|
|
In advanced economies, financial regulation and other forms of public intervention have contributed to global fragmentation. Government bail-outs, risk-based capital requirements and the ring-fencing of capital and liquidity by local supervisors have constrained banks’ risk-taking outside domestic jurisdictions. In the euro area, this has been compounded by the perception of a rising risk of sovereign default, eroding the fiscal backing of cross-border liquidity provision. As a result, the rise in idiosyncratic country risk in peripheral countries and the associated increase in government bond yields was accompanied by a steady increase in the share of domestic holdings of government debt securities. Financial fragmentation can, however, also be observed at the global level. Looking at banking statistics in advanced economies, the relationship between domestic and international bank lending has steepened compared with the pre-crisis credit boom.
Global liquidity is an important concept and our understanding of its drivers and its effects has improved considerably over the past two years. The further evolution of global liquidity will depend on the way world trade and investment, and the related financial flows, globalise and sometimes de-globalise, and this in turn depends on policy reactions to the financial crisis.
Overall, these trends will have profound effects on international risk-sharing, which for the time being appears to have decreased or at least levelled off in the immediate post-crisis environment.
The world has gained a lot from being financially open and the benefits from international risk-sharing should be preserved. Current concerns related to international spillovers of unconventional monetary policy in the major advanced economies must not lead to a rise in financial protectionism. When confronted with a surge in capital flows, the first line of defence should always consist in macro-economic adjustment. Capital flow management measures are also available but they should be used exceptionally and on a temporary basis if all other policy options have been exhausted, as the IMF has recently said.
In advanced economies, post-crisis policy interventions should avoid encouraging financial fragmentation by confining banks’ risk-taking to domestic jurisdictions. This is why achieving a level playing field in the implementation of new financial regulations is so important. This is also why the European banking union project, with its single supervisory and its single resolution mechanisms, matters so much. It is only by restoring the free flow of capital within the euro area that the full benefits of Economic and Monetary Union can be reaped, and growth can restart in Europe.
Concerns related to the “excess elasticity” of global credit supply and the pro-cyclical nature of private liquidity need to be addressed ex ante if we want the international monetary and financial system to become more resilient to shocks. This is currently being done in various policy circles, particularly in BIS-associated committees. It covers not only work achieved within the Basel III framework to improve the resilience of systemically important banks to shocks to their capital and liquidity, but also ongoing work related to financial market infrastructures and the regulation of shadow banking. This work is geared at improving the resilience of individual institutions but also, and maybe more importantly, at dampening the global financial cycle. If well coordinated at the international level, the new micro- and macro-prudential instruments should go a long way in addressing global liquidity issues and potential imbalances.
Further reflection is also warranted on the provision of public liquidity, i.e. precautionary foreign exchange reserve holdings and on international coordination in the face of global liquidity shocks. The rise of regional risk-sharing, if confirmed, will make regional financing arrangements (such as the European Stability Mechanism and the Chiang Mai Initiative) even more useful, but it will also call for fresh thinking on their interaction with each other and with global financial safety nets. Following the seminal work of the G20 Korean Presidency, I expect that the IMF will be doing further work in this area.