Capital Flows: The Role of Bank and Nonbank Balance Sheets
IMF Working Papers, April 29, 2019
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Bibliographic details
- Authors: Yuko Hashimoto, Signe Krogstrup
- Published: April 29, 2019
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781498311472.001
Summary
- This paper assesses the role of bank and nonbank financial institutions’ balance sheet foreign exposures and risk management practices in driving capital flow responses to global risk.
- Uses a unique and previously unexplored dataset on domestic and cross border balance sheet positions of financial institutions collected by the IMF.
- Main empirical finding: the response of overall capital flows to global risk shocks is associated with the on-balance sheet foreign exposures of nonbanks, but not with that of banks.
- Proposed interpretation: risk-averse and dynamically optimizing nonbanks reduce their foreign risk exposure when global risk perceptions increase, leading to capital flows, while banks tend to be hedged against these risks off balance sheet.
- In advanced countries, nonbank portfolio adjustment to changing risk conditions may take place through derivatives transactions with banks; the hedging practices of banks trigger bank related capital flows rather than portfolio flows.
Key findings and evidence
- The response of overall capital flows to global risk shocks is associated with on-balance sheet foreign exposures of nonbanks.
- The response is not associated with on-balance sheet foreign exposures of banks.
- Nonbanks appear to adjust foreign risk exposure on balance sheet when global risk perceptions increase.
- Banks tend to be hedged against these risks off balance sheet, implying different channels through which capital flows manifest.
- In advanced economies, nonbank portfolio adjustments may be intermediated via derivatives transactions with banks, producing bank-related capital flows.
Mechanisms and interpretation
- Nonbank behavior:
- Characterized as risk-averse and dynamically optimizing.
- Reduce foreign risk exposure on balance sheet in response to increased global risk perceptions.
- Bank behavior:
- Tend to implement hedging off balance sheet (derivatives), which mutes a direct association between bank on-balance-sheet foreign exposures and capital flow responses.
- Interconnectedness:
- Nonbank portfolio adjustments via derivatives with banks can lead to bank-related capital flows rather than portfolio flows, especially in advanced countries.
Policy implications and considerations
- Monitoring and analysis should differentiate between bank and nonbank balance sheet foreign exposures when assessing vulnerability to global risk shocks.
- Attention to off-balance-sheet hedging practices of banks is important for understanding observed capital flow dynamics.
- Consider the role of derivatives and bank-nonbank interconnectedness as transmission channels for capital flows during episodes of rising global risk.
Subjects and keywords
- Subject: Balance of payments, Banking, Capital flows, External position, Financial institutions, Financial statements, Foreign assets, Foreign currency exposure, Money, Nonbank financial institutions, Public financial management (PFM)
- Keywords: Africa, bank credit, bank share, bank-nonbank interconnectedness, capital flow, capital flow management measures, Capital flows, Financial statements, Foreign assets, Foreign currency exposure, foreign exposure, forward contract, Global, global factor, global financial crisis, macro prudential policy, nonbank balance sheet exposure, nonbank balance sheets, nonbank client, Nonbank financial institutions, nonbank investor, nonbank liability, nonbank risk management behavior, nonbank risk management practice, nonbank share, portfolio adjustment, risk aversion, risk management behavior, WP
Source: IMF Working Paper "Capital Flows: The Role of Bank and Nonbank Balance Sheets" (Working Paper No. 2019/085) by Yuko Hashimoto and Signe Krogstrup, April 29, 2019.
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- Working Paper