VoxEU Column Financial Markets

Cross-border financial linkages: Identifying and measuring vulnerabilities

There has been spectacular growth in cross-border financial linkages over the last 20 years.  Moreover, boom-bust cycles in international financial flows have contributed to financial instability and financial crises in a number of countries. While the coverage of international financial datasets has sharply improved in recent years, this column introduces CEPR Policy Insight 77, explaining that the currently available data lacks the detailed information (in particular, the matrix of cross-border sectoral exposures) to provide a sufficient basis for risk surveillance and monitoring. Accordingly, a high priority for policymakers is to implement current proposals to improve the scope and quality of international financial data.

As shown in Figure 1,  cross-border financial positions have expanded rapidly since the mid-1990s (Lane and Milesi-Ferretti 2007). International financial integration promises significant benefits.  The funding of current-account imbalances by net international financial flows can support welfare-enhancing consumption smoothing and efficient international capital allocation. In addition, gross international financial flows provide an important mechanism by which international risk diversification can be implemented, while also enabling more intense competition in the provision of financial services. 

Figure 1. Foreign assets and foreign liabilities (world aggregates)

Note: Calculated from updated version of External Wealth of Nations data, as described in Lane and Milesi-Ferretti (2007). Percent of world GDP.

However, international financial integration also can prove costly.  It may amplify domestic distortions if poor local corporate governance and inadequate financial regulation permit risk-taking entrepreneurs and aggressive domestic banks to expand more rapidly by taking on international leverage. Indeed, consumption volatility might increase and the efficiency of international capital allocation decrease, in contrast to textbook predictions.

Even without such distortions, international financial integration also presents new types of financial risks (see also Rey 2013).  External financial shocks might trigger a reversal in the scale and direction of international financial flows, while shifts in international asset prices and exchange rates can generate sizeable valuation effects on the holdings of foreign assets and foreign liabilities. Moreover, the macro-financial impact of domestic shocks may be amplified by the pro-cyclical response of international financial flows. 

Despite the vast expansion in the availability of international financial data over the last 15-20 years, the existing data sets remain inadequate for the interpretation and analysis of cross-border financial linkages. Currently, international investment position datasets focus on the measurement of foreign assets and liabilities on a category-by-category basis (portfolio debt, other debt, portfolio equity, foreign direct investment, official reserves).  Only a limited number of countries report the sectoral identities of international investors (banks, other financial corporations, non-financial corporates, households and governments). Even in those cases, the sectoral identities of the cross-border counterparts are typically not reported, while information on the domestic financial positions of international investors is also necessary in order to obtain a full picture of the matrix of financial linkages.

To some extent, the existing cross-border datasets can be combined with domestic sectoral financial data in order to infer the financial linkages between sector  in country A and sector  in country B (see Errico et al 2014). Still, considerable data gaps and limits to data sharing mean that the full exploitation of currently available data is restricted.  Moreover, to take account of multi-country entities (international banks, multinational corporations), this residence-based approach has to be supplemented with complementary data on consolidated positions.

In a related manner, the currently available official data on the currency composition of cross-border positions is quite sparse. Using indirect methods and considerable guesswork, Lane and Shambaugh (2010) and Benetrix et al (2014) show that gross and net foreign currency positions are quite considerable and can account for substantial currency-induced fluctuations in the value of foreign assets and foreign liabilities. However, such estimates are a poor substitute for the official collection of the currency composition of foreign assets and foreign liabilities, cross-indexed by sector and instrument.

Finally, within sectors, it is also important to differentiate between domestic and foreign-owned entities since the nationality of ownership is essential in understanding the distribution of ultimate risk exposures. The importance of foreign-owned entities in the acquisition of foreign assets and issuance of foreign liabilities means that it is essential to differentiate between domestically-controlled and foreign-controlled firms in both the financial and non-financial sectors.

In relation to cross-border banking, recent moves to improve the international banking statistics collected by the BIS are welcome.  Stage I of this process does not require additional data collection from the reporting banks, but involves an expansion in the data categories assembled by the national central banks from the underlying data.  These include the presentation of full balance sheets for banking systems, so that the international banking data can be integrated with domestic banking positions.  In addition, the reporting of the geographical composition of the “locational by nationality” data enables a new perspective on consolidated banking data, since it provides details on the office-by-office exposures on both the liability and asset sides. The Stage I process also includes a more extensive currency breakdown of banking positions.

Stage II of this process requires the collection of new data from reporters. First, Stage II aims to improve measurement of country credit risk by providing a more detailed counterparty sectoral breakdown in the consolidated banking statistics, with the additional inclusion of consistent measures of bank equity and the total balance sheet. Second, the “locational by residence” data will decompose the banking system between domestic banks, foreign branches and foreign subsidiaries, while the locational data will also show the breakdown of cross-border borrowing by resident banks, non-bank financial institutions and the non-financial private sector. Third, the consolidated data will include a breakdown of liabilities between deposits, debt securities (short-term and long-term), derivatives, other liabilities and total equity.  Finally, Stage II will also seek to fill in data gaps and improve access to the international banking statistics.

In relation to the international financial positions of non-financial corporates, it is desirable to gain a better understanding along two dimensions.  First, in addition to its domestic funding sources, this sector also obtains direct cross-border credit from foreign banks and through issuing international debt securities, while also raising equity funding from foreign investors.  Second, the intra-firm cross-border financial transactions of multinational corporates require special attention.  In addition to the internationally-integrated funding of business activities, some multinational corporates may treat treasury operations as a profit centre.  For example, Shin and Zhao (2013) highlight the role of such firms as financial intermediaries by simultaneously issuing liabilities in some locations and currencies and acquiring financial assets in other locations and currencies.

In relation to the household sector, the direct cross-border positions of households can include foreign bank deposits and other financial assets, real estate and, on the liability side, foreign loans.  The tracking of the foreign financial assets of households is problematic, especially in relation to assets held in offshore centres (Lane and Milesi-Ferretti 2011, Johannesen and Zucman 2014).  In addition, the ownership of foreign real estate is part of the foreign direct investment category but data collection in this area is quite varied across countries.

Finally, the prominence of official reserves and sovereign wealth funds in aggregate foreign assets (especially for emerging and developing economies) means that greater transparency about the asset and currency composition of these holdings would improve overall understanding of the matrix of cross-border positions. On the liability side, more information on the geographical and sectoral identities of foreign investors in sovereign debt markets would help governments in understanding the nature of the investor base in this category.

The collection of the extra data required to improve understanding of cross-border financial linkages would be greatly facilitated by the standardisation of financial data (Ali et al 2012). Since 2012, there has been considerable progress in the promotion of legal entity identifier (LEI) codes, with the establishment of the Global LEI Foundation (GLEIF) in June 2014 an important milestone (see www.leiroc.org). The widespread adoption of LEI codes will make it easier to identify counterparts in a consistent manner. As described by Gross (2014a), the Global LEI System (GLEIS) will collect two types of data. Level 1 data will identify an entity through a 20-digit code and provide basic information about the legal entity. Level 2 data will represent relationships between entities registered at Level 1 (for example, the relationships among affiliates and a parent firm).

The adoption of common definitions for financial instruments would further facilitate the collection of useful data.  In turn, the representation of financial instruments in terms of the underlying constituent elements would help to clarify risk exposures and enable greater use of IT in the automatic collection and reporting of financial exposures (see also www.projectactus.org). Taken together, the adoption of LEI codes and standardised financial product identifier (PI) codes would enable a much richer understanding of the matrix of financial interconnections, both domestically and across borders.


In recent years, there has been an impressive expansion in the volume of international financial data. We now know much more than was previously possible about the level, composition and geography of cross-border financial positions. In parallel, there has also been a recent expansion in the availability of sectoral financial data in domestic national accounts. In combination, these different datasets can be exploited to advance our understanding of risks and vulnerabilities embedded in cross-border financial positions. This paper has documented the significant narrowing of current account global imbalances following the financial crisis of 2008, with projections suggesting a further compression in current account imbalances going forward. So is this the end of global imbalances? The evidence is not clear-cut: despite this compression, stock imbalances have continued to expand, both in relation to domestic GDP and global GDP. As of end-2012 four major creditor groups (European surplus countries; emerging Asia including China; Japan; and oil exporters) held a roughly comparable stock of net foreign assets, with three debtor groups (European deficit countries; the United States; and the rest of the world) accounting for a similar absolute level of net external liabilities. Absent large valuation changes favoring debtor countries or a further compression of current account imbalances, stock positions may well widen further in coming years.

In relation to the cross-country evidence on current account adjustment after the crisis confirms the patterns obtained in our earlier work – namely, current account balances have shifted to narrow the gaps that emerged during the pre-crisis period. Furthermore, pre-crisis current account gaps and pre-crisis net external positions help explain an important part of subsequent cross-country differences in demand growth. However, even over this medium-term period, real exchange rates have not consistently moved in a stabilising direction, so that external adjustment has involved very costly declines in expenditure in high deficit countries. We have also underscored some differences in adjustment behavior across exchange rate regimes--further exploration of the sources of these differences is warranted.

In regard to capital flows, the evidence suggests that the lion share of the shift in current account balances maps into shifts in net debt flows. Specifically, net debt inflows have declined dramatically for countries with large and negative current account gaps, despite the fact that some of these countries received substantial official assistance (which is classified as a debt inflow). We have subsequently explored whether monetary policy changes during the crisis period are correlated with the size of initial imbalances. The answer is yes for countries without an exchange rate peg, where those with excess deficits have cut interest rates by more, but not so for pegs, a sample dominated by euro area countries where changes in the policy rate were of course common across surplus and deficit countries. We have instead found little evidence of a robust relation between the initial current account gap and changes in the structural fiscal balance between the pre-crisis and post-crisis period. We have also shown that for pegged exchange rate regimes inflation did decline by more in countries with excess deficits, but not enough to ensure a real depreciation (as the evidence on real exchange rate shows). Finally, we have provided some suggestive evidence that valuation changes have been in a ‘stabilizing’ direction but only for countries without an exchange rate peg. This is consistent with the evidence on exchange rate changes relative to the pre-crisis period and also with the expected pattern of changes in asset prices more generally.

Taken together, this pattern of results reinforces the case for monitoring external imbalances, and for ensuring that external adjustment happens not just through expenditure reduction in excess deficit countries. Indeed, while the decline in current account imbalances is projected to be persistent, this is associated with persistently weak demand in deficit countries

Still, compared to the scale of financial globalisation and the social costs of financial crises, the available data remains remarkably limited and insufficient for comprehensive risk analysis.  Accordingly, the filling of gaps in current datasets and innovations such as the upgrading of the BIS international banking statistics and, importantly, the LEI initiative have the potential to sharply improve the evidence base for analysts and policymakers.  To this end, it is important that the current momentum to make progress in these areas is maintained and reinforced.


Ali R D, A Haldane and P Nahai-Williamson (2012), “Towards a Common Financial Language,” mimeo, Bank of England.

Benetrix A S, P R Lane and J C Shambaugh (2014), “International Currency Exposures, Valuation Effects and the Global Financial Crisis,” Journal of International Economics, forthcoming.

Errico L, R Walton, Y Korniyenko, G Amidzic, H AbuShanab and H S Shin (2014), “Mapping the Shadow Banking System Through a Global Flow of Funds Analysis,” IMF Working Paper No. 14/10.

Ghosh A R, J D Ostryand C G Tsangarides (2011), Exchange Rate Regimes and the Stability of the International Monetary System. International Monetary Fund Occasional Paper No. 270, March.

Johannesen, N and G Zucman (2014), “The End of Bank Secrecy? An Evaluation of the G20 Tax Haven Crackdown,” American Economic Journal: Economic Policy 6(1), 65-91.

Lane, P R and G M Milesi-Ferretti (2007), “The External Wealth of Nations Mark  II,” Journal of International Economics 73, 223-250.

Lane, P R and G M Milesi-Ferretti (2011), “Cross-Border Investment in Small International Financial Centers” International Finance 14(2), 301-330.

Lane, P R (2013),  Financial Globalisation and the Crisis. Open Economies Review 24(3), 555-580.

Lane, P R, Milesi-Ferretti, G.M. 2001.  The External Wealth of Nations Mark: Measures of Foreign Assets and Liabilities for Industrial and Developing Countries. Journal of International Economics 55, 263-294.

Lane, P R and G M Milesi-Ferretti (2007), "The External Wealth of Nations Mark II: Revised and Extended Estimates of Foreign Assets and Liabilities", 1970–2004. Journal of International Economics 73, November, 223-250.

Lane, P R and J C Shambaugh (2010), “Financial Exchange Rates and International Currency Exposures”, American Economic Review 100(1), 518--540.

Rey, H (2013), “Dilemma not Trilemma: The Global Financial Cycle and Monetary Policy Independence”, mimeo, London Business School.

Shin, H S and L Y Zhao (2013), “Firms as Surrogate Intermediaries: Evidence from Emerging Economies”, mimeo, Princeton University.

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