McKinsey Global Institute report ~ Global capital markets: Entering a new era

[Slimprofits]

http://www.mckinsey.com/mgi/publicat...ve_summary.asp

Capital flows not only fell, but most types went into reverse as investors, companies, and banks and other financial institutions sold foreign assets and brought their money back to their home countries. As in past financial crises, cross-border lending accounted for much of the overall decline.8 It fell from $4.9 trillion in 2007 to minus $1.3 trillion in 2008 (Exhibit 8). This indicates that lenders withdrew more cross-border loans—canceling or not renewing lines of credit, not rolling over loans, and so on—than they made. About 40 percent of this decline was due to the drying up of interbank lending after the collapse of Lehman Brothers in September 2008. But the majority reflects the withdrawal of foreign lending to nonbank borrowers, particularly in emerging markets. In the worst-hit countries, foreign bank credit contracted by as much as 67 percent.

The plunge in cross-border lending, for instance, is causing many governments to reconsider the advisability of allowing foreign banks to dominate the local economy. Particularly in Eastern Europe and in Latin America, the crisis forced local subsidiaries of foreign banks to withdraw credit as the capital adequacy of the home bank came into question. This reaction partly reflects the well-known “home bias” in the investments of both investors and bankers, who tend to give more weight to local investments than foreign ones. However, the withdrawals also resulted from political pressures on banks to maintain or even increase domestic lending in return for government support. Policy makers are now weighing the benefits of foreign banks—that they increase competition and provide more efficient financial intermediation—against the costs of abrupt declines in funding.

In the United States, the bond market plays a bigger role than the traditional banking sector. Loans held on bank balance sheets in the United States account for just 20 percent of total credit outstanding (Exhibit 18). The rest comprises multiple other forms of credit. Thus, the assets of traditional, deposit-taking banks in the United States have been surpassed in size by those of other institutions we refer to collectively as the “nonbank financial system” (Exhibit 19). Restoring health to US credit markets, therefore, will require more than boosting bank lending; also essential will be reviving securitization and other forms of credit.

In the eurozone and the United Kingdom, in contrast, traditional banks played a much larger role than nonbanks in the borrowing boom. On-balance sheet loans by banks account for 44 percent of credit outstanding in the eurozone and 46 percent in the United Kingdom (Exhibit 20). The securitization markets in the eurozone and UK have grown rapidly, but each is the source of less than $1 trillion in outstanding credit—and therefore remains much smaller than the $9 trillion US market. Thus, for Western Europe in the short term, restoring the health of the banking sector is critical to repairing the financial system. In the longer term, it may also help to foster the growth of bond markets and securitization markets as alternative sources of financing.

Over the next two years, in the United States alone, $1.5 trillion of financial institution debt will roll over.

Writers goes on to speculate a little bit into how securitization could develop in emerging markets. Register (for free) in order to download the report.