Should financial globalisation survive? As in the case of individual financial systems, financial globalisation entails risks and challenges that derive from three features of financial markets: · They are prone to suffer from information imperfections and asymmetries that create poor incentives and induce excessive risk-taking. · Failure of some of their institutions or segments may have systemic and macroeconomic consequences. · They behave procyclically, propagating and exacerbating macroeconomic shocks. As pointed out by Taylor, these features give rise to financial crises and to deep and protracted recessions that follow a period of excessive leveraging and risk-taking. And, as argued by Lane, financial globalisation amplifies the scale and the scope of these problems while making their solution more difficult due to their size, complexity, and the need for coordination between different countries. Hence, if some degree of financial globalisation is desirable, it must be made sustainable by appropriate “global” supervision and macro- and microeconomic regulation in the same fashion that a healthy financial system is sustained in each individual country. This would probably be part of the “first best” solution. However, it is not a practical one in the current state of affairs. As noted by Taylor, not even Europe, with a commitment to a long-term economic and political project, has been able to institute such an arrangement. Therefore, we must move to the world of the “second best” solutions, in which a more restricted but sustainable financial globalisation is obtained. As the evidence reviewed by Lane suggests, the degree of cross-border financial integration between countries depends on the institutional capacity of each country. Extrapolating this result to the world as a whole, one may say that the world’s institutional capacity to deal with financial integration is rather limited. This applies not only to the world’s inability to coordinate adequate crisis resolutions, liquidity or capital regulation and supervision, but it also may be understood in a wider sense as the absence of general macroeconomic policy frameworks that would mitigate the probability of financial imbalances and crises. As noted by Taylor, unlike emerging economies in the past decade, advanced economies generally did not conduct countercyclical fiscal policies or build buffers in good times. Will they in the future? Unlike some emerging economies that were badly hit by previous financial crises, advanced economies did not pay enough attention to credit growth in their monetary and financial policy strategies. Will they from now on? Thus, as long as neither of these two factors – liquidity provision and crisis prevention/resolution mechanisms – are sufficiently coordinated between countries, and as long as appropriate fiscal/monetary policy frameworks are lacking in relevant advanced and emerging economies, it could be better to proceed on a gradual path of financial globalisation under the following conditions: · Limited bank and private sector leverage: this would cut credit supply and increase the cost of finance but would reduce the size and contagion of financial market disruptions. · Stricter FX and local currency liquidity requirements: this is key, especially in the absence of coordinated liquidity provision plans between countries. · International banks should preferably work as fully incorporated local institutions wherever they are present, subject to the domestic capital and liquidity regulations, and covered by the domestic financial safety net. Again, this could make credit moreexpensive, but it would limit contagion and rely on supervision and regulation by agencies that are probably more familiar with the local risks and environment. · Financial innovation should not be discouraged, but new products should carry large capital requirements whenever their risks or valuation are not fully understood by the authorities. · Large counter cyclical capital and provisioning requirements (with respect to the credit cycle) should be embedded as part of the existing rules. This way, an excessive credit expansion is not only more easily curbed, but it is also made less likely since banks can expect that the costs of feeding it will increase.Elements along these lines are included in the Basel III initiative and are welcome. It will be desirable for them to be shared by many financially relevant economies, so that regulatory arbitrage is limited and the effectiveness of the regulation is not significantly weakened. This would be the minimum of international coordination that is necessary for financial globalisation to be sustainable. Some may argue that this is a return to financial repression. That is one way to put it. Another is that financial globalisation went too far in the first place given the “institutional capacity” of the world as a whole, so it is necessary to step back somewhat. Yet, although a movement in this direction is clearly a retrenchment of financial liberalisation for a number of advanced countries, for many emerging economies there is still ample room to continue adopting financial products and deepening their financial systems within this more prudent framework. Finally, a word on financial globalisation and macroeconomic resilience in some emerging economies. The behaviour of some emerging countries in the face of the shocks observed since 2008 illustrate the benefits of flexible exchange rate regimes (among other policy response elements). The shock absorber role played by the exchange rate and the fact that flexible regimes enabled countercyclical monetary policy responses suggest that for many emerging economies, this will continue to be a useful part of their policy framework. But a properly working flexible exchange rate regime requires limits on currency and FX maturity mismatches, limited financial dollarisation and other related regulation. Hence, from the point of view of these economies, sustainable financial and trade globalisation imply the presence of such restrictions on some financial activities and exposures.
Posted on: Tue, 22 Jul 2014 12:21:05 +0000
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