Global Banking, Financial Spillovers, and Macroprudential Policy Coordination

BIS Working Papers  |  No 764  | 
17 January 2019
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Summary

Focus

There is growing evidence that international financial spillovers have become a two-way street. They occur not only from the major advanced economies to the rest of the world, but also, and increasingly, from a group of large middle-income countries to advanced economies. Because financial markets are prone to amplification effects, and because business and financial cycles remain imperfectly synchronised across countries, this new environment creates the potential for shocks in one jurisdiction to be magnified and transmitted to others through short-term capital flows. In turn, these flows may exacerbate financial instability in both originating and recipient countries, thereby creating a case for international macroprudential policy coordination. The paper focuses on measuring how large the gains from such coordination are likely to be.

Contribution

The paper develops a model to assess the gains from international macroprudential policy coordination. Financial integration is imperfect and a global bank in the core region lends to banks in the periphery. The model is calibrated for two groups of countries, the major advanced economies and a group of large (systemically important) middle-income countries, which have been identified in recent studies as generating significant reverse spillovers (or spillbacks) to advanced economies.

Findings

The results show that the welfare gains from macroprudential policy coordination are positive, albeit not large, for the world economy. In addition, these gains tend to increase with the degree of international financial integration. However, depending on the origin of shocks, they can be asymmetric across regions. The fact that gains are not large and that coordination does not necessarily benefit all parties raises a general question about incentives for them to remain voluntarily in a cooperative agreement.

 

Abstract

The gains from international macroprudential policy coordination are studied in a two-region, core-periphery macroeconomic model with imperfect financial integration and cross-border banking. Financial frictions occur at two levels: between firms and banks in each region, and between periphery banks and a global bank in the core region. Macroprudential regulation takes the form of a countercyclical tax on bank loans to domestic capital goods producers, which responds to real credit growth and is subject to a cost in terms of welfare. Numerical experiments, based on a parameterized version of the model, show that the welfare gains from macroprudential policy coordination are positive, albeit not large, for the world economy. In addition, these gains tend to increase with the degree of international financial integration. However, depending on the origin of financial shocks, they can also be highly asymmetric across regions.

JEL classification: E58, F42, F62

Keywords: global banking, financial spillovers, macroprudential policy coordination