Prof. Dr. Paul JJ Welfenswww.eiiw.euUniversity of WuppertalDecember 2016

Additional Aspects on Regulations; Role of International (Gross) Inflows and Current Account Deficit

See (slides): AL-SAFFAR, Y.; RIDINGER, W.; WHITAKER, S. (2013), The Role of External Balances Sheets in the

Financial Crisis, Financial Stability Paper No. 24, October 2013, Bank of England; also see:

IMF (2016), Capital Flows – Review o Experience with the Institutional View, IMF Policy Paper, Washington DC

Some Further References

Bruno, V.; Shim, I., Shin, H. (2015), ComparativeAssessment of Macroprudential Policies, BIS Working Paper 502

Eichengreen, B.; Gupta, P. (2016), Managing Sudden Stops, World Bank, Policy Research Working Paper No. 7639, Washington DC

Fratzscher, M. et al. (2016), Bubble Thy Neighbor: Portofolio Efects and Externalities from Capital Controls, Journal of International Econmoics, 85-104

P.J.J. Welfens www.eiiw.eu (2016) 2

Macroprudential Aspects CA deficit-GDP position; if rather high and

for many years there is a risk of sudden stop

CA deficit zero – does not mean that there isno risk: Thinking about role of gross capital

flows/exposure e.g. of firms with loans fromabroad and risk of currency mismatch

Nominal exchange rate volatility plays a role here(if there is depreciation there will be nervousnessin markets = capital outflows?)

Monetary policy in source country of capital flowscan play a role, higher interest rate = change in international capital flows

;P.J.J. Welfens www.eiiw.eu (2016) 3

How to Deal with International Shocks?

Flexible Exchange Rates; shock absorber?

Capital controls; capital flow management –fear of volatility of capital inflows

Problem of capital controls is addressed in someinternational investment treaties – capital controlsmay be imposed under specific circumstances (rules-

based system is desired, transparency; see also G20/IMF reports)

Question: if country A adopts controls, what isthe impact on economy B (C as source of capitalflows: CA in surplus...); B gets more inflows thanotherwise, r falls, bubble risk/negative spillover?

P.J.J. Welfens www.eiiw.eu (2016) 4

Banks in an International Perspective

Banks have loans from abroad and give loansto other banks abroad – or firms, governments; linkages, interdependency

Issue of regulation; underregulation = higherprofits= higher stock market price =opportunityto take over foreign banks; regulation in countryB thus under pressure from regulation in A

Minimum equity capital (absorbing losses); how isrestructuring of banks organized

Risk provision/risk management adequate

Is BIS framework (Basel II/III) consistent?P.J.J. Welfens www.eiiw.eu (2016) 5

Global Current Account Imbalances andGross Capital Flows

P.J.J. Welfens www.eiiw.eu (2016) 6

Sources: Bank for International Settlements, IMF, World Economic Outlook and Bank calculations

Evolution of Gross External Dept in Advanced and Emerging Market Economies

P.J.J. Welfens www.eiiw.eu (2016) 7

Sources: Reinhart and Rogoff 2009

Net Foreign Assets and Output Losses

P.J.J. Welfens www.eiiw.eu (2016) 8

Sources: IMF, Lane and Milesi-Ferretti (2010) and QEDS

Gross External Liabilities and Output Losses

P.J.J. Welfens www.eiiw.eu (2016) 9

Sources: IMF, Lane and Milesi-Ferretti (2010) and QEDS

Composition of Gross External Liabilities in 2007

P.J.J. Welfens www.eiiw.eu (2016) 10

Sources: IMF, Lane and Milesi-Ferretti (2010) and QEDS

Gross External Debt by Sectors in 2007

P.J.J. Welfens www.eiiw.eu (2016) 11

Sources: IMF, Lane and Milesi-Ferretti (2010) and QEDS

Gross External Liabilities and Dept

P.J.J. Welfens www.eiiw.eu (2016) 12

Estimated Contributions of Private ExternalDebt to Output Losses

P.J.J. Welfens www.eiiw.eu (2016) 13

Sources: IMF and Bank of England

External Leverage and Output Losses

P.J.J. Welfens www.eiiw.eu (2016) 14

Sources: IMF and Gourichas and Obstfeld (2012)

Gross External Dept and Domestic CreditGrowth

P.J.J. Welfens www.eiiw.eu (2016) 15

Foreign Rollover Risk and Output Losses

P.J.J. Welfens www.eiiw.eu (2016) 16

Sources: Cerutti, Claessens and McGuire (2012) and IMF

Growth in Domestic Credit in Economies withCurrent Account Deficits and Surpluses

P.J.J. Welfens www.eiiw.eu (2016) 17

Sources: World Bank World Developtment Indicators

The Interaction between Gross External Deptand Growth in Domestic Product

P.J.J. Welfens www.eiiw.eu (2016) 18

Sources: IMF, World Bank World Development Indicators and QEDS

Schematic Summary of the Transmission Channels

P.J.J. Welfens www.eiiw.eu (2016) 19

The thick arrow in the middle represents how domestic credit growth together with

funding stops arising from large gross external liabilities leads to a particularly large fall in GDP

Gross External Dept of Banks and Non-Banks

P.J.J. Welfens www.eiiw.eu (2016) 20

Estimated Contribution of Bank and Non-Bank External Dept to Output Losses

P.J.J. Welfens www.eiiw.eu (2016) 21

Sources: IMF and Bank of England

Gross External Bank Liabilities to Banks andNon-Banks

P.J.J. Welfens www.eiiw.eu (2016) 22

Sources:

Bank Maturity and Currency Mismatches

P.J.J. Welfens www.eiiw.eu (2016) 23

International Activity of UK-owned Banks, $ billion, 2007, Q1

P.J.J. Welfens www.eiiw.eu (2016) 24

Sources: BIS International Banking Statistics

Changes in Bank CDS Spreads andConsolidated Liabilities of Banking Systems

P.J.J. Welfens www.eiiw.eu (2016) 25

Sources: Kamin and DeMarco (2010), Markit Group Ltd., SNL Financial and

McGuire and Von Peter (2009)

Changes in Bank CDS Spreads and Currency Mismatches of Consolidated Banking System

P.J.J. Welfens www.eiiw.eu (2016) 26

Sources: Kamin and DeMarco (2010), Markit Group Ltd., SNL Financial and

McGuire and Von Peter (2009)

Summary Equation

P.J.J. Welfens www.eiiw.eu (2016) 27

Estimated Contributions to Output Losses

P.J.J. Welfens www.eiiw.eu (2016) 28

Sources: IMF and Bank of England