Cross-Border Flows Drive European Dis-Integration

Despite reassurances from Draghi this morning, the truth of the matter is that cross-border capital flows - which reflect the degree of integration in the global financial system - have plunged in recent years. As of the end of 2012, cross-border capital flows - including lending, foreign direct investment, and purchases of equities and bonds - remain more than 60% below their peak. In the decade up to 2007, Europe accounted for half of the growth in global capital flows, reflecting the increasing integration of European financial markets. But today the continent’s financial integration has gone into reverse. Clearly, cross-border lending, which dominated capital flows in the years leading up to the crisis, has proven to be short term and can dry up quickly.

 

As McKinsey notes:

Cross-border capital flows - including lending, foreign direct investment, and purchases of equities and bonds - reflect the degree of integration in the global financial system. While some of these flows connect lenders and investors with real-economy borrowers, interbank lending makes up a significant share. In recent decades, financial globalization took a quantum leap forward as cross-border capital flows rose from $0.5 trillion in 1980 to a peak of $11.8 trillion in 2007. But they collapsed during the crisis, and as of 2012, they remain more than 60 percent below their former peak (Exhibit E2).

 

 

 

As with financial deepening, it is important to disentangle the different components of growth and decline in capital flows. In the decade up to 2007, Europe accounted for half of the growth in global capital flows, reflecting the increasing integration of European financial markets. But today the continent’s financial integration has gone into reverse. Eurozone banks have reduced cross-border lending and other claims by $3.7 trillion since 2007 Q4, with $2.8 trillion of that reduction coming from intra-European claims (Exhibit E3). Financing from the European Central Bank and other public institutions now accounts for more than 50 percent of capital flows within Europe. With hindsight, it appears that capital mobility in Europe outpaced the development of institutions and common regulations necessary to support such flows.

 

 

 

Outside of Europe, global lending flows have also slowed. The modest increase in assets of banks in the United States, United Kingdom, Canada, and Australia is not nearly enough to fill the gap left by retreating European banks.

 

Clearly, cross-border lending, which dominated capital flows in the years leading up to the crisis, has proven to be short term and can dry up quickly.

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