The Bank for International Settlements says that risk tolerance has been rising since mid March, as credit market conditions have improved, and the climate for many asset classes has improved, too.

The BIS released its latest quarterly review today, which reports that, “Following deepening turmoil and rising concerns about systemic risk in the first two weeks of March, financial markets witnessed a cautious return of investor risk tolerance over the remainder of the period up to end-May 2008.”

“The process of disorderly deleveraging which had started in 2007 intensified from end-February, with asset markets becoming increasingly illiquid and valuations plunging to levels implying severe stress. However, markets subsequently rebounded in the wake of repeated central bank action and the Federal Reserve-facilitated takeover of a large U.S. investment bank,” it adds. Although, the BIS allows that interbank money markets have failed to recover, as liquidity demand remained elevated.

Mid-March was a turning point for many asset classes, it says. “Amid signs of short covering, credit spreads rallied back to their mid-January values before fluctuating around these levels throughout May. Market liquidity improved, allowing for better price differentiation across instruments,” it says. “The stabilization of financial markets and the emergence of a somewhat less pessimistic economic outlook also contributed to a turnaround in equity markets.”

In this environment, government bond yields bottomed out and subsequently rose considerably, the BIS observes. “A reduction in the demand for safe government securities contributed to this, as did growing perceptions among investors that the impact from the financial turmoil on real economic activity might turn out to be less severe than had been anticipated,” it explains. “Emerging market assets, in turn, performed broadly in line with assets in the industrialised economies, as the balance of risk shifted from concerns about economic growth to those about inflation.”

In the international debt securities markets, net issuance remained broadly stagnant in the first quarter of 2008, declining to $360 billion, the BIS says. The fall in net issuance of bonds and notes came chiefly from the Euro-denominated segment, also net issuance of bonds and notes by private financial institutions in developed countries continued to fall markedly, as did the issuance of mortgage-backed bonds.

Trading on the international derivatives exchanges rebounded in the first quarter of 2008, it reports. The total turnover based on notional amounts increased from the previous quarter’s $539 trillion to $692 trillion in the latest quarter, resulting in year-on-year growth of 30%. Most of the increase was observed in derivatives on short-term interest rates. Gains in turnover were also seen in derivatives on long-term interest rates and foreign exchange. In contrast, turnover in derivatives on stock indices showed a slight decline.

The over-the-counter derivatives market also showed relatively steady growth in the second half of 2007, the BIS notes. Growth was particularly strong in the credit segment, and notional amounts of all categories of OTC contracts increased by 15% to $596 trillion at the end of December, following a 24% increase in the first half of the year. Other segments, including markets for foreign exchange, interest rates and commodity derivatives, were also robust, each recording double digit growth. By contrast, the equity segment posted a negative growth rate.

In the international banking market, activity continued to expand in the fourth quarter of 2007. A significant portion of this increase was accounted for by new credit to emerging markets, with claims on Asia-Pacific and Africa and the Middle East expanding the most, it says. In addition, there were large movements in reporting banks’ liabilities to key emerging markets; while some central banks reduced their holdings of reserves in commercial banks, Middle East oil exporters deposited record amounts in banks abroad, as did the banking sector in China.