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A decade after Lehman, puzzles and challenges in the international monetary system

While some improvements have occurred in the wake of the Global Crisis, the international monetary system still is rife with puzzles and challenges. This column summarises the latest Global Research Forum, which took stock of global financial stability a full decade on from Lehman. The starting points for many discussions were that international financial linkages remain strong, but have evolved in their composition; the US dollar continues to be the key currency for international trade and financial transactions; and banking systems have increased their resiliency and broadened their toolkits for dealing with stresses. Meanwhile, corporate debt issuance has soared and average US dollar-denominated liabilities have increased in most major emerging market economies.

On 29-30 November the ECB, the Federal Reserve Board and the Federal Reserve Bank of New York held their biannual high level conference, the Global Research Forum, which was a stock-taking about global financial stability a full decade after Lehman.

An old acquaintance: The international role of the dollar ten years later

The dollar’s dominance and use as a vehicle currency in international transactions was a feature of the pre-crisis era, often explained by macroeconomic performance, institutional development, network externalities and inertia (e.g. Goldberg and Tille 2008). This work mainly centred around the dollar’s usage in trade invoicing and official reserves, with less emphasis on its dominance as a global funding currency. More recently, research has focused on how these respective roles in international trade invoicing, bank funding, corporate borrowing, and global foreign exchange reserves can reinforce each other. Firms in emerging markets may endogenously take on currency mismatches in trade and financial transactions by borrowing in US dollars, as argued at the conference by Gita Gopinath and co-author Jeremy Stein (2018), with negative repercussions for financial stability. In such countries, fear of financial instability increases demand for foreign currency assets by savers since dollar denominated deposits provide insurance in the event of financial crises. This in turn enables firms to borrow more in dollars by lowering the cost of dollar funding. As argued in the conference paper by Guido Lorenzoni and his co-author Luigi Bocola (2018), the fact that savers do not internalise the financial instability effect of their savings in dollar deposits can generate multiple equilibria, with the bad equilibrium characterised by dollarisation and financial instability.

New kids on the block: The CIP deviation and the global financial cycle

Developments in the international costs of funding in the wake of the Global Crisis have received significant research attention. One dimension of interest centres around the effects of central banks’ monetary policy and open market operations, while a second dimension considers potential transactional frictions that might give rise to limits to arbitrage. With respect to the first dimension, a notable post-crisis novelty has been the expansion of foreign currency liquidity swap lines between central banks. According to Saleem Bahaj and his co-author Ricardo Reis (2018), the Federal Reserve’s swap lines put a ceiling on covered interest parity (CIP) deviations, mimicking discount-window credit from the source central bank to the recipient-country banks. Conference participants highlighted that this argument potentially only applies to banks that can access dollars through these channels. As regards the second dimension, the post-crisis observation of a persistent, non-zero, and non-negligible ‘basis’ in cross-currency basis swaps has given rise to a debate on whether this represents a violation of the CIP relation. At the conference, Alfred Wong and Jiayue Zhang (2018) questioned some of the popular arguments and concluded that the basis is well explained by the presence of asymmetries in counterparty and liquidity risk in the domestic and foreign money markets, in conjunction with market participants’ increased risk awareness since the crisis.

The existence and importance of the ‘global financial cycle’ – co-moving risk premia and capital flows on a global scale, possibly partly driven by US monetary policy – is another important post crisis theme. Linda Goldberg, in her panel remarks based on her research with co-authors (Avdjiev et al. 2017, Golberg and Krogstrup 2018), argued that the strength of the cycle is episodic and the structural drivers have evolved significantly over time, along with changing policy stance and institutions involved in international capital flows. Using post-1990s data, Maurizio Habib and his co-author Fabrizio Venditti (2018) showed that a fixed exchange rate increases the transmission of global risk to capital flows, in particular in the case of bank lending. Moritz Schularick and co-authors Òscar Jordà, Alan Taylor, and Felix Ward (Jorda et al. 2018) provided evidence based on equity price synchronisation, showing this has increased over time across 17 advanced economies, especially after the 1980s, and argued that it far exceeds the correlation in equity prices during the declines associated with the Great Depression. They further argued that the main driver of equity price co-movement stems from a synchronisation of risk premiums, not dividends. 

Another angle from which the concept of a global financial cycle can be understood is through its effect on the local supply of credit. Sebnem Kalemli-Ozcan and co-authors (di Giovanni et al. 2018) used detailed administrative data on loans, firms, and banks in Turkey to show that the funding cost differential of a firm borrowing in local currency versus foreign currency indeed diminishes at times of accommodative global financial conditions, especially for those banks with large non-core liabilities, leading to significant domestic credit expansion when risk premia fall.  The role of changing risk appetite among foreign investors also links to the literature which stresses the destabilizing role of foreign capital flight at the time of financial stress. However, Ricardo Caballero and his co-author Alp Simsek (2018) instead emphasised the important stabilising role of financial capital retrenchments in providing liquidity insurance to quell country-specific fire sales and prevent a downward spiral of asset prices. 

The elephant in the room: Are global banks really safer?

The Global Crisis, which had global banks at its epicentre, prompted regulatory reforms aimed at improving banks’ resilience to adverse shocks, and at reducing their incentives toward excessively leverage. These efforts culminated in a range of changes in regulation and supervision, including the finalisation of the remaining elements of Basel III. The effects of these reforms were discussed in the conference’s keynote address by Luc Laeven (2018), by Sujit Kapadia and co-authors Aikman, Haldane, and Hinterschweiger (Aikman et al. 2018), and in a panel moderated by ECB board member Benoît Cœuré which featured former ECB Vice President Vítor Constâncio, Federal Reserve Bank of New York senior vice president Linda Goldberg, IMF director Gian Maria Milesi-Ferretti, BlackRock senior researcher Tara Rice, and Bruegel co-founder and Peterson Institute for International Economics senior fellow Nicolas Véron. The importance of international cooperation in the implementation of these reforms in an interlinked global financial system was emphasised by Enisse Kharroubi and his co-author Giovanni Lombardo (2018).

The conference participants agreed that a decade on, good news appears to dominate at first glance. Supervision has been largely strengthened (the euro area has introduced supranational supervision and stress tests are used extensively in a broad group of countries around the world;) and macroprudential frameworks have been developed in many countries to focus on the risks affecting not only single financial institutions but also the system as a whole. In addition, efforts are being made to reduce cross-sectional pro-cyclicality; the multiple sources of balance sheet fault lines, risks and Knightian uncertainty to which banks are exposed are being addressed through multiple liquidity and capital regulatory metrics, including the notable complementarity between risk-weighted capital requirements and the leverage ratio; and the total absorption capacity (TLAC) of bank capital has been expanded and some countries require their financial institutions to also hold bail-inable capital.

The conference discussion, however, revolved around important lingering shortcomings: regulation and bank leverage remain pro-cyclical and some reform agendas have stalled (e.g. the regulatory treatment of sovereign exposures and the cross-border resolution of global banks) or have been implemented unevenly (the bail-in rules); international banks remain subject to national regulation (“international banks die nationally”), which limits fiscal backstops leaving scope for regulatory arbitrage; some criticism of global banks may over-emphasise international shock and credit cycle transmission from specific economies, while undervaluing the role of international banks in international risk sharing; the rapid international growth of non-bank financial institutions highlights the absence of a level regulatory playing field with banks, and the need for the extension of stress-testing to market-based finance as well; leverage and debt have been insufficiently tamed and global debt has further increased due to  higher corporate debt levels in emerging markets and higher public debt levels in the advanced economies; partly because of this latter issue, the sovereign–bank nexus has also remained a concern; and while many central banks now have macroprudential toolkits at their disposal, an optimal regulation of credit booms requires an understanding of the sources of booms.

Furthermore, although stress-testing frameworks are an important contribution to the regulatory toolkit, certain implementation practices also raise questions about whether they are achieving their intents. Friederike Niepmann and co-author Viktors Stebunovs (2018) presented suggestive evidence that the continued reliance on banks’ internal risk models and on book values instead of market-based values as measures of bank regulatory capital and in stress tests may provide a misleading picture of a bank’s actual solvency and resilience. 

Autors’ note: The views expressed in this column belong only to the authors and are not necessarily shared by the ECB, the Federal Reserve Bank of New York or the Federal Reserve System.


Aikman, D, A G Haldane, M Hinterschweiger and S Kapadia (2018), “Rethinking financial stability”, Bank of England, Working Paper No. 712.

Avdjiev, S, L Gambacorta, L Goldberg and S Schiaffi (2017), The Shifting Drivers of Global Liquidity, FRNBY Staff Report no. 819. 

Bahaj, S and R Reis (2018), “Central Bank Swap Lines”, Discussion Papers 1816, Centre for Macroeconomics (CFM).

Bocola L and G Lorenzoni (2018), “Financial Crises, Dollarization, and Lending of Last Resort in Open Economies”, NBER Working Paper No. 23984.

Caballero, R J and A Simsek (2018), “A Model of Fickle Capital Flows and Retrenchment”, presentation delivered at the Global Research Forum on International Macroeconomics and Finance, European Central Bank, Frankfurt am Main, 29-30 November 2018.

di Giovanni, J, S Kalemli-Ozcan, M Fatih Ulu and Y Soner Baskaya (2018), “International Spillovers and Local Credit Cycles”, NBER Working Papers 23149.

Goldberg, Linda S. and Cédric Tille (2008), “Vehicle Currency Use in International Trade”, Journal of International Economics 76(2): 177-192.

Goldberg, L S and S Krogstrup (2018), "International Capital Flow Pressures", NBER Working Paper No. 24286. 

Gopinath, G, and J Stein (2018), “Banking, Trade and the Making of a Dominant Currency”, Working Paper, Harvard University.

Habib, M and F Venditti (2018), “The global capital flows cycle: structural drivers and transmission channels”, presentation delivered at Global Research Forum on International Macroeconomics and Finance, European Central Bank, Frankfurt am Main, 29-30 November 2018.

Jorda, O, M Schularick, A M Taylor and F Ward (2018), “Global Financial Cycles and Risk Premiums”, Working Paper Series 2018-5, Federal Reserve Bank of San Francisco.

Kharroubi, E and G Lombardo (2018), “International Coordination of Monetary and Macroprudential Policies”, presentation delivered at Global Research Forum on International Macroeconomics and Finance, European Central Bank, Frankfurt am Main, 29-30 November. 

Laeven, L (2018), “Has Financial Regulation made the Financial System safer?”, Keynote speech delivered at the Global Research Forum on International Macroeconomics and Finance, European Central Bank, Frankfurt, 30 November.

Niepmann, F, and V Stebunovs (2018), "Modeling Your Stress Away", CEPR Discussion Paper 12624.

Wong, A and J Zhang, 2018. "Breakdown of covered interest parity: mystery or myth?", in The Price, Real and Financial Effects of Exchange Rates, BIS Paper No. 96, Bank for International Settlements.

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