A number of developments in recent years have put the concept of financial system stability at the top of the agenda of economic policymakers. There is no clear-cut definition of what constitutes financial instability. However, a “stable financial system” has been generally defined as one in which there is a high degree of confidence that the institutions can continue to perform their contractual obligations, intermediation, and wealth management services without interruptions and outside assistance, and participants can confidently transact in the key markets at prices that reflect fundamental forces and that do not vary substantially over short periods when there have been no changes in fundamentals (see Crockett, 1997b and 1997c).1
One focus of the policy debate surrounding financial system stability is the role that capital mobility and international financial integration may play in the stability of financial systems. Capital account liberalization and international capital mobility can be seen as an extension of financial liberalization and financial system development in an international context. Experience with financial liberalization across the globe over the past couple of decades has brought to the fore some important relationships between financial liberalization and financial sector performance and stability. Mainly focusing on domestic liberalization, it has been generally agreed that if carried out effectively, through appropriate sequencing of reforms and supported by a sound and sustainable macroeconomic environment, financial liberalization would improve economic growth and efficient allocation of resources, and help develop deeper, more competitive, diversified, and efficient financial markets. At the same time, it is recognized that liberalization of financial transactions can introduce new risks and result in severe financial crises if inappropriately sequenced and insufficiently supported by necessary policies and reforms. In particular, by intensifying competition in the financial sector, liberalization removes the cushion protecting intermediaries from the consequences of bad loan decisions and management practices (Eichengreen and Mussa, 1998). Liberalization would also allow banks to expand risky activities at rates that far exceed their capacity to manage them prudently, as well as induce them to pursue risky investment projects and use expensive and potentially volatile market funding. By allowing banks to engage in complex financial transactions, including those involving derivatives instruments, liberalization could make it more difficult to evaluate bank balance sheets and strain the regulators’ capacity to monitor, evaluate, and limit risks. Country experiences have provided insight into the appropriate sequencing of domestic reforms and liberalization, including the pursuit of sound economic policies; development of monetary instruments, markets, and institutions; and building up an effective system of prudential supervision to discourage individual institutions from taking on excessive risks.
You are viewing: Which Of These Results From Greater Capital Mobility
Read more : Which Molecule Is Most Acidic
The increasingly global nature of financial markets—in part reflecting financial innovations and advances in information technology and the liberalization of international capital transactions by many countries in the past two decades—has increased the volume and mobility of capital flows across borders, made financial institutions increasingly more interdependent, and brought an additional perspective into the relationship between financial liberalization and systemic stability. The severe financial crises of the last decade—particularly those in East Asia and Russia in 1997-99, as well as in Latin America in 1994-95 and Europe in 1993—have increased the emphasis placed on the international aspects of financial instability, that is, the potential contribution to financial instability of external financial liberalization and the associated increase in capital mobility.
The impact on financial stability from external financial liberalization operates through similar channels as in the case of domestic financial liberalization—i.e., increased competition, complexity, and opportunities for excesses—but it also involves additional risk factors and unique elements inherent in capital flows and their liberalization. Certain elements of domestic financial liberalization—adopting market-based monetary policy instruments, developing liquid money and foreign exchange markets, strengthening bank balance sheets, etc.—also assume higher priority to ensure stability in the presence of capital account opening.
Read more : Which Arcane Characters Are You
In addition to foreign exchange, transfer, and operational risks involved in cross-border transactions, another important element of risk is the potentially higher levels of asset price volatility and the possibility of asset price misalignments following capital account liberalization. Capital flows and asset price volatility undermine solvency of banks and their customers—for example, through the impact of unexpected exchange rate depreciation on the balance sheets of banks and nonbanks. This in turn could raise uncertainty and induce capital flow reversals. In such circumstances, weaknesses in banking systems and nonbank borrowers can limit the authorities’ willingness to use interest rates to defend the exchange rate, or more generally constrain the policy mix that would be feasible, and this could exacerbate asset price misalignments, increase the probability of speculative attacks, and provoke a currency and financial crisis. There is evidence of greater asset price volatility and misalignments in both emerging markets and industrial countries in recent years (White, 2000), while the close linkages between banking sector weaknesses and balance of payment problems have become evident since the Asian crisis (Lindgren and others, 1999; Lane and others, 1999). The increasing frequency and severity of the financial crises in recent years—reflecting, in part, the growing integration of financial markets—also raise concerns about contagion among countries and markets, and the possibility of extreme market dynamics in emerging markets due to asymmetries in size between large financial firms and small and medium-sized markets. Also, global financial integration has highlighted the need to harmonize financial system standards across countries to ensure both a level playing field and sound financial systems. These considerations have led to concerted response at both national and international levels in order to strengthen national financial systems as well as “international financial architecture.”.
This paper focuses on the international aspect of financial system stability, i.e., the additional dimensions through which capital account mobility impacts on financial system stability. Accordingly, it reviews the basic characteristics of cross-border capital flows that distinguish them from domestic transactions, analyzes the main linkages between capital mobility and financial system stability, and illustrates the positive contributions that capital mobility can have on financial sector stability, as well as the circumstances under which capital mobility may result in financial system instability. The paper also discusses alternative approaches to safeguard financial system stability with a view to maximizing the benefits of international capital mobility while minimizing its risks. In particular, it focuses on the role of consistent macroeconomic policies, prudential and supervisory framework, and other supporting financial sector reforms, as well as on the merits of resorting to capital controls in managing capital flows that may threaten financial system stability. Finally, it discusses the implications of these systemic responses for the sequencing of capital account liberalization with financial sector reforms. The last section provides some concluding remarks.2
Source: https://t-tees.com
Category: WHICH
