Cross-border financial flows:
Sustainable macroeconomic policies needed to reap benefits
The world has become more integrated, not just through trade, but
through steadily rising cross border financial flows and accumulation of
large and rising foreign assets and liabilities, said the Deputy
Governor of the Central Bank, Chandra Premarathne, at the inauguration
of a training program on 'Cross border financial flows and related
issues' organised by the Centre for Banking Studies for the officers of
the Bangladesh Bank.
Following are excerpts of her speech:
Cross border financial flows can take the form of portfolio
investments in bonds or equities, FDI, in enterprises or loans between
residents between different countries. Generally the level of total
cross border financial flows indicates the intensity of financial
linkage or financial integration between different countries.
For three decades the globalisation of finance appeared to be an
unstoppable trend as the world economy become more tightly integrated.
New technology and access to new markets propelled cross-border capital
flows to unprecedented heights.
Global foreign assets and liabilities grew six-fold between 1980 and
2007, from around 60% of world GDP to more than 360% of world GDP. Over
the same period gross global financial flows grew from 6% of world GDP
in 1980 to 36% of world GDP.
But the financial crisis brought that era of rapid growth to a halt.
During the global financial crisis global cross border investment as
measured by global asset and liability, financial flows plunged from 35%
of world GDP in 2007 to less than 5% of world GDP in 2008. It is
important to note that the financial crisis has only temporarily halted
the process of increasing financial integration but it was observed that
in the past few years cross-border investment has steadily been
increasing and recovering.
Global cross border investment is beneficial to both the investing
and recipient economies and in the long run the benefits can be
sizeable. First, cross-border holdings of assets and liabilities allow
economies to share the risk associated with their individual domestic
Improved risk sharing in turn enhances the ability of countries to
specialise in their most productive sectors that leading to increase
economic efficiency. Second, international financial flows are essential
to direct global capital to the areas where it can be used most
Third, capital should flow from economies where it yields a
relatively smaller marginal return to economies where the marginal
productivity of capital is higher. Fourth, cross-border finances allow
economies to expand investment and production beyond the constraints
imposed by domestic savings helping the recipient to raise its rate of
economic growth and improve its living standards.
Finally, cross-border financing may associate with transfer of
knowledge and technology and have a beneficial impact on the efficiency
of the domestic banking system by increasing the depth and breadth of
domestic financial markets.
Challenges and risks
Despite these beneficial effects imbalanced and unmanaged financial
flows can pose considerable challenges and significant risks for
domestic economies. Excessively prolonged and large net financial
inflows can have undesirable macroeconomic effects, including rapid
monitory expansion and inflationary pressure and can thus inflate asset
prices and fuel credit growth raising the risk of boom and bust cycles.
Therefore, balanced and sustainable macroeconomic policies are needed
to reap the benefits of cross-border financing which are conducive to
the long-term growth of the economy. At the same time to address any
systemic risk or contagion effects of the financial integration,
adherence to macro prudential measures is essential.
Having experienced the adverse repercussions of integrated financial
markets, Central Bank and the regulatory authorities around the world
are now more focused on defending their local financial market from the
adverse effects of cross border flows through sound macroeconomic
policies and strong regulatory and governance framework.
Sri Lankan experience
If we look at the Sri Lankan experience, Sri Lanka is moving towards
$ 100 billion economy by 2016 with $400 per capita income. The savings
investment gap is around 4%. Our strategy mainly focuses on improving
productivity through technological advancement and attracting high level
of cross border financial flows.
Sri Lanka has introduced far reaching measures to liberalise and
develop financial markets through relaxation of exchange control
regulations, widening the range of financial instruments offered,
increasing the efficiency and accessibility of commercial banks and
strengthening institutional and legal framework.
These measures specially encouraged the foreign corporate sector to
invest in the Sri Lankan capital market. Meanwhile, Sri Lanka has placed
great emphasis on promoting the corporate bond market by introducing
several measures to enhance capital flows.
In 2012 banks tapped the international market and borrowed more than
$ 1 billion. In 2012, for the first time, a state bank issued bonds in
international markets, at an attractive rate.
Sri Lanka has adopted a cautious approach to counter downside risks
associated with cross border financial flows such as reversal of capital
flows, vulnerabilities due to build up of foreign liabilities in
corporate balance sheets, appreciation of domestic currency eroding
external sector competitiveness.
Mandatory corporate governance directions were issued in 2007 to the
banks to enhance their governance structure and conduct the banking
business in a responsible and accountable manner.
The integrated risk management framework has been set up in the banks
to mitigate risks arising from foreign borrowers.
Meanwhile, banks were required to enhance their minimum capital on a
staggered basis to improve their soundness and stability and thereby
increasing borrowing capacity.
Banks are required to maintain their capital adequacy ratio against
risk weighted assets at 10% minimum which is above the Basel requirement
Banks are required to maintain a liquid asset ratio of 20% at a
minimum to be resilient and to go for more foreign borrowings from the
international market. Directions on risk management relating to foreign
exchange business of commercial banks were issued to standardise and
strengthen foreign exchange risk management systems in the banks.
To promote greater harmonisation with international regulatory
standards, the Central Bank is taking measures to implement Basel III
capital and liquidity standards on a staggered basis. The Central Bank
is developing macro-prudential approaches to regulation which would
pre-emptively address any systemic risks and contagion risks to the