Financial globalisation – and de-globalisation – is a topic at the heart of the financial reform policies being discussed in reaction to the global crisis and more recently the Eurozone crisis. Academic attention, however, goes back much further, sparked by heightened financial globalisation and transmission of shocks and crises (see Obstfeld and Taylor 2004, and Kose et al. 2009, among many others).
Yet despite all this attention, the concept ‘financial globalisation’ remain somewhat elusive and its measurement problematic. There are at least two interconnected, albeit essentially distinct dimensions of financial globalisation.
- Financial diversification, that is, the cross-country holdings of foreign assets and liabilities; and
- Financial offshoring, that is, the use of foreign jurisdictions to conduct financial transactions.
While the former focuses on who holds the assets, the latter deals with where the assets are transacted.
Financial diversification: Macroeconomics
Financial diversification refers to a macroeconomic aspect of globalisation. It relates to country-level capital flows and gross investment stocks. In theory, diversification allows for a more efficient global distribution of risk and provides opportunities for exploiting cross-border risk-adjusted return differentials. In addition, this dimension might play an important role in the development of local capital markets, enhancing liquidity, improving the quantity and quality of information, increasing transparency, and promoting better corporate governance practices. However, financial diversification might also have its downside. Surges in capital inflows to countries with relatively shallow domestic financial markets could generate systemic problems. Increased diversification can also be associated with a greater exposure to external crises through the financial channel, with a crisis in one country prompting international investors to sell off assets or curtail lending to other countries.
The evidence suggests that financial diversification continued rising across emerging countries during the first decade of the 2000s. Namely, both the stock of foreign assets and liabilities and capital flows by domestic and foreign agents increased. Interestingly, this trend was more accentuated in developed countries than in emerging ones, despite the fact that the former group started from a higher level of diversification. Therefore, while the notion that emerging countries became more financially globalised during the first decade of the 2000s seems correct, in relative terms they lagged behind the deeper globalisation experienced by the developed world. Furthermore, this increased financial globalisation was characterised by a two-way process that entailed a higher participation of both foreigners in local markets and domestic agents in foreign markets. Interestingly, the large expansion in cross-country holdings led by greater volumes of gross capital flows was not matched by an expansion in net capital flows (Broner et al. 2011).
A noteworthy feature of the process of financial diversification during the first decade of the 2000s was the safer form of financial integration of many emerging countries, arising from the changing structure of their external assets and liabilities. More specifically, emerging countries typically became net creditors in debt assets and net debtors in equity assets. This contrasts sharply with the structure prevalent in the 1990s, when emerging countries held large debtor positions, especially in debt assets. This new structure of foreign assets and liabilities is particularly helpful in turbulent times, when balance-sheet effects become beneficial. For example, during the global financial crisis of 2008 the local currency value of emerging countries’ foreign assets tended to increase, given that they owned hard-currency debt (which appreciated vis-à-vis emerging countries’ currencies), while that of their foreign liabilities shrank, given that they owed equity to the rest of the world (see Lane and Milesi-Ferreti 2007 for the ex-ante cross-border holdings).
Financial offshoring: Microeconomics
Financial offshoring, on the other hand, is mainly microeconomic in nature and is related to the functioning of the financial sector. This dimension is based on the use by local residents of offshore (or external) markets or the use of foreign (rather than onshore) intermediaries. A number of reasons could be behind offshoring, including access to markets with greater depth and liquidity as well as to better regulatory environments, or a comparative advantage in certain aspects (including price) that make them preferable for specific transactions. When firms and agents use domestic and foreign markets for different purposes, the correlation between local financial development and financial offshoring might be positive. Nonetheless, increased offshoring may also be associated with some negative spillovers, such as reduced liquidity in domestic stock markets through the migration of international firms’ trading to offshore markets or a drop in the trading and liquidity of stocks of the remaining domestic firms.
In contrast to the widespread expansion of diversification, financial globalisation exhibited more mixed patterns during the first decade of the 2000s. While a large expansion had occurred in the 1990s (mostly due to very low initial levels), the growth in financial offshoring was not widely sustained during the following decade, with a significant heterogeneity across countries and markets. For example, capital-raising activity in foreign markets through syndicated loans expanded around the world as a percentage of GDP during the first ten years of the 2000s, especially for developed countries. On the other hand, foreign capital-raising activity through debt and equity issues as a percentage of GDP remained somewhat stable during this period and even declined in several countries. Moreover, offshoring remains highly concentrated, with only few firms participating in foreign markets. (See Ceballos, Didier, and Schmukler 2012 for a more detailed analysis.)
The relative use between local and foreign markets during the 2000s showed a similar degree of heterogeneity. For instance, while foreign bond markets gained importance in relative terms for the financing needs of the private sector, this trend was not as pronounced in the case of equity markets. In contrast, public sector bond financing shifted away from foreign markets toward domestic markets in most countries, reflecting to some extent the authorities’ attempts to reduce their dollar exposure and to develop their local currency public debt markets. The nature of foreign bond financing in emerging economies changed too, in general toward the better, with an increase in maturity and a lower degree of dollarisation.
In sum, since the early 1990s there has been a broad-based increase in financial diversification through larger gross capital flows, tightening the linkages across countries. This trend was not, however, accompanied by a similar widespread increase in financial offshoring through the use of foreign capital markets as a financing source or trading place.
Future research is needed to study in more depth the pros and cons of these developments and the prospects for different aspects of financial globalisation.
Broner, Fernando, Tatiana Didier, Aitor Erce, and Sergio Schmukler (2011), “Gross Capital Flows: Dynamics and Crises”, CEPR Discussion Paper No. 8591.
Ceballos, Francisco, Tatiana Didier, and Sergio Schmukler (2012), “Financial Globalization in Emerging Countries: Diversification vs. Offshoring”, in M Lamberte and E Prasad (eds.), New Paradigms for Financial Regulation and Reforms in Emerging Markets, ADBI and Brookings Institution, forthcoming. Also available as World Bank Policy Research Working Paper 6105.
Kose, MA, E Prasad, K Rogoff, and SJ Wei (2009), "Financial Globalization: A Reappraisal," IMF Staff Papers, Palgrave Macmillan Journals, 56, 8-62.
Lane, P. R., and G. M. Milesi-Ferretti, 2007. “The External Wealth of Nations Mark II: Revised and Extended Estimates of Foreign Assets and Liabilities, 1970-2004”, Journal of International Economics, 73:223-250.
Obstfeld, M and A Taylor (2004), Global Capital Markets: Integration, Crises, and Growth, Cambridge University Press.