1/3  First, the greater role of hedge funds and other unregulated entities in our financial system today requires more attention by the major banks and investment banks to counterparty risk management. The greater diversity of participants in risk intermediation is probably on balance a positive thing for our financial system. Hedge funds, private equity funds and other kinds of investment vehicles help to disperse risk and add liquidity. Their greater prominence in our markets, however, means that banks and investment banks face a heightened challenge in managing the risks involved in their exposure to these firms and in understanding the firms’ ability to weather conditions of stress and their impact on market conditions in those circumstances. The degree of the systemic risk presented by the growth in the leveraged, unregulated financial institutions depends in part on how well the major dealers manage these challenges. Market practice in these areas has improved significantly since 1998, but progress has been uneven across the dealer community, and competitive pressures have caused some erosion in counterparty discipline relative to the risks in exposures.
BIS Review 159/2010  7  Recent data suggest that the recovery in domestic demand is slightly stronger than expected and that a more moderate growth process was assumed in the second half of the year. Indicators pertaining to private sector demand indicate that private sector consumption and investments continued to rise rapidly in the third quarter in annual terms (Figure 21). Consumption and investment expenditures are likely to accelerate in the final quarter of the year with the support of the counter-cyclical stance of monetary and fiscal policies as well as strengthening capital inflows. The steady rise in credits confirms continuing recovery in economic activity (Figure 22). Another noteworthy point about this period is that credit expansion continues to extend across a greater part of our economy in terms of both sectors and scale. Low interest rates and easing credit risk indicators suggest that credit growth will be strong, and therefore, the credit channel should continue to underpin domestic demand over the forthcoming period. 8  BIS Review 159/2010  As supply-side constraints have widely subsided, we believe that credit realizations rather reflect the dynamics pertaining to credit demand. The Loans Tendency Survey suggests that the borrowing motivation of firms tends to change in the post-crisis period. Firms used to demand credits to facilitate debt rollover or to finance their working capital during the crisis. However, as the effects of the crisis tapered off, loans for rolling over debts decreased while loans for investment purposes increased (Figure 23).