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Banking

Crisis Reshapes Cross-Border Financial Flows

graphic of world map with arrows The global financial crisis had a significant impact on the flow of investors' funds around the world, according to a recent study from the Federal Reserve Board. Once the financial crisis hit, U.S. cross-border financial flows indicated a "flight-to-safety" shift, with foreign investors selling U.S. securities other than U.S. Treasury securities. Similarly, U.S. investors sold more foreign securities, especially in the second half of 2008.

The flow of funds to the United States typically comes from sources including foreigners' purchases of U.S. securities and foreign direct investment in the United States. The financial crisis, however, significantly altered the composition of this inflow.

Cross-border flows affected from three angles
The Federal Reserve Bulletin article, "The Financial Crisis and U.S. Cross-Border Financial Flows," by Carol C. Bertaut and Laurie Pounder, asserts that global financial turbulence affected markets in three major ways:

  • Investors' "flight to safety" moved away from riskier securities and toward investments in safe and liquid markets, particularly U.S. Treasury securities;
  • Unusual flows through the banking system resulted from a shortage of dollar liquidity abroad and the breakdown in interbank markets that accompanied the financial crisis; and
  • Investors tended to pull back from cross-border positions during the financial crisis, a reflection of a general increase in risk aversion.

Looking at the shift in flows
In recent years, most of the inflows to the United States occurred through foreign acquisitions of U.S. securities, the authors write, adding that these acquisitions typically accounted for more than the U.S. current account deficit. During the crisis, foreign investors pulled back from purchasing U.S. securities, just as U.S. investors pulled back on buying foreign securities and kept their money at home.

Cross-border banking flows tend to be stable over time, but they revealed unusual patterns during the financial crisis. The crisis was reflected in cross-border bank flows, specifically the flow of liquidity to banks' home countries to shore up the parent bank. European banks generated the strongest net flows from U.S. offices, the authors write, to meet unusually high demand for U.S. dollars in Europe.

Finally, the increased aversion to risk during the financial crisis led to notable flight-to-safety flows in securities portfolios. Cross-border trading in U.S. securities fell sharply in fall 2008 as the crisis gathered intensity, signaling further investor caution. Trading has been slow to recover since then but has picked up in recent months for Treasury securities, the authors' data show.

Normalcy on the global horizon?
With the lessening severity of the financial crisis, many of the unusual financial flows that the crisis generated appear to be reversing. "U.S. and foreign data indicate that investors are making renewed purchases of riskier foreign securities such as equities and that purchases are no longer concentrated in safer and more liquid short-term government debt securities," they write. However, they caution that cross-border data indicate that the effects of the crisis may endure for some time.

 

December 28, 2009