Yesterday, the Bank for International Settlements (BIS), an international organization that serves as a bank for central banks, publlishedthe BIS Quarterly Review, September 2009 International banking and financial market developments. The report includes an overview of recent developments in financial markets and detailed highlights from the latest BIS data on international banking and financial activity. The report concludes that, although markets have "continued to show signs of normalizing, as risk tolerance edged further upwards and risk premiums receded," there should be "cautious optimism on gradual recovery."

The report also presents four special feature articles:

1) The future of securitization: how to align incentives? - This article reviews the recent collapse of global securitization markets and the loss of investor confidence in them, along with recommendations for measures that could revive and strengthen the securitization process, including "reducing the complexity of securitized instruments, enhancing the availability and quality of information, and improving the reliability and use of ratings." A "revival" in the securitization market would require "the entry of new investors into the market, which can happen only once confidence has been restored." Moreover, "action will need to be taken with respect to all market segments, including those that have not suffered from the same misaligned incentives as US subprime mortgage markets." In a similar vein, the Obama administration's regulatory reform plan has called for risk retention and transparency in securitization markets, including risk retention requirements for securitizers and secondary market disclosure requirements.

2) Central counterparties for over-the-counter derivatives - The article calls for "wider use of central counterparties (CCPs) for over-the-counter derivatives" in order to "potentiaal[ly] improve market resilience by lowering counterparty risk and increasing transparency." Among other benefits, the introduction of well designed CCPs "help[s] bring about significant gains in operational efficiency through the standardization of risk management and more efficient management of collateral," "improves market transparency" and "should increase the amount of collateral and capital available to absorb potential losses." Late last week, the Securities and Exchange Commission adopted amendments to interim final temporary rules that provide exemptions for certain credit default swaps (CDS) in order to facilitate the operation of one or more CCPs for those CDSs. Congress has also introduced several legislative initiatives dealing with the regulation of derivatives in general, and CDSs specifically, which have been recommended by Treasury, and the Committee on Payment and Settlement Systems and the Technical Committee of the International Organization of Securities Commissions have established a working group to evaluate the application of recommendations made by both groups for CCPs with respect to OTC derivatives.

3) The cost of equity for global banks: a CAPM perspective from 1990 to 2009 - This article describes a study undertaken to estimate the cost of equity for banks headquartered in six countries over the period from 1990–2009, using the single-factor capital asset pricing model used by the Federal Reserve. The cost of equity is an "important input for bank management when raising capital and making investment decisions and for investors when they value equity securities and construct their portfolios." According to the study, "the real cost of equity decreased steadily across all countries except Japan from 1990 to 2005 but then rose from 2006 onwards." The primary contributors to the period of decline include "the fall in real risk-free rates," and "the banking sector risk premium, which represents more than two thirds of the estimate."

4) The systemic importance of financial institutions - This article presents a methodology that "takes as inputs measures of system-wide risk and allocates them to individual institutions," in order to "quantify the impact of the various drivers of an institution’s systemic importance," including "riskiness on a standalone basis, their exposure to common risk factors and the degree of size concentration in the system." Applying its methodology to 20 unnamed large financial institutions, the report concluded that "there is a clear rationale for having tighter prudential standards for larger institutions," and that large banks risks to the system "generally increases more than proportionately with its size." The G20 finance officials who met in London earlier this month identified the implementation of stronger regulation and oversight for systemically important firms as a key action item to ensure the strengthening of the global financial system