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Lagging capital flows: A Sign of Safer Financial Markets?

September 1, 2017

With gross cross-border capital flows totaling 65 percent less than in 2007, the global financial crisis is continuing to shape the global financial system; large European and US banks have retrenched from foreign markets. Investors should be aware that these facts don’t symbolize a detrimental future for financial globalization. Despite inherent risks, the slow recovery from pre-crisis conditions signals towards an increasingly stable and risk-sensitive opportunity for financial globalization. Measurements in the volatility of foreign direct investment reveal a larger share in global equity than before the crisis. Overall, current financial and capital accounts imbalances have decreased – dropping from 2.5 percent of world GDP in 2007 to 1.7 percent in 2016.

One of the major factors towards the retreat of gross cross-border capital flows are the Eurozone banks.  The total of foreign loans and other claims in 2016 were down by $7.3 trillion (45%) since the crisis. Close to half of the retreat in investment occurred at the hands of intra-Eurozone borrowing, with interbank showing the largest decline. This retrenchment reveals that global banks are reappraising country risk. Domestic policies aimed at promoting internal investments, and new regulations complexifying foreign operations result in the current market developments.

Blockchain, new digital platforms and machine learning will create new systems for cross-border capital flows and further broaden participation. Keith Knutsson of Integrale Advisors argues, “New technologies most definitely increase transaction speeds and reduce cost barriers to transact across borders, but the challenges arise through the methods regulators will employ to monitor and manage a new financial age.”

Indeed, central banks of developed countries have been increasingly prevalent in capital markets, providing both capital as well as liquidity through unconventional policies. Assets of the European, Japanese, English and US central banks have nearly tripled since 2007, reaching $13.4 trillion in 2016. Central banks were forced to intervene in the money and financial markets to ensure liquidity.

 

 

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