Cross-border Borrowing of Financial Institutions, Exchange Rate Regime and Macroprudential Policy
Wen Xingchun, Mei Dongzhou, Gong Liutang
China School of Banking and Finance, University of International Business and Economics; School of International Trade and Economics, Central University of Finance and Economics; Institute for Advanced Study, Wuhan University
Summary:
China is expanding the external openness of its financial sector while concurrently advancing the processes of Renminbi (RMB) internationalization through market-oriented reforms in RMB exchange rate and the reduction of capital controls. Consequently, understanding how cross-border borrowing of financial institutions impacts a country's economic fluctuations and determining measures to mitigate associated risks are crucial theoretical and practical considerations. This is particularly pertinent in the current highly complex and uncertain international environment. The urgent need is to investigate the mechanisms through which cross-border borrowing of financial institutions affects the economy and to conduct in-depth analysis on the coordination between cross-border borrowing of financial institutions and exchange rate marketization and policies such as cross-border financing regulation. To address this, we introduce cross-border borrowing of financial institutions into a Dynamic Stochastic General Equilibrium (DSGE) model, analyzing the relationships among cross-border borrowing of financial institutions, exchange rate regime selection, and cross-border financing regulatory policy. Numerical simulation results indicate that, when financial institutions engage in cross-border borrowing, external shocks impact capital inflows and outflows, causing exchange rate fluctuations. This then affects the financial intermediary's balance sheet, leading to a reduction in the financial intermediary's lending to the real sectors and ultimately resulting in adverse effects on investment and output. If not taking cross-border financing regulatory policy into account, when cross-border borrowing or the cross-border borrowing by financial institutions doesn't exist or is low, the floating exchange rate regime outperforms the fixed exchange rate regime in terms of output stability and welfare implication, aligning with traditional conclusions of studies on monetary policy in open economies. However, with the increase in the scale of foreign debt borrowed by financial institutions, the negative impact of capital flows and exchange rate fluctuations on the financial system increases. At this juncture, relative to a floating exchange rate, a fixed exchange rate regime proves effective in stabilizing the exchange rate, reducing the volatility of capital flows, and consequently mitigating output fluctuations and welfare losses. Furthermore, the study assesses the role of macroprudential regulatory policy in cross-border borrowing of financial institutions and RMB exchange rate marketization. Results indicate that cross-border financing regulatory policy can mitigate capital flow and exchange rate volatility under cross-border borrowing of financial institutions, thereby reduces the adverse impact of external shocks on the financial intermediary's balance sheet, leading to decreased output fluctuations and welfare losses. The efficacy of regulatory policy increases as the scale of cross-border borrowing by financial institutions increases. In the presence of cross-border financing regulatory policy, the output fluctuations and welfare losses under a floating exchange rate regime are lower than those under a fixed exchange rate regime. Based on these conclusions, the paper proposes the following policy recommendations. Firstly, as the opening up of financial institutions progresses, China should vigilantly guard against adverse international economic impacts, such as rising global interest rates. The frequent movement of cross-border capital can amplify financial intermediary volatility and systematic financial risks, exacerbating macroeconomic fluctuations. Establishing and refining a policy framework to address cross-border financing risks in the financial intermediary, including implementing macroprudential controls for cross-border financing, is crucial. Secondly, while acknowledging the inevitability of financial institutions' openness, it is imperative to expedite the establishment and improvement of a regulatory framework for cross-border capital flows. On this foundation, the gradual promotion of RMB exchange rate marketization is recommended, allowing for increased exchange rate flexibility. Without a well-coordinated cross-border financing regulation framework, hastening the cross-border borrowing of financial institutions and endorsing exchange rate marketization could compromise the overall financial system's stability, triggering systemic financial risks and potentially inciting a financial crisis, thereby intensifying economic fluctuations. Thirdly, until a comprehensive cross-border financing regulatory framework is in place to manage capital flows, maintaining exchange rate stability and restricting cross-border capital movements remains a necessary means to mitigate adverse impacts of external shocks and guard against systemic financial risks. In comparison to existing literature, the contributions of this paper lie in several aspects. Firstly, departing from prior studies that predominantly focused on currency mismatches in the balance sheets of enterprises in an open economy, this paper focuses on the balance sheets of financial intermediaries to investigate the impact of cross-border borrowing of financial institutions on economic fluctuations. This is particularly relevant given the accelerating opening up of China's financial industry and provides a foundational analytical framework for subsequent research. Secondly, the findings of this paper provide a novel perspective on understanding the impact of cross-border borrowing of financial institutions on macroeconomic policies. Cross-border borrowing of financial institutions amplifies economic volatility resulting from external shocks. Without considering cross-border financing regulatory policy, a fixed exchange rate regime outperforms a floating exchange rate regime in terms of both output fluctuations and welfare implication, which is significantly different from the previous results derived from the perspective of enterprise behavior. Finally, beginning with the stability of the financial system, this paper comprehensively synthesizes the coordination and collaboration among cross-border borrowing of financial institutions, floating exchange rates, and cross-border financing regulatory policy within a general equilibrium framework. This holds theoretical significance and provides policy insights for the ongoing practice of financial institutions' openness.
[1]康立和龚六堂,2014,《金融摩擦、银行净资产与国际经济危机传导——基于多部门DSGE模型分析》,《经济研究》第5期,第147~159页。 [2]芦东、周梓楠和周行,2019,《开放经济下的“双支柱”调控稳定效应研究》,《金融研究》第12期,第125~146页。 [3]梅冬州和龚六堂,2011,《新兴市场经济国家汇率制度选择》,《经济研究》第11期,第73~88页。 [4]裘翔和周强龙,2014,《影子银行与货币政策传导》,《经济研究》第5期,第91~105页。 [5]王曦、王茜和陈中飞,2016,《货币政策预期与通货膨胀管理——基于消息冲击的DSGE分析》,《经济研究》第2期,第16~29页。 [6]温兴春和龚六堂,2023,《金融业开放、政府隐性担保与系统性金融风险防范》,《国际金融研究》第10期,第38~49页。 [7]温兴春和梅冬州,2020,《金融业开放、金融脆弱性以及危机跨部门传递》,《世界经济》第10期,第144~168页。 [8]张礼卿和钟茜,2020,《全球金融周期,美国货币政策与“三元悖论”》,《金融研究》第2期,第15~33页。 [9]Aoki, K., G. Benigno and N. Kiyotaki, 2020, “Monetary and Financial Policies in Emerging Markets”, Princeton University Working Paper. [10]Bruno, V. and H. S. Shin., 2015, “Capital Flows and the Risk-taking Channel of Monetary Policy”, Journal of Monetary Economics, 71, pp.119~132. [11]Chang, C., Z. Liu and M. M. Spiegel, 2015, “Capital Controls and Optimal Chinese Monetary Policy”, Journal of Monetary Economics, 74, pp.1~15. [12]Costinot, A., G. Lorenzoni and I. Werning, 2014, “A Theory of Capital Controls as Dynamic Terms-of-trade Manipulation”, Journal of Political Economy, 122(1), pp.77~128. [13]Davis, J. S. and I. Presno, 2017, “Capital Controls and Monetary Policy Autonomy in a Small Open Economy”, Journal of Monetary Economics, 85, pp.114~130. [14]Gandhi, A., S. Navarro and D. A. Rivers, 2020, “On the Identification of Gross Output Production Functions”, Journal of Political Economy, 128(8), pp.2973~3016. [15]Gertler, M., S. Gilchrist and F. M. Natalucci, 2007, “External Constraints on Monetary Policy and the Financial Accelerator”, Journal of Money, Credit and Banking, 39, pp.295~330. [16]Gertler, M. and P. Karadi, 2011, “A Model of Unconventional Monetary Policy”, Journal of Monetary Economics, 58(1), pp.17~34. [17]Gertler, M., N. Kiyotaki and A. Queralto, 2012, “Financial Crises, Bank Risk Exposure and Government Financial Policy”, Journal of Monetary Economics, 59, pp. S17~S34. [18]Korinek, A and D. Sandri, 2016, “Capital Controls or Macroprudential Regulation?”, Journal of International Economics, 99, pp. S27~S42. [19]Obstfeld, M., 2015, “Trilemmas and Tradeoffs: Living with Financial Globalization”, BIS Working Papers, No.480. [20]Reinhart, C. M., 2015, “The Antecedents and Aftermath of Financial Crises as Told by Carlos F. Díaz Alejandro”, NBER Working Paper, No. 21350. [21]Reinhart, C. M. and V. R. Reinhart, 2008, “Capital flow Bonanzas: An Encompassing View of the Past and Present”, NBER Working Paper, No.14321. [22]Reinhart, C. M., K. S. Rogoff and M. A. Savastano, 2014, “Addicted to Dollars”, Annals of Economics & Finance, 15(1), pp.1~50. [23]Rey, H., 2015, “Dilemma not Trilemma: The Global Financial Cycle and Monetary Policy Independence”, NBER Working Paper, No. 21162. [24]Shi, K., J. Xu and X. Yin, 2015, “Input Substitution, Export Pricing, and Exchange Rate Policy”, Journal of International Money and Finance, 51, pp. 26~46.