Since the crisis, a preference for debt markets over bank loans

A few things actually have changed since the financial crisis. Banks, for example, are no longer the primary suppliers of international credit. A new report by the Bank of International Settlements (BIS) shows that after the crisis, borrowers began to fund themselves through debt issuance instead. But because most of this debt is dollar-denominated, much of what's new has ended up affirming something very old: the world wants US dollars.

Let's start with what's new.

The BIS — the bank for central banks — finds that debt securities, not bank loans, have driven the surge in global liquidity since 2010. Between the turn of the century and 2008, bank loans' share of global GDP doubled to 20 per cent. But after a sharp contraction following the crash, bank loans have flatlined. One debt replaced another, and since then, international debt securities have grown. As of the first quarter of 2018, debt securities make up roughly 57 per cent of total international credit, up from 48 per cent in the first quarter of 2008. The BIS documents the shift here:

Not all countries have pulled back from bank loans at the same rate, however. Advanced economies have pivoted more dramatically to debt securities. Since the crisis, debt securities equal about 24 per cent of regional GDP, whereas the share held by bank loans has fallen below 18 per cent. Emerging markets, on the other hand, have seen both rise in tandem. Here's a side-by-side comparison:

The BIS takes a stab at why:

Bank loans to [advanced economies] has been declining – with the decline accelerating after the euro zone sovereign debt crisis. This was to a large extent driven by European banks reducing their international loan exposures in response to the GFC and the euro area debt crisis – in particular those denominated in US dollars to US residents...

Add to that the capital, leverage and liquidity requirements mandated by Basel III after the crisis, and it's no wonder banks in developed economies have been reluctant to lend. Global banks have not just pulled back on lending, either. As the dotted blue line in the above chart shows, they have also pared down their holdings of international debt securities, further relinquishing their roles as global liquidity providers to non-banks.

Now onto what's old.

The BIS data confirms a preference that's been held for more than 70 years now: borrowers want dollars. While some regions want dollars more than others (Asia and Latin America are hooked, central and eastern Europe less so), dollar-denominated issuance has outpaced euro-denominated and yen-denominated credit creation at a faster rate since 2008. The below chart shows just how much the gap has widened:

Paying back dollar-denominated debt hurts more when the dollar is strong. From Turkey to Argentina, emerging markets painfully (re)learned this lesson over the last nine months, as the following chart from Oxford Economics shows:

While the dollar has weakened in recent weeks, investors have ample reasons to lift it higher: We have new tariffs. China's growth slowdown is starting to weigh on the global economy. And tomorrow, the Federal Reserve is all but guaranteed to raise interest rates.

Related Links:
Most bonds don't trade - FT Alphaville

Global liquidity is drying up - FT Alphaville
One more reminder that the US dollar is dominant - FT Alphaville