The risk sensitivity of global liquidity flows: Heterogeneity, evolution and drivers

Summary

Focus

Global liquidity has two main components: cross-border bank loans and international bonds. The sensitivity of those components to global risk varies considerably over time. Understanding the nature of this variation is key for properly assessing the exposure of economies to global shocks and designing the optimal policy responses to them.

Contribution

We investigate the determinants of the global risk sensitivities of global liquidity flows. We distinguish between borrowing countries and sectors. We test whether tighter balance sheet constraints faced by banks and non-bank financial institutions (NBFIs) amplify the sensitivity of their international credit supply to global risk shocks. We also examine how the post-Great Financial Crisis (GFC) shift from cross-border bank loans to international bonds has influenced the risk sensitivities of these flows.

Findings

The risk sensitivity of global liquidity flows is higher when funding is provided by banks and NBFIs that face greater capital and leverage constraints. Post-GFC tightening of bank regulation strengthened global banks' capacity to absorb risk but also increased the balance sheet cost of risky bank loans. As a result, riskier borrowers shifted to international debt securities markets, where funding is mainly provided by NBFIs. The post-GFC migration of borrowers from cross-border loans to international debt securities was associated with a decline in the risk sensitivity of global liquidity flows to EME borrowers.

Abstract

The period after the Global Financial Crisis (GFC) was characterized by a considerable risk migration within global liquidity flows, away from cross-border bank lending towards international bond issuance. We show that the post-GFC shifts in the risk sensitivities of global liquidity flows are related to the tightness of the balance sheet (capital and leverage) constraints faced by international (bank and non-bank) lenders and to the migration of borrowers across funding sources. We document that the risk sensitivity of global liquidity flows is higher when funding is provided by financial intermediaries that are facing greater balance sheet constraints. We also provide evidence that the post-GFC migration of borrowers from cross-border loans to international debt securities was associated with a decline in the risk sensitivity of global liquidity flows to EME borrowers.

JEL classification: G10, F34, G21

Keywords: global liquidity, international bank lending, international bond flows, emerging markets, advanced economies