Transcript their Sources and the Policy tools to manage Them

VOLATILE CAPITAL FLOWS:
THEIR SOURCES AND THE POLICY
TOOLS TO MANAGE THEM
Presentation by G. Russell Kincaid, St. Antony’s College, Oxford
High-Level Seminar Organized the Central Bank of Bosnia and Herzegovina
and SEESOX, June 5 and 6, 2014
SOURCES OF VOLATILE CAPITAL FLOWS
 New Normal in Advanced Economies—low interest rates and the search for yield
followed by interest rate “normalization”
 Surges and sudden stops also possible in currency union—common monetary policy
does not fit all members
 Beware nominal convergence running far ahead of real convergence, or optimal
currency criteria
 Deleveraging by financial institutions—balance sheet repair driven in part by markets
 Euro-area reforms—tackling the crisis by fixing its architecture—fiscal, MIP, and
financial
 Basel III—pushing for more and better capital will make banking more expensive
EUROPEAN BANKING UNION—
THREE KEY PILLARS
BANKING UNION—AN EARLY ASSESSMENT
 Important, but incomplete, progress; most progress on single supervisor and
least on unified deposit insurance; resolution mechanism is complex and
potentially too cumbersome in a crisis
 AQR is major test for ECB; it must not repeat past EBA mistakes; all eyes
are on Italy
 In preparation, euro-area banks have shed assets—7 percent in 2013 alone
and built up capital; still estimated capital shortfalls has wide range--Euro
50-300 billion or ½-3 percent of euro-area GDP
 EC staff have estimated that in a crisis, banking union would benefit the
euro-area as a whole only slightly with big gains to periphery at modest
cost to core. Creditor bail-in at national level provides roughly same
distribution of gains. No estimate of spillover outside euro area.
REGULATORY ACTION—POSSIBLE IMPACTS
 Spread impact would be equivalent to one/two customary-sized interest
rate increases
 Concerns about unintended consequences for trade finance and project
finance have been voiced by G20; CRD IV accommodates but only partially
 AML/CFT rules could hit remittances, which are sizable in region on
average 6½ percent of GDP, although much higher in some cases.
 100 billion in capital supports some 1,250 billion in risk weighted assets or
3,300 billion in total assets; capital needs induce more deleveraging
TRI-LEMMA, OR THE IMPOSSIBLE-”UNHOLY”
TRINITY AS APPLIED TO SOUTH-EAST EUROPE
 EU-mandates that no restrictions on capital movements are allowed within
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EU or with other countries.
Foreign banks—principally from the euro area—are the dominant owners
of SEE banking systems—85 percent of the bank assets on average
excluding Slovenia.
As regards exchange rate regimes, three countries have adopted the euro,
two countries have currency boards linked to the euro, and two countries
have fixed exchange rate linked to the euro. Three countries have managed
exchange rates.
Even for these three counties, the high share of euro-denominated
lending/deposits constrains the conduct of monetary policy, lender-of-lastresort duties in a foreign currency, and limits scope for exchange rate
flexibility.
With tri-lemma or currency union, policymakers lose an instrument.
Close trade links to EU add another spillover channel.
MACROPRUDENTIAL POLICIES TO THE RESCUE?
 Macroprudential policy adds an instrument. But does it also add a
target—financial stability?
 What are nature and type of macroprudential tools?
Cross section/structural, and time varying
LTV/DTI/risk weights and capital/liquidity buffers
Quantity/price oriented
Calibration/effectiveness
 Capital flow measures—can deal with surges and sudden stops; can
increase effectiveness by curtailing leakages
 “Jurisdictional reciprocity” introduced by BCBS for counter-cyclical
capital buffers; needs to be expanded to other macropru instruments
 ECB and ESRB have overlapping macroprudential responsibilities
KEY LESSONS FROM FIVE CASE STUDIES IN THE REGION
 In all cases (Bulgaria, Croatia, Romania, Serbia and Turkey), macroprudential measures
tackled primarily macro-imbalances and not financial instability. On the whole, timevarying or cyclical tools were exercised. Multi-tools were utilized simultaneously,
making it difficult to asses individual tools.
 Only Turkey, which was outside the EU, employed CFMs. However all countries
utilized FX-denominated measures. Romania had to modify some macropru tools in
light of EU concerns.
 Monetary policy was not tightened, suggesting that macropru may have been a
substitute rather than a complement. Fiscal balances improved during boom phase
owing to buoyant revenues but in all cases structural fiscal balances deteriorated,
leaving no fiscal space when the bust came.
 In general, bank credit growth slowed at these briefly (1-2 years); however,
macroprudential measures were circumvented via several channels—mainly
regulatory arbitrage and foreign leakages.
 Macropru measures did nevertheless increase the resiliency of these banking systems
because capital and liquidity buffers were enhanced. Risk transfer abroad also
contributed but not transfers to domestic nonbanks with close links to banks.
TYPES OF MACROPRUDENTIAL TOOLS UTILIZED
Country/
Tool
Bulgaria
LTV/DTI
Croatia
Romania
Serbia
Turkey
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Capital
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Provisionin
g
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Res. Req.
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FX
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Credit
target
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Other
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