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65% drop in global capital flows part of new globalisation paradigm

What are the factors shaping the new globalised financial landscape, from China's increasing connectedness to Eurozone banks retreating from cross-border capital lending? A study by McKinsey, The new dynamics of financial globalisation, shows that gross cross-border capital flows, i.e., annual flows of FDI, purchases of bonds and equities, and lending and other investment, have shrunk by 65 per cent and are now at levels last seen in 2000.

Eurozone banks are one of the leading factors in this decrease – their total foreign loans and other claims are down by $7.3 trillion, or by 45 per cent, since 2007, according to McKinsey. The report notes: “Nearly half has occurred in intra-Eurozone borrowing, with interbank lending showing the largest decline. Swiss, UK, and some US banks also reduced their foreign business.”

The graph below shows that it's not just the level of cross-border capital flows that have decreased, but the debt-related percentage of flows has also fallen significantly. It shows that FDI and equity flows now account for 69 per cent of cross-border capital flows, up from 36 per cent before 2007. The report also explains why this is a good sign for the future stability of the global economy: “Because FDI reflects companies’ long-term strategies, it is, by far, the least volatile type of capital flow, while bank lending – particularly short-term lending – is the most volatile.”

G20 turning rapidly to protectionist trade

But the lower levels of cross-border capital flows do not mean countries are becoming more insular – despite the G20 economies having introduced new protectionist trade measures at the quickest rate since the financial crisis, according to World Trade Organisation (WTO). The WTO data shows that from October 2015 to May 2016, the G20 countries introduce five new protectionist trade measure per week. However, the McKinsey report found that the world’s financial markets remain deeply interconnected and some developing economies – China in particular – are becoming more connected financially.

Risk and volatility remain

The report also suggests that the future model for financial globalisation will be more stable, partly due to less volatile FDI becoming a larger portion of total gross capital flows and also because global imbalances in financial- and capital-account surpluses and deficits have shrunk. The report states: “Nevertheless, potential sources of risk and volatility remain. Gross capital flows – particularly cross-border lending – remain volatile, and financial contagion is still a concern in a deeply interconnected system. Equity-market valuations in some countries are high despite weak economic growth, raising questions about whether a bubble is forming. The rise to prominence of financial centers, particularly those that lack transparency, bears some scrutiny.”

CTMfile take: There have been some fundamental changes in the globalised financial landscape since the 2007-8 crisis but, as the report points out, globalisation is far from over.

This item appears in the following sections:
Cash & Liquidity Management
Global Cash & Liquidity Management
Liquidity Risk Management
Fraud Prevention
Risk Management
Financial Risk Management

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