United States defines the path of the market and the world market swings around it. Since the financial crisis that emerged in summer of 2007, the Federal Reserve used various liquidity and credit programs and other monetary policy tools. These tools aimed at addressing severe liquidity strains in key financial markets, cultivating faster economic recovery by lowering the longer-term interest rates and providing ready available credit to troubled and fractured financial institutions.

Here is a brief about the different policy tools used by Federal Reserve; these tools are widely used by other countries too.

Open Market Operations – The Federal Reserve considers it as the principal tool for implementing monetary policy. The objective of OMO can be a desired price (Federal Funds rate) or a desired quantity of reserves. The federal funds rate is the interest rate at which the depository institutions lend balances at the Federal Reserve to other depository institutions overnight (similar to Call rate in India).

However, Fed objectives on OMOs have varied over the years. During the 1980s, it concentrated on attaining the specified level of the federal funds rate and in 1995, it explicitly targeted federal fund rates. Table 1 explains the movement of Fed’s fund rates.

The Discount Rate – It is the interest rate charged by the Federal Reserve Bank to commercial banks and other financial institutions on loans under its lending facility – the discount window (Similar to Call Money in Overnight Segment). The Federal Reserve Bank offers three discount windows to depository institutions – primary credit, secondary credit and seasonal credit, each with its own discount rate. All discount window loans are fully secured.

In the primary credit program, the loans are extended for a very short term (usually overnight) for financially sound institutions. Those institutions which are not eligible for primary credit may apply for a secondary credit to meet short-term liquidity needs or to resolve severe financial difficulties. Seasonal credit is extended to relatively small depository institutions that have recurring intra-year fluctuations in funding needs, such as banks in agricultural or seasonal resort communities. The rates charged are minimum in Primary Credit followed by Secondary Credit while the discount rate for seasonal credit is an average of selected market rates.

Reserve Requirements

Against specified deposit liabilities, the banks are required to hold a minimum percentage of holding in reserve in the form of vault cash or deposits with Federal Reserve Banks. Reservable liabilities consist of net transaction accounts, non-personal time deposits and Eurocurrency liabilities. Since Dec 27, 1990, non-personal time deposits and Eurocurrency liabilities have had a reserve ratio of zero. Beginning Oct 2008, the Federal Reserve Banks will pay interest on required reserve balances and excess balances. The table 2 shows the reserve requirements as decided by Federal Reserve.

Interest on Required Balances and Excess Balances

The Federal Reserve pays interest on required reserve balances – balances held with Federal Reserve to satisfy reserve requirements and on excess balances – balances held in excess of required reserve balances and contractual clearing balances.

The interest rate on required reserve balances and excess balances is determined by the Federal Reserve Board. It gives the Federal Reserve an additional tool for the conduct of monetary policy.

Term Asset-Backed Securities Loan Facility

The Term Asset-Backed Securities Loan Facility (TALF) is a funding facility that will help market participants meet the credit needs of households and small businesses by supporting the issuances of asset-backed securities (ABS) collateralized by loans of various types to consumers and businesses of all sizes.

Under the TALF, the Federal Reserve Bank of New York (FRBNY) will lend up to $200 billion on a non-recourse basis to holders of certain AAA-rated ABS backed by newly and recently originated consumer and small business loans.

Term Deposit Facility

It is a new tool announced in 2010 by which the Federal Reserve can manage the aggregate quantity of reserve balances held by depository institutions. It will facilitate the implementation of monetary policy. Funds placed in term deposits are removed from the accounts of participating institutions for the life of the term deposit and thereby drain reserve balances from the banking system. Reserve Banks will offer term deposits through the Term Deposit Facility (TDF), and all institutions that are eligible to receive earnings on their balances at Reserve Banks may participate in the term deposit program.

While the above mentioned policy tools are currently operative, some of the programs has been wound down on improved economic scenario. The Money Market Investor Funding Facility expired on Oct 30, 2009, and the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Primary Dealer Credit Facility, and the Term Securities Lending Facility were closed on February 1, 2010. Also, the final Term Auction Facility auction was conducted on March 8, 2010.

The world dynamics has changed; so with geo-political issues. PIIGS (Portugal, Ireland, Italy, Greece, Spain), once a flying and splendid investment horizon have been on the verge of sovereign crisis. We believe that the Keynesian has left a strong theory to be followed by US which have initiated many quantitative programs – QE-I (worth Trillion dollars) followed by QE-II (worth US$ 600 billion). 

Happy Reading!

Source: Federal Reserve