Financial Services Liberalisation Forum SADC - Johannesburg

David BicchettiEconomic Affairs Officer

July 2013

Financial sector like any other sector?

• The financial sector has the capacity to hamper/support all the sectors of the economy – During expansion phases support the economy

by providing credit & financial intermediation– During a crisis, focus on their "core" market

and leave the "periphery" (Developed vs developing countries, North Europe vs South Europe, etc.)

Capital flows to developing countries

Rational for liberalisation (1)

• Rational is based on the Efficient Market Hypothesis (EMH)

• Specifically for financial markets:– Provide a medium of exchange and unit of account– Allocate credit to its most productive uses– Efficient intermediary between savers and investors– Efficient means to save for the future ("smoothing

consumption stream over time")

Rational for liberalisation (2)

• Practically at the international level:• Higher level of output and investment• More rapid productivity growth and economic

growth overall• Allocation of financial resources from K-surplus

towards K-deficit countries Less risk (better risk management) Smooth consumption overtime

Rational against full liberalisation

• All the rationals earlier have a domestic and microeconomic logic

• Might not fully apply at the international level because of macroeconomic issues like unemployment and financial instability

Objectives of Capital Management Techniques

• Promote financial stability• Encourage desirable investment and

financing arrangements; e.g. support a key industry

• Enhance policy autonomy, including the maintenance of stable and competitive exchange rates

Academic literature on financial liberalisation & growth

• A number of studies have attempted to examine the link between free capital mobility and growth

• Kose et al (2006): "taken as a whole, the vast empirical literature provides little robust evidence of a causal relationship between financial integration and growth"

What history tells us?

Trilemma

• Difficult to maintain all of them at the same time:– Free capital mobility– Autonomous monetary policy directed to

domestic concerns– Managed exchange rates

• Need to find a balance between full liberalization and full control

Risks that affect financial stability• Currency risk (appreciation/depreciation on a very short

period of time, in particular with "carry trade" strategies)• Maturity risk (most of the liabilities mature at the same

time)• Investor flight risk (massive sell off)• Lender flight risk (terminate lending programmes or

extend in prohibitive terms)• Fragility risk (vulnerability of the domestic economy to

internal/external shocks)• Contagion risk (financial and macroeconomic instability

originating elsewhere)

Some concrete examples• borrowers might employ financing

strategies that involve maturity or locational mismatch;

• agents might finance private investment with capital that is prone to flight risk;

• or investors (domestic and foreign) might over-invest in certain sectors, thereby creating overcapacity and fuelling unsustainable speculative bubbles (real estate)

Rep. Korea approach to volatile capital flows

• Rep. Korea faced important inflows of capital that affected the exchange rate and consequently its trade balance

• Introduced K control, although a member of OECD and subject to the Code of Liberalization of Capital Movements

• Market friendly measures include: ceiling on forex forward positions of banks, a levy on non-deposit liabilities and a withholding tax on interest income from foreign holdings of treasuries and monetary stabilization bonds

Other countries also followed with market friendly measures

• Brazil: taxes and unremunerated reserve requirements

• Peru: tax on foreign purchases of CB papers• Indonesia: special reserve requirements• Thailand: withholding taxes• Switzerland: fixed exchange rate to the EUR

Commodity prices volatility

Bicchetti & Maystre, 2012

Financial markets become also prone to herding

Filimonov et al. (2013)

Financial innovation may hide risks

• Many private (rating agencies but also banks, e.g. Lehman Brothers, etc.) and public entities (regulators, IMF) failed to understand fully financial innovation

• CDOs, CDS, MBA, NINJA, etc.• Resulted in important bail out and recent

bail in (Cyprus)

IMF new view of 2012 (1)

• The IMF now recognises that capital flows carry risks, and that the liberalisation of capital flows before nations reach a certain threshold of financial and institutional development can accentuate those risks.

• • It also acknowledges that under certain circumstances, cross-border capital flows should be regulated to avoid the worst effects of capital flow surges and sudden stops.

•

IMF new view of 2012 (2)

• It rightly says that nations that are the source of excessive capital flows should pay more attention to the potentially negative spillover effects of their macroeconomic policies.

• Finally, the IMF boldly notes that its new view on capital flow management may be at odds with other international commitments, such as in trade and investment treaties that restrict the ability to regulate cross-border finance.

Source: Gallagher and Ocampo, 2013

Conclusion• Any liberalization process should take account of

countries/regions specific (weight cost/benefit analysis in a dynamic fashion)

• It should allow for some degree of policy autonomy • From the current experiences, a dynamic

management of the capital account seem to work best

• Provision for market failures issues (financial stability, too big to fail, etc.)

• Capacity-building of the regulators is key to ensure the financial stability

• Balance between full liberalization and total control

Thank you

• Questions? david.bicchetti@unctad.org

A current example

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Evolution of Foreign Banks' Claims in Selected European Countries, US$ mln

Foreign claims on Ukraine Foreign claims in Hungary (right axis)

Source: BIS