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The financial stability implications of increased
capital flows for emerging market economies
Dubravko Mihaljek
Bank for International Settlements
Presentation at the Economics Institute Zagreb
Zagreb, 11 November 2008
The views expressed are those of the author and not necessarily those of the BIS.
1
Outline
1. Data description
2. Recent trends in capital flows to/from EMEs
3. Financial stability implications of increased capital flows
– Focus on bank-intermediated capital inflows and CEE
– Policy responses
– Financial stability implications of debt portfolio outflows
2
Data description

Focus (mostly) on private capital flows

Gross vs. net flows

•
Gross flows: to study financial integration, financial stability
issues; composition of flows important for macroeconomic
management
•
Net flows: key for macroeconomic (demand) management
Sample
•
Mostly 2001-2006
•
Some comparisons with 1990s
•
3 EM regions: Asia and Latin America, CEE (Baltics, central
Europe, SEE)
3
Data description (2)
 Data sources
•
BoP data (IMF, International Financial Statistics)
•
BIS: locational and consolidated statistics
 Look at average of countries in the region, and regional
totals:
n
n
1 KFi
vs.

n i 1 Yi
 KF
i
i 1
n
Y
i 1
i
4
Recent trends – gross inflows
All emerging markets
Asia
16
16
Gross inflows
Gross outflows
12
12
8
8
4
4
0
0
1990
1994
1998
2002
2006
-4
-4
1990
1994
1998
2002
2006
% of GDP, regional totals
10
22
8
5
Recent trends – gross inflows (2)
Central and eastern Europe
Latin America
10
22
8
16
6
10
4
4
2
-2
0
1990
1994
1998
2002
2006
1990
1994
1998
2002
2006
% of GDP, regional totals
6
Recent trends: regional distribution
Share in gross inflows of private capital to EMEs, %
1995
2006
CEE
11
26
Asia
51
47
Latin America
29
12
Other EMEs
9
19
7
Gross inflows and outflows for CEE
Inflows
Outflows
% of GDP, unweighted country average; except net flows (regional average).
8
Net flows to CEE - latest data
Net private capital flows to CEE - Oct. 2008 WEO
% of GDP, regional total
12
9.5
10
8.2
7.8
8
3.1
7.5
5.8
6
4.0
3.5
0.5
0.6
3.3
3.4
2008
2009
0.7
4
2
4.4
0
4.1
-0.4
-2
2006
Direct investment, net
2007
Private portfolio flows, net
Other private capital flows, net
9
Recent trends – breakdown of gross inflows
10
Recent trends – breakdown of gross outflows
11
Portfolio outflows
- mostly for purchases of foreign debt securities
- mostly from China (70% of Asian total, $140 bn. from 2002-06)
- “private” sector probably includes SOCBs
12
% of gross outflows
Two main developments from FS perspective:
(a) “other” investment inflows; (b) portfolio outflows
“Other” investment: flows to banks and to other sectors nonfinancial corporations, NBFIs, households
80
Gross inflows of other investment
80
60
60
40
40
20
20
0
0
-20
-20
Trade credit
EME total
Loans
Asia
Currency and
deposits
Latin America
Other
liabilities
CEE
Gross outflows of other investment
Trade credit
EME total
Loans
Asia
Currency and
deposits
Latin America
% of gross inflows/gross outflows of “other investment”; unweighted country average for 2004-06.
Other assets
CEE
13
Other investment flows increased very strongly in CEE
External positions of BIS reporting banks vis-à-vis emerging market countries
Amount outstanding
USD billions
Emerging markets1
Vis-à-vis all sectors
Vis-à-vis non-bank private sector
Asia2
Vis-à-vis all sectors
Vis-à-vis non-bank private sector
Latin America3
Vis-à-vis all sectors
Vis-à-vis non-bank private sector
Central and eastern Europe4
Vis-à-vis all sectors
Vis-à-vis non-bank private sector
Per cent of GDP
1998
2002
2007
1998
2002
2007
1,017
366
865
354
2,290
914
19.3
6.9
14.6
6.0
17.3
6.9
574
105
442
87
1,068
270
26.6
4.9
14.7
2.9
16.9
4.3
263
170
233
156
350
213
13.9
9.0
15.1
10.1
11.1
6.8
82
44
118
70
579
289
12.1
6.5
16.5
9.8
32.4
16.2
Assets of BIS reporting banks vis-à-vis individual emerging market countries; end of period. Totals for positions
in US dollars; simple averages for positions as a percentage of GDP.
Sources: IMF; BIS locational banking statistics.
14
The increase was most pronounced in the past three years
Cross-border claims of BIS reporting banks
vis-à-vis emerging markets
Changes in amounts outstanding at end-period, as a percentage of GDP
Cumulative increase in CEE since 2005:
7.5% of GDP
5.7% of GDP
Vis-à-vis banks
Vis-à-vis non-the bank private sector
4.0
4.0
3.4
Asia
Latin America
CEE
3.0
2.9
2.0
1.7
1.4
1.0
1.5
2.0
1.5
1.2
1.2
0.7
3.0
3.0
1.2
1.0
0.7
0.4
0.0
0.0
0.4
0.1
0.0
0.2
0.3
0.1
1.0
0.5
0.3
0.1
0.0
-1.0 -0.7
-0.2
-0.2
-0.5
-0.9
-0.4
-0.5
-0.8
-0.2
-1.0
-2.0
-0.8
-2.0
2002
2003
2004
2005
2006
2007
2002
Source: BIS, Locational Banking Statistics; IMF, World Economic Outlook.
2003
-1.6
-1.6
2004
2005
2006
2007
15
Cross-border loans account for a large share of domestic credit in CEE
Cross-border and domestic bank credit
in emerging market economies
As a percentage of total bank credit
100
75
68
50
85
87
0
13
15
2002
2007
Asia
2002
63
39
37
2002
2007
78
25
32
61
22
2007
Latin America
Cross-border loans
Sources: IMF; national data; BIS locational banking statistics.
CEE
Domestic bank credit
16
Financial stability implications of cross-border loans
 In the past, “pure” cross-border loans
• Latin America in 1980s  debt crisis
• Asia in 1990s  1997/98 crisis
 Now parent banks  loans to subsidiaries in EMEs
 “Pure” cross-border loans mainly to large corporations
from EMEs
17
Financial stability implications of cross-border loans (2)
 Parent banks  loans to subsidiaries
• Most pronounced in CEE and Mexico, where banking
systems are 80-95% foreign-owned
• In CEE, cross-border loans are convergence flows –
economic, financial, institutional integration with EU, which
is different from Asia in the 1990s
• Cross-border loans were taking place in financially
repressed banking systems in Latin America in the 1980s
and Asia in the 1990s; banking systems in CEE are
competitive and open
• Cross-border loans were financing import-substituting
development in Latin America, not the case in CEE
18
Financial stability implications of cross-border loans (3)
 Risk of a solvency crisis smaller
• Parent banks large, well-capitalised, well supervised,
focus on traditional commercial banking, did not invest
in subprime/structured products
 But the risk to sustainability of cross-border flows still large
• Underestimation of credit risk during credit boom
• High targets for ROE (to exploit franchise value)
19
Financial stability implications of cross-border loans (4)
Return on equity for banks in major home and host countries, 2005
Host countries
ROE
(%)
Major home
countries
ROE
(%)
Asia
Indonesia
Korea
Malaysia
24.0
19.1
14.1
Netherlands
UK
US
16.0
17.3
17.7
Latin America
Brazil
Chile
Mexico
27.7
17.3
24.4
Spain
UK
US
16.0
17.3
17.7
Central Europe
Czech Republic
Hungary
Poland
Slovakia
Slovenia
Estonia
Latvia
Lithuania
Bulgaria
Croatia
Romania
Turkey
32.1
27.0
20.6
13.7
17.0
19.4
25.1
16.0
21.4
20.2
14.9
17.8
Austria
Belgium
France
Germany
Italy
Denmark
Sweden
Finland
Austria
Greece
Italy
14.8
19.2
14.4
13.9
14.0
18.9
20.7
9.4
14.8
15.3
14.0
Baltic states
South-eastern Europe
20
Financial stability implications of cross-border loans (5)
 Risk of regional contagion
• Parent banks pursue similar strategies across regions
(eg, lending to households)
• Transmission of shocks from home countries (eg, via
funding in wholesale markets)
• Asymmetry of host country vs. parent bank exposures
• Other channels: short maturity of cross-border loans,
concentration of foreign creditors, common creditors
across region
21
Financial stability implications of cross-border loans (5)
22
Risks at the current juncture:
sudden stop/reversal of bank intermediated flows
Net cross-border loans by BIS reporting banks to banks in EMEs1
30
In billions of US dollars
29
22
20
2008:Q1
2006
2002
15
10
8
10
6
0
0
0
-1
-2
-10
-4
-20
-19
-160
-30
RO
HU
LV
LT
EE
CZ
HR
BG
RS
PL
TR
ZA
RU
Cross-border loans to banks in EMEs, less deposits of EME banks in BIS reporting banks; end-period.
Source: BIS, locational banking statistics.
23
Risks at the current juncture:
sudden stop/reversal of bank intermediated flows (2)
70
Net cross-border loans by BIS reporting banks to the non-bank sector
in EMEs1
61
In billions of US dollars
55
2002
50
30
2006
2008:Q1
27
18
18
17
14
7
10
4
4
3
-1
-10
-30
PL
RO
HR
HU
CZ
BG
LT
LV
EE
RU
TR
ZA
Cross-border loans to the non-bank sector in EMEs, less deposits of the EME non-bank sector in BIS reporting banks; end-period.
Source: BIS, locational banking statistics.
24
Risks at the current juncture:
sudden stop/reversal of bank intermediated flows (3)
Private sector deposits
100
80
As a percentage of total liabilities
74
1
2002
69
64
60
63
62
59
58
52
52
57
49
2008
48
42
46
40
40
25
20
24
43
36
34
32
38
32
22
12
16
13
0
IN
TH
ID
PH CN MY KR AR BR CL PE CO MX VE HR RS BG RO PL CZ HU LT EE LV TR ZA RU
1
Total private sector deposits; domestic banking system, end-period levels (for 2008, May).
Source: IMF, International Financial Statistics.
25
Risks at the current juncture:
sudden stop/reversal of bank intermediated flows (4)
Ratio of total loans to total deposits1
3.0
2.6
2.4
2008
2.1
2.0
1.9
2002
1.9
1.7
1.5
1.4 1.4 1.3
0.9 0.8
0.8 0.8 0.8
1.0
0.9
1.1 1.1
1.0
0.8 0.8
0.7
0.5
1.1
0.8
0.8
0.6
0.0
KR
TH
ID
MY
IN
CN
PH CO
CL VE MX BR
PE
AR LV
EE
LT
RO HU
BG HR
RS
PL
CZ
RU
ZA
TR
1
Private sector loans divided by private sector deposits (end of period; for 2008, May), domestic banking system.
Source: IMF, International Financial Statistics.
26
Policy responses – how to deal with these risks?
1. Macroeconomic policies
•
Allow greater exchange rate flexibility – trade-off
between the consequences of ER appreciation and
sterilisation
•
Reduce policy rates – trade-off between the
consequences of capital inflows and domestic
objectives (inflation target, domestic credit growth)
•
May have limited room for manoeuvre on ER, IR
•
Relax controls on capital outflows – eg, for institutional
portfolio investors
•
Fiscal tightening – best approach; should focus on
expenditure restraint
27
Policy responses (2)
2. Macroprudential and microprudential responses
•
Tighten oversight of banks’ management of credit risk
(to make sure banks hold sufficient capital)
•
Improve quality of creditor information (accurate
company financial reports, credit registry for
households, tighter debt/income & debt service/
income ratios, etc)
•
Diversify sources of bank funding
•
Temporary capital controls
28
Policy responses (3)
Funding sources of EME banks are poorly diversified
Bank borrow ing from other dom estic
financial institutions 1
As a percentage of total liabilities
Domestic money market instruments and bonds1
As a percentage of total liabilities
28
30
25
25
21
2002
2002
20
2008
2008
20
12
15
12
8
10
8
10
4
0
0
6
1
0
5
0
CL
CO
ZA
MY
MX
BR
RO
KR
CN
VE
9
4
3
3
1
PE
1
0
0
0
Money market instruments
1
End-period levels (for 2008, May), domestic banking system.
Source: IMF, International Financial Statistics.
Domestic bonds issued by
banks
CO CN BR ZA TH MX CL MY
ID
TR
1 Liabilities to other domestic banking institutions and non-bank
financial institutions; end-period levels.
Source: IMF, International Financial Statistics.
29
Policy responses (4)
3. Home-host supervisory cooperation
– International scope of banking institutions vs. national
scope of regulation and supervision
– Conflict between macroeconomic and financial
stability concerns in small economies hosting large
international banks
– Divided responsibilities for financial stability and
financial sector supervision within home and host
countries
30
Policy responses (5)
3. Home-host supervisory cooperation (cont’d)
– Subsidiaries vs. branches
– MOUs, supervisory colleges, joint supervision
– Resolution of cross-border bank failures
31
Are there any financial stability implications of EME
investments in foreign portfolio capital?
 Redirecting FX inflows helps macroeconomic policy
(no need to deal with impact of capital inflows)
 But is it good investment?
• Interest rate differential vis-à-vis US
• Assets denominated in depreciating currency (USD)
 If investments are made by SWFs, additional issues:
• Protectionist backlash
• SWFs might not be subject to supervisory oversight in
their home jurisdictions
32