A recent PhD thesis in applied macroeconomics and international finance distils policy insights into the benefits and risks of financial globalisation. Specifically, Alexander Raabe shows that global banks play an important role for the international financial integration of real estate markets. He also highlights the effect of capital inflows on banks’ allocation of credit to domestic and foreign borrowers.
Why do you have such a deep interest in financial globalisation?
Well-managed globalisation bestows enormous benefits and opportunities to mankind despite the recent backlash against globalisation and the pandemic-fuelled notion of “slowbalisation”. While trade has long been a well-known vehicle of global economic integration, until the 2008 Global Financial Crisis (GFC) less attention has been paid to globalisation through financial channels. Cross-border capital flows, global financial markets and the activities of globally active financial institutions and their regulation affect all areas of our lives, but only started to be systematically explored in the aftermath of the 2008 GFC. I am fascinated by the study of financial globalisation as it challenges our understanding of the interdependencies in the world economy and signals the need for new analytical frameworks. Thanks to my pre-PhD work experience at the International Monetary Fund, United Nations development agencies and in economic diplomacy in Asia and Latin America, I have come to recognise the power of research to shape macroeconomic policies. This is why I conducted research that addresses economic policy challenges arising from financial globalisation, and in particular capital flows and global banks as key enablers of globalisation.
Your PhD thesis comprises three chapters. Can you describe the research questions, methodology and findings of each one?
The chapters address, respectively, the following questions:
1) What drives the international synchronisation of house prices?
To address this first question, the analysis exploits the structure of the international banking network as well as the heterogenous exposure of global banks to variations in global dollar funding conditions. Together with my co-authors Mathias Hoffmann (University of Zurich) and Torsten Ehlers (Bank for International Settlements, BIS), we develop a statistical framework to derive an empirically testable relationship between the international synchronisation of house prices and global dollar funding conditions. Based on data from the BIS, we test this relationship empirically using state-of-the-art econometric techniques, allowing for the elimination of confounding factors.
We find that capital inflows into the United States (US) are an important determinant of house price synchronisation around the globe. As more capital flows on net into the US from the rest of the world, it becomes easier for non-US global banks to borrow in US dollars. As non-US global banks finance on average about 45 percent of their foreign lending in US dollars, they are exposed to variations in US dollar funding conditions. These variations drive these banks’ foreign lending to third-party borrowing countries – a novel concept we call dollar dependence. We construct the empirical counterpart for the dollar dependence by combining detailed data from the BIS banking statistics. Recipient banks in the borrowing countries allocate much of the foreign lending to mortgage markets, resulting in pressure on house prices. As this pattern replicates itself across borrowing countries, housing markets in these countries co-move more strongly. Thus, this work highlights a novel channel of the international transmission of US dollar funding conditions explaining the synchronisation of real estate markets.
2) How do global banks shape the international spillovers of house price shocks?
To answer this second question, I rely on a similar procedure, but start with a different statistical framework. I show that global banks facilitate these spillovers. The underlying mechanism entails that global banks rebalance their portfolios by lending more to relatively safer borrowing countries when some other borrowing countries in their portfolios experience house price declines. This implies an increase in house prices in borrowing countries other than those hit by the initial house price decline. I also show that selected macroprudential policy measures are effective at shielding countries from these spillovers.
3) How do banks channel capital inflows to the domestic sectors of an economy and to overseas residents?
The empirical identification of this third question relies on confidential bank-level data from the Bank of England (BoE). A particular challenge for causal identification is to disentangle supply and demand for foreign capital inflows. To address this challenge, my co-author Christiane Kneer (BoE) and I use detailed information about the source country of foreign capital deposited with UK banks to introduce a novel econometric technique to isolate the exogenous component of capital inflows unrelated to economic conditions of individual UK banks.
Our research suggests that prior to the 2008 GFC capital inflows drive lending to domestic non-financial firms – mostly to the construction sector – and to other domestic financial institutions, but capital inflows are not directly associated with increased credit to households and the public sector. In the post-GFC period, additional foreign funding of banks is not absorbed domestically. Instead, capital inflows are associated with increased lending abroad, in line with the UK’s role as global financial centre.
Is there a topical issue on which these insights into financial globalisation can shed a new light?
The COVID-19 pandemic highlighted the dominant role of US dollar liquidity for the functioning of the global financial system. As the fallout from the pandemic led to sharply rising dollar funding costs in global financial markets, the US Federal Reserve eased dollar funding strains by activating swap lines with foreign central banks, in turn lowering funding costs for global commercial banks. My PhD research shows that variations in US dollar funding conditions not only affect the refinancing conditions of global banks, but also real estate markets worldwide.
How can your research findings serve society?
As part of globalisation at large, over the last two decades domestic real estate markets experienced strong growth in international linkages. Financial innovations such as the rapid rise in the securitisation of mortgage-backed securities fuelled this globalisation process and contributed to the international tradability of what was once a local asset which turned into a global asset class. The increased international linkages between real estate markets imply immediate repercussions for domestic financial markets, households and policymakers. For instance, capital inflows into domestic real estate markets not only change the spatial and social structure of urban societies, but also can undermine financial stability due to excessive price developments and even lead to financial crises. Given that real estate constitutes the largest share of wealth in households’ portfolios, variations in house prices have direct implications for inequality and social cohesion. Against this backdrop, it is important to understand to what extent house prices are co-moving with those in other countries, and what drives this synchronisation. My research, produced while I was affiliated with the University of Zurich Center for Urban and Real Estate Management (CUREM), highlights some of the drivers and can serve to guide policies aimed at staying in control of domestic house price developments.
What are you doing now?
Following my PhD defence in October 2020 I joined the European Stability Mechanism as an Economist.
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Alexander Raabe defended his PhD thesis in International Economics in October 2020. Professor Ugo Panizza presided the committee, which included Professor Cédric Tille, supervisor, and Steven Ongena, Professor at the Department of Banking and Finance of the University of Zurich.
Full citation of the PhD thesis:
Raabe, Frank-Alexander. “Essays in Financial Globalization.” PhD thesis, Graduate Institute of International and Development Studies, Geneva, 2020.
For more details on Dr Raabe’s research and contact details, please consult his personal website.
Banner picture: excerpt from an image by Pushish Images /Shutterstock.com.
Interview by Nathalie Tanner, Research Office.