Danae Kyriakopoulou: Gaps in Global Financial Safety Net

2018-02-26 IMI

This article first appeared in The Bulletin (February 2018) published by OMFIF. Danae Kyriakopoulou is Chief Economist and Head of Research at OMFIF. This risk of financial instability may have risen over the past decades as globalisation has intensified. This is in spite of a string of international measures to improve financial regulation and tighten surveillance over countries that follow unbalanced policies. Some elements of a ‘global financial safety net’ intended to protect countries against crises are in place, but large gaps remain. Following a sharp drop after the 2008 financial crisis, global capital flows have begun to recover. Their composition has also changed. As analysed in the September Bulletin, the post-crisis regulatory wave has succeeded in curbing cross-border bank lending. However, this has been partly offset by increasing levels of direct investments. Banks’ total foreign claims stood at $25.8tn in 2017, $4.6tn down from their pre-crisis peak. Globally integrated capital markets offer important rewards to individual economies, enabling them to expand investment opportunities and diversify risk internationally, and to borrow to smooth consumption in the face of shocks. The potential gains resulting from such international risk sharing and efficient resource utilisation can be large. But capital flows can also be volatile and unpredictable, and abrupt reversals can have damaging effects on the real economy. As developed countries’ central banks navigate a period of normalising monetary policy, the global economy is entering a juncture where these risks may intensify, particularly in emerging markets. This backdrop highlights the importance of an effective global financial safety net, defined as the collective value of countries’ sources of insurance and financing. These include individual countries’ reserves as well as external public financing at the regional and global level, such as central bank bilateral swap arrangements, regional financial arrangements such as regional reserve pooling, and the International Monetary Fund. These measures are intended to provide countries with insurance against crises, financing when shocks hit and incentives for sound macroeconomic policies. As shown in Figures 1&2, the elements of a potential safety net grew strongly following the financial crisis, as individual countries amassed more foreign reserves and BSAs and RFAs were introduced.

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Danae Kyriakopoulou: Gaps in Global Financial Safety Net

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