Cross-border interbank lending flows fell by around 20% between 2008Q2 and 2010Q2. The largest crossborder banks – the “super-spreaders” – appear to have played a central role in instigating and propagating this global contagion (Hills and Hoggarth (2013)). (e)  Correlations among sub-systems  Another dimension when gauging risks to the macro-financial system is the correlation between layers of the system. For correlations between individual banks and the financial system as a whole, one metric is provided by looking at the common component within the joint distribution of bank equity prices. For example, the first principal component of UK bank equity prices accounts for around 70% of the overall movement in bank equities. At the time of the financial crisis, this common component rose to nearer 90%. These correlations are high and highly crisis-sensitive, suggesting a close link between individual and systemic bank risk. The picture is similar when looking at correlations between developments in the financial system and the wider economy. For example, the pairwise correlation between the financial and non-financial components of UK equity prices is high, at around 0.8–0.9. The picture is similar if we move from the national to the international level: the first principal component of international equity prices accounts for around 80–90% of the variation. Each of these  11  This analysis uses the Bank for International Settlements bilateral locational statistics. This does not capture flows between periphery countries, so there is a risk that it overstates the importance of the core.

This is how best to deal with common shocks to global safe and risky yields. One striking feature of the past few years has been the extremely high correlation among asset prices globally, in particular among advanced economies. This is true of both “safe” rates of return on government assets and “risky” rates of return on private assets (Chart 20). In either case, correlations are extremely high, hovering around 0.9. This begs a number of questions, both research and policy. What is the root cause of these correlations? One possibility is portfolio shifts by global asset managers, allocating their portfolio on an asset-by-asset basis. If so, what implications does this carry for national monetary and macro-prudential policymakers, seeking to steer safe and risky rates respectively? Do high global correlations strengthen the case for international co-ordination of monetary and macro-prudential policies? There may be greater scope to co-ordinate macro-prudential tools. One way of doing so is to develop macro-prudential instruments which operate on an asset-class basis, rather than on a national basis. This would be recognition that asset characteristics, rather than national characteristics, may be the key determinant of portfolio choices and asset price movements, perhaps reflecting the rising role of global asset managers. There has already been some international progress towards developing asset market specific macro-prudential tools, specifically in the context of securities financing transactions where minimum collateral requirements have been agreed internationally (FSB (2014)).