The new dynamics of financial globalization-MGI
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.