Banks and Cross-Border Capital Flows: Policy Challengesand Regulatory Responses

Philip R. Lane, Trinity College Dublin

Policy Institute, 27th September 2012

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Introduction

CIEPR?

Banks

Financial Globalisation

Analysis

Policy Reforms

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The �First Best�

Banks play a vital role in modern economies

(But regulation needed, to avoid �runs�)

Financial globalisation - improves e¢ ciency of capital allocation; smoothsconsumption; risk diversi�cation

(Financial openness opposed by vested interests)

Financial development and �nancial integration highly desirable

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Real-World Distortions

Banks behave procyclically - destabilising

Capital in�ows procyclical also

Equity/FDI in�ows - risk transferred to foreign investors

Debt in�ows - risk carried domestically

Banks the major intermediaries of cross-border debt �ows

Interaction of bank procyclicality and debt �ow procyclicalitymagni�es �nancial instability, macroeconomic instability, �scalinstability

Requires major regulatory reforms to manage ampli�ed risks

Problem: global capital �ows but national regulatory systems

(Euro area?)

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Analytics of Cross-Border Capital Flows and Banking

Gross Flows versus Net Flows

Traditional emphasis on aggregate net �ows (current accountimbalances)

Gross �ows matter (especially debt in�ows/out�ows)

Procyclical Behavior of Banks and Asset Price Ampli�cation

Funding Models and Wholesale Funding Markets

Cross-Border Banking Groups: Organizational Structure

Valuation E¤ects, Dollar Funding and Flight to Safety

Capital Flows and the Exhange Rate

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Global Banking: Regulatory Response

Data sharing

Globally-coordinated �nancial regulation

Globally-coordinated crisis resolution (ex ante loss sharing plan)

[Global monetary policy coordination]

Negotiations on global banking reform - national interests versus globalcommon good

�Second Best�Approach - reform of national regulations; �capital �owmanagement�

Euro area - banking union feasible?

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Euro Area: Special Features

Common central bank

Absence of currency risk, underestimation of national �nancial stabilityrisks: highly procyclical pattern of cross-border debt �ows

�Diabolic loop�between national banking systems and national sovereigns

Two options:

Banking union - common supervision; common deposit insurance;common resolution fund

Tight national �nancial regulation

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Macro-Prudential Regulation of Banks

Systemic View

Countercyclical capital requirements / leverage ratios

�Bail in�bonds

Bank assets

Loan-to-value (LTV) ratio; debt-to-income (DTI) ratio

Credit/GDP ratio

Bank liabilities

Levies on non-core liabilities (short-term wholesale funding)

Subsidiaries versus branches

Controls on capital in�ows? on capital out�ows?

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Macro-Prudential Regulation of Banks

Systemic View

Countercyclical capital requirements / leverage ratios

�Bail in�bonds

Bank assets

Loan-to-value (LTV) ratio; debt-to-income (DTI) ratio

Credit/GDP ratio

Bank liabilities

Levies on non-core liabilities (short-term wholesale funding)

Subsidiaries versus branches

Controls on capital in�ows? on capital out�ows?

Political economy issues

Tactical controls versus long-term controls

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Conclusions

Policy challenge: reap bene�ts from cross-border capital �ows, whileguarding against �nancial stability risks

Embed analysis of current account imbalances inside wider perspective onfull matrix of cross-border capital �ows

International balance sheet analysis, as well as �ow analysis

Promote equity �nancing over debt �nancing

Tighter bank regulation at national and international levels

Euro Area: banking union?

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