- 2018-12-11
Global cross-border capital flows: shocks and challenges
The global cross-border flow of capital is accelerating, which poses higher challenges to the economic policies of different regions, and China is no exception. The Bank for International Settlements (BIS, also known as the Bank for International Settlements) and the Reserve Bank of New Zealand (the Central Bank of New Zealand) recently co-organized a conference "Cross-border Financial Links: Challenges to Monetary Policy and Financial Stability". This article is an introduction to the conference proceedings.
The ever-expanding global financial links are increasingly influencing policy. The Governor of the Reserve Bank of New Zealand (Graeme Wheeler) pointed out that after the international financial crisis, countries in the Asia-Pacific region have experienced particularly rapid growth in financial capital flows. He emphasized that capital account liberalization is a powerful reform measure, because greater cross-border financial links can greatly improve the efficiency of resource allocation. At the same time, he also warned that cross-border capital flows pose challenges to monetary policy and financial stability. Monetary policy has to face huge uncertainties in exchange rate transmission channels; and global financial market conditions may lead to unreasonable appreciation of the real effective exchange rate, which will distort the allocation of resources in the economy, thus inhibiting long-term economic potential. Wheeler also reminded that cross-border financial links may have an important impact on financial stability, and the herd behavior of international investors often causes international capital flows to magnify financial shocks.
The Bank for International Settlements (BIS) has always compiled relevant data on cross-border bank lending and securities, and has paid more attention to research in these areas in recent years. Borio (2014) pointed out that cross-border financial links will cause the international financial system to magnify financial imbalances. During the credit boom, the inflow of external credit will cause the economy to get rid of domestic credit, which greatly increases the probability of a financial crisis (Borio et al., 2011). At the same time, cross-border U.S. dollar loans and U.S. dollar bonds have increased, reflecting the key role of the U.S. dollar to developing Asian countries. The dominance of the US dollar will cause the U.S. monetary policy and leverage cycle to be transmitted to other countries, thus affecting the financial environment of these countries (McCauley et al., 2015).
In addition, the channels through which cross-border financial links have an impact are also evolving. For example, in the post-financial crisis period, there has been a shift in financing channels from international banks to global bond markets, or the “second stage” of global liquidity (Bruno and Shin, 2015). This trend has contributed to the strong expansion of domestic bank credit in many Asian countries (Shin and Turner, 2015). In addition, when tracking corporate risks, regulators should also consider the transfer between offshore and onshore bond issuance (Mizen et al., 2012). In general, borrowers and lenders from emerging markets are playing an increasingly important role in the global bond market, linking long-term interest rates more closely (Turner, 2015).
Cross-border financial link model
Curculu, Thomas, and Warnock pointed out in their papers on cross-border investment portfolios that emerging markets in Asia were relatively unaffected by the global financial crisis, mainly due to the limited external connections in the region. The author combined several database materials to compare the structure of emerging Asian cross-border financial links with advanced economies. The analysis focuses on illiquidity adjustment. This concept covers the impact of asset prices, exchange rate changes, and other statistical adjustments. The illiquidity adjustment loss of emerging Asian economies from 2006 to 2011 is estimated to be approximately US$600 billion, which is very small relative to GDP. Such limited losses reflect the relatively small scale of Asian foreign investment and relatively small yields. The significant local preferences in investment also indicate that it is also important to consider the risks from the domestic investment portfolio when assessing the overall investment portfolio risk of a country.
Ehlers and Wooldridge's paper on the channels of foreign bank loans and their determinants focused on international banking in the Asia-Pacific region. International banking can include operations carried out locally by branches of international banks in the host country, as well as cross-border operations carried out outside the host country. The development status and vulnerability of the borrowing country’s banking industry will affect the form of foreign loans: foreign banks tend to lend locally to economies with weak or underdeveloped banking systems; while in economies with stable or developed banking systems, cross-border loans More common.
Ehlers and Woodridge also paid attention to another feature of financial links in the Asia-Pacific region: the regionalization of banking activities. Today, the creditor base of Asia-Pacific economies is more diversified than in the past. In particular, they have become increasingly dependent on funds provided by regional banks. This trend may enhance the region’s response to adverse shocks brought by creditor countries outside the region. However, another risk may increase: cross-border funds in the region are mainly denominated in U.S. dollars, and these U.S. dollar funds may not fully hedge currency risks.
Foreign exchange market and exchange rate risk
The research of Levich and Packer shows that the development of the foreign exchange market in the Asia-Pacific region is faster than that of other regions. The three-year survey report on the development of foreign exchange and derivatives markets released by the Bank for International Settlements in 2013 showed that the currency trading volume (especially RMB) of developed countries and emerging Asian economies is much higher than the rapid growth of the global average. The turnover of all products in the Asian foreign exchange market (such as spot and derivatives transactions, onshore and offshore markets, etc.) has expanded rapidly.
A variety of simultaneous payment (PVP) systems such as CLS Bank have significantly enhanced the institutional guarantees for transactions in the foreign exchange market, despite the relatively loose regulatory and reporting requirements in these markets. In addition, the herding behavior in foreign exchange transactions has become less obvious in recent years. The relative stability of the regional foreign exchange market during the “shrinking panic” period in 2013 reflects these development trends. During this period, currencies in the Asia-Pacific region have generally suffered less depreciation pressure than other regions, although exchange rate fluctuations have also increased. Compared with 2008-2009, the market price did not deviate significantly from the interest rate parity, and the bid-ask quotation spread did not fluctuate significantly. And compared with earlier periods, the withdrawal of arbitrage trading is relatively orderly.
Levic and Parker put forward two policy recommendations to further strengthen the security and resilience of the foreign exchange market in the Asia-Pacific region. First, more countries should adopt CLS or other PVP systems for their currencies. Second, it is necessary to improve and regularly publish the crowdedness metrics of foreign exchange market trading activities to remind the fragility of the financial market.
Based on his earlier research, Munro wrote in "Exchange rates, expected returns and risk: what can we learn from Asia-Pacific currencies?" (Exchange rates, expected returns and risk: what can we learn from Asia-Pacific currencies? ) An article analyzes the risks and benefits of Asia-Pacific currencies. This paper proposes a more sophisticated method to test the non-covering interest rate parity (UIP) theory. The deviation of UIP estimated according to standard methods is usually very significant, possibly because certain risks have not been fully considered. Especially after taking into account the bond premium, the estimated exchange rate's response to changes in expected returns is very close to theoretical predictions. The empirical results of the paper also show that policy makers do not have to be limited to the "corner point" solution: through exchange rate management, Asian countries can reduce their control of interest rates when trading, thereby reducing exchange rate fluctuations.
Regional financial market spillovers
The papers of Shu, He, Wang, and Dong focused on comparing the impact of the US and Chinese financial markets in the Asia-Pacific region. There is a lot of literature on the spillover effects of the US financial market on the global market, and many other research articles have also analyzed China's global influence in the real economy. This paper attempts to systematically study the spillover effects of China's financial markets on the financial markets of the Asia-Pacific region for the first time, and compares them with the corresponding effects in the United States. Empirical analysis shows that the trend of China's stock and foreign exchange markets has been quite influential in the region. Under normal market conditions, the influence of the Chinese stock market in the region is close to that of the U.S. stock market, although the U.S. market still dominates during periods of tension. The trend of the renminbi is one of the important driving forces of regional currencies. In contrast, the Chinese bond market has no impact on other financial markets in the region.
Global liquidity
Helene Rey's keynote speech explained how large-scale capital flows affect the international transmission of monetary policy. In recent years, there have been several trends that are obvious to all: large-scale global credit growth; increased synergy of capital flows; global cycles of risky asset prices. Rey’s speech explained these phenomena based on a series of studies she and her collaborators completed.
Rey built a theoretical model to demonstrate the role of financial intermediation and leverage in the transmission of global financial conditions. Compared with Bruno and Shin (2014), which mainly focuses on the analysis of global banks, Rey's model includes multiple types of financial intermediaries including banks and asset managers. The price of risky assets in the global financial market proved to be dependent on a global factor. This global factor is a function of actual volatility and comprehensive risk appetite over time. And this total comprehensive risk appetite depends on the risk appetite of various investors and their leverage.
Rey empirically evaluated the impact of the central country's monetary policy on global credit conditions and the risk appetite of multinational banks. A global factor extracted by the dynamic factor model can explain a considerable part of the fluctuations in the returns of global risk assets. A deeper analysis based on the large-scale Bayesian VAR model shows that the U.S. monetary policy is one of the important drivers of credit growth in the country and other countries, especially affecting the cross-border credit flow and leverage of European banks. Therefore, even in countries with flexible exchange rates, the US monetary policy can affect their domestic financial environment.
Rey concluded that major central banks have driven the global liquidity cycle; for economies affected by the cycle, the policy dilemma has changed from a "trilemma" to a "dilemma" between free capital flow and independent monetary policy. Under such circumstances, macroprudential policies can help strengthen the independence of monetary policy.