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The Determinants of Cross-border Bank Flows to Emerging Markets: New Empirical Evidence on the Spread of Financial Crises by Herrmann and Mihaljek Discussion David Vavra 16th Dubrovnik Economic Conference June 24 2010 Discussion Points What I have learnt What I would like to learn What puzzled me Data and specification issues What I have learnt (I) Global and country specific factors are significant determinants of cross-border flows Global risk aversion and market volatility most important factors behind the decline in flows in the crisis What I have learnt (II) Deeper financial integration and sounder banking systems limited the decline in CESE Fixed exchange rate limited the decline in CESE Long-Term Impact of Crisis GDP Level and Potential Output (CNB‘s Forecast) 4000 Potential GDP (PF-Approach) Real GDP (s.a.) Linear trend before crisis (10Y) 3500 3000 2500 2000 1999 2001 2003 2005 2007 2009 2011 2013 Permanent loss in output level, but not in growth rate (in line with IMF, WEO, Oct 2009)? Real Convergence Real convergence observed only in the past 10 years Question: will it resume? Importance of free capital flows Czech GDP in PPP as % of EU27 82 80 78 76 74 72 70 68 66 64 62 1997 1998 Source: Eurostat 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Real Convergence and bank cross-border flows Unique data set on bank flows Banks were the main source of capital for catch-up growth in CESE Financial markets in CESE dominated by banks External positions of BIS reporting banks (ex rate edjusted, q-o-q, in % GDP) What I would like to learn about: Policy Implications What is the effect of regulation on these flows? What can policy do about affecting these determinants? What was the effect of specific policy actions preventing the decline in cross-border flows. e.g. the Vienna initiative. How come that CESE performed better in region specific factors in the crisis than other EMs, when CESE flows were actually hit more? Could we distinguish between a cross-border flows to banking and non-banking sectors? The openness and bank health story not too convincing Fixed ex rate as a shelter in the crisis Conducive to more flows and perhaps also more growth? Floaters’ Output Performance on Average Better than Peggers’ Max Extent of Depreciation since July 2008* 50 Poland 45 40 35 Romania 30 25 Hungary EA 15 20 CR 15 10 5 0 -20 Latvia -15 Lithuania Estonia -10 Bularia Slovenia Slovakia -5 0 5 GDP Growth 2009 * to Euro, EA15 to USD Source: Eurostat, CNB 9 Other comments: The choice of explanatory variables Endogeneity and causality Risk-return characteristics of loans Changing sings, decreasing significance with lag effects UIP, or excess return performance? Should really a high interest rate differential imply higher flows? Exchange rate depreciation reducing flows? Nominal vs real rates of return CA deficit and credit growth as explanatory variables – why surprised by positive signs Other comments: Data issues The flow data are adjusted for exchange rate movements – wouldn’t some real measure or relative to GDP be even more appropriate? How does the database incorporate NPLs – does it keep loans at a book value? Data are gross – e.g. Vienna initiative made participating banks keep their exposures – this effect is not captured Each type of flow finances different activity and should have different determinants Is capital included – an important type of cross-border flow Subsidiary flow – mortgages and small business Non-bank flows – businesses