The dilemma facing Asian central banks is the ability to adapt to the risk of normalization of monetary policy in advanced economies, in particular the United States. Years of expansionary monetary policy in the US, with policy rates at almost zero, low long-term interest rates and expansionary balance sheet of the US Federal Reserve Bank, has reinforced a puzzling trend, the secular decline in real long term interest rates.
Given financial market interconnectedness, Asian financial markets are now more closely linked to long term interest rates in the US and this has introduced new constraints for Asian central banks’ monetary and policy choices, NewsNow reported.
The dilemma potentially facing Asian investment banks however are different. A trend that has occurred due to decline in real long term interest rates in the US is increased borrowing in international bond markets by Asian corporates. The money raised in the US is parked as deposits in Asian investment banks. This allows the Asian investment banks to expand their balance sheet.
Across the Asian financial markets space, investment banks that are locally driven, have tapped these deposits to the hilt and have influenced the domestic banking systems in an expansionary direction. It was literally the golden years for Asian based investment banks, more so for locally established ones. The key here is the risk of the US Federal Reserve Bank normalizing monetary policy, Asian domestic investment banking landscape face the risk of drying up of wholesale bank deposits. This in turn threatens to contract the overall liquidity in the banking system of many economies in Asia.
The question that begs to be asked is, are Asian investment banks prepared for prolonged years of contraction in their wholesale deposits? And would they be prepared to reorganize their modus operandi in light of new operating conditions in global financial markets?
Tie-Ups, Collaboration
In the past few years, the main staple for Malaysian investment banks has been businesses from government linked corporates, large family owned corporates with domestic and ASEAN operations as well as large bond issuance and underwriting.
Even after having tie-ups and collaboration with global investment banks success has been limited. This has been mainly due to lack of skilled investment banking professionals and know-how as well as the scarcity of globally oriented financial products.
Financial products currently offered by Malaysian Investment banks often have a domestic underlying financial instrument and/or has an ASEAN and Asian underlying theme that is susceptible to extreme global market volatility emanating from advanced economies.
The relevance for monetary policy in general and business strategy of Asian based investment banks, there are three links that need to be looked at:
1. The crowding out effect: When extremely easy external financing conditions allow large firms and corporates to borrow cheaply from abroad, local investment banks have to look for other domestic based customers that do not have the clout and ability to borrow from abroad. A tightening in external financing conditions could reverse this. Small firms and households might then find it difficult to obtain financing even if total domestic bank credit continues to rise.
2. Pro-cyclicality of deposits: When Asian corporates are awash with cash due to easy external financing conditions, they will increase their wholesale deposits with local investment banks. A rise in such deposits will allow bank credit to expand.
The problem is that such deposits are flighty whereby a worsening of external financing conditions for corporates can make it difficult for domestic investment banks to fund themselves at home, drying up liquidity rapidly.
3. Hedging does not eliminate risks: The third link is through the hedging activities of Asian corporates foreign exchange or maturity exposures that are often done via derivative contracts with local investment banks. Asian based investment banks during the period of quantitative easing by the US Federal Reserve Bank, have been able to expand their derivative desks by providing an array of hedging solutions and products. These products minimize risks for both Asian corporates and Asian based investment banks but it does not eliminate risks.
