The new dynamics of financial globalization

Since the global financial crisis began in 2007, gross cross-border capital flows have fallen by 65 percent in absolute terms and by four times relative to world GDP. Half of that decline has come from a sharp contraction in cross-border lending. But financial globalization is still very much alive—and could prove to be more stable and inclusive in the future.

  • Eurozone banks are at the epicenter of the retreat in cross-border lending, with total foreign loans and other claims down by $7.3 trillion, or by 45 percent, since 2007. Nearly half has occurred in intra-Eurozone borrowing, with interbank lending showing the largest decline. Swiss, UK, and some US banks also reduced their foreign business.
  • The retrenchment of global banks reflects several factors:
    • a reappraisal of country risk;
    • the recognition that foreign business was less profitable than domestic business for many banks;
    • national policies that promote domestic lending;
    • and new regulations on capital and liquidity that create disincentives for the added scale and complexity that foreign operations entail.
  • Some banks from developing and other advanced economies—notably China, Canada, and Japan—are expanding abroad, but it remains to be seen whether their new international business is profitable and sustained.
  • Central banks are also playing a larger role in banking and capital markets.
  • Financial globalization is not dead. The global stock of foreign investment relative to GDP has changed little since 2007, and more countries are participating. Our new Financial Connectedness Ranking shows that advanced economies and international financial centers are the most highly integrated into the global system, but China and other developing countries are becoming more connected. Notably, China’s connectedness is growing, with outward stock of bank lending and foreign direct investment (FDI) tripling since 2007.
  • The new era of financial globalization promises more stability. Less volatile FDI and equity flows now command a much higher share of gross capital flows than before the crisis. Imbalances of current, financial, and capital accounts have shrunk, from 2.5 percent of world GDP in 2007 to 1.7 percent in 2016. Developing countries have become net recipients of global capital again.
  • But potential risks remain. Capital flows—particularly foreign lending—remain volatile. Over 60 percent of countries experience a large decline, surge, or reversal in foreign lending each year, creating volatility in exchange rates and economies. Equity-market valuations have reached new heights. Financial contagion remains a risk. The rise of financial centers, particularly those that lack transparency, is worth watching.
  • Looking forward, new digital platforms, blockchain, and machine learning may create new channels for cross-border capital flows and further broaden participation.
    • Banks need to harness the power of digital and respond to financial technology companies or fintechs, adapt business models to new regulation, improve risk management, and review their global strategies.
    • Regulators will need to continue to monitor old risks and find new tools to cope with volatility, while creating a more resilient risk architecture and keeping pace with rapid technological change.

Financial Globalization

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