Research On Effects Of International Capital Flow On China’s Financial Stability

Accompanied with the strengthening of globalization, the economic and financial relationship among different countries tied closely, effect of frequent capital flow on the world is more and more serious. After 2008, the Federal Reserve not only injected financial institute with liquidity directly, but also took some unconventional measures to inject liquidity to the market to stop economy declining. At the same time, it announced it would maintain low interest rate to 0-0.25 percent for a long period. The Central Bank of Japan, England, Australia and Brazil followed the Federal Reserve’s action to inject money to the market by expanding central bank’s balance sheet. However, liquidity injection which ought to promote real economy hasn’t been absorbed. Thereafter, it dissociate all over the international financial market. The Asia Development Bank believed that Asian countries was shocked seriously than other countries, China is the one of them. According to Chinese cross-border Capital Flow Report(2011), net capital flow to new emerging markets was over ﹩2.1 billions, the yearly growth near 40 percent, which is far beyond the average over the past fifteen years. While improved economic benefits, it also increased inflation pressure, caused stock market and real estate price fluctuating, which challenged their financial stability. In addition, along with China’s capital and financial account opening, the scale of capital flow will become larger and larger, inflow and outflow of international capital will be more and more frequent, the effect will be more and more serious. So, it is meaningful to research how China’s financial stability is shocked by capital flow and how to manage capital flow effectively to refrain financial stability from the shock of international capital flow.This dissertation considers that financial stability is such a state as,(1) currency stability;(2) key financial institution stability;(3) financial market stability. The domestic factors that affect financial stability including economic growth, maro-economic polices, while foreign factors including the gloabal economic growth, international macro-economic polices and international capital flow etc. This dissertation mainly analyzes the influence of international capital flow on China’s financial stability, which through channels such as inflation, the capital price fluctuate and financial institutions.Specificialy, capital flow into China contributed to the increase of foreign exchange reserve and corresponding money supply, which resulted in amplify liquidity. Thereafter, inflation and increase of asset price come out, which is precursor of financial instability. That is to say, capital flow influences financial stability through inflation and asset price. Meanwhile, banking is dominant in China, bank’s asset structure will change under the profit motive when ample liquidity come out, which will affect bank stability. Capital flow was accused of financial crises. However, it is not reasonable to due financial instability to capital flow, for many other factors would also influence financial stability. However, how the effects are have to be tested by positive analysis. Furthermore, with ingternatioal relationship among countries tied closely, capital flow to China will increase and the influence will be amplified.Viewed from the facts that countries have undergone currency crises, bank crises or stock crises, crises were indeed closely related to capital flow and capital flow was accused. However, other countries’ financial stability was not affected because of their constructure of financial stability, measuremenst to deal with negative shock. These measurements are helpful for us to alleviate the negative effects of capital flow on our country.This dissertation contains seven chapters, the content as follows:The first chapter, the author elaborates the background and significance, the present views on the subject, the route, the way, the structure, the innovative and shortcoming of the dissertation.The second chapter introduces related theory of capital and financial stability. It analyzes the source of financial instability and the channels influence financial stability firstly. Then it analyzes the mechanism which capital flow affect financial stability by IS-LM-BP model, which provides theoretical foundation for later research.The third chapter examines the relationship between international capital flows and inflation. This chapter derives the impact of international capital flows using IS-LM-BP theory,which provides theoretical basis for the subsequent analysis. Then, it introduces the background, causes and effects of capital flows mechanism of inflation. Finally, it analyzes the relationship between international capital flows and inflation, based on the theoretical and practical background on the results. The result shows that inflation had certain inertia, and capital flow has limited influence on inflation.The fourth chapter consideres financial stability depends on bank stability because of their importance in China. China began banking internationalization from the early 20 th century, bank instability is influenced by enlarging leverage rate, increasing foreign equity and changing foreign currency asset and liability structure. This chapter analyzes 15 banks’ stability with reference to the approach used in eastern and central European countries, combined with the CBRC document on bank risk measurement. Result reveales that,(1) there is considerably difference between “four big banks”(Agriculture bank is not included) and other joint-stock banks, the introduction of strategic investor to maintain bank stability was not consistent with the former mind.(2) the structure of foreign currency asset and liability has a significant effect on bank stability, net gap between foreign currency asset and liability influences bank stability, especially the sign of foreign currency asset is contrary to that of its liability because of most of their asset dominated by dollar while the banks’ statements dominated by RMB in this special period, during which appreciation of RMB will reduce profitability of the banks. Besides, bank stability was influenced naturally because of the decline of foreign currency value or even non-performing assets. These results are useful to maintain financial stability during special stage that capital flow exacerbates.The fifth chapter points out that there is difference among different capital flow. Generally speaking, short-term capital flow shock financial stability more severely. At the same time, short-term capital does not influence macro-economy directly, but influence some certain sphere through micro- or intermediate-aspect instead of influencing it directly. This chapter analyzes short-term capital flow in China firstly, then analyzes the mechanism that influence of short-term capital on asset price and the relationship between asset price fluctuation and financial stability. At last, we study the influence of capital flow on asset price using TARCH, the result reveals that there is asymmetric effect to asset price fluctuation. Large fluctuation in stock price is an indicator of financial instability in countries that crisis has happened, so it is meaningful to supervise capital flowing into asset market.The sixth chapter considers the impact of international capital flows on the financial stability as a whole. It constructs financial stability index on the basis of the previous chapters. Then, it analyses of the impact of international capital flows on financial stability, combing with fiscal policy, monetary policy and economic cycle. The conclusion shows that: international capital flows’ impact on financial stability in different economic cycles are different because of monetary policy and the economic cycle interaction.Capital is often sneak into at stage of economic prosperity, if the government does not implement counter-cyclical policy, international capital inflows will further exacerbate economic fluctuations,which will eventually worsen financial stability; If the government does not implement the positive macro-economic recession economic policy, international capital will flow out and financial stability will also deteriorate thereafter. At present, China implemented counter-cyclical macro-management and limited capital to enter high-risk industries. At the same time, China has huge foreign exchange reserves as a guarantee, foreign debt in affordable range. Therefore, the active role of international capital flows overall financial stability of our country is more than negative effect.Based on the analysis of influence of capital flow on financial stability and combined with the relevant national management experience in international capital flows, the seventh chapter provides some recommendations on effecive managment of capital flow and maintains financial stability.The innovations in this article lies on:(1) It takes the total- sub-analysis paradigm to study the financial stability, enriching the financial stability analysis framework.This paper analyzes the channels and mechanisms of international capital to financial stability firstly, then discusses the shock of international capital flow to financial stability from the perspective of monetary stability, stability of financial institutions and financial market stability. Lastly, it examines the impact of international capital flows on the entire financial system by building financial stability index;(2)It measures the stability of banks with the methods used by Eastern European countries, combined with the CBRC relevant documents on the part of commercial banks, and selects 15 joint-stock bank data analyzes the impact of international capital flows to its stability;(3) It analyzes the shock of international capital flow to financial system by construting a continuous variable- financial stability index which including monetary stability, bank stability and price volatility of the asset price. This analysis examines intermediate state between the financial stability and instability, which avoids the shortcoming of the method that only uses 0-1 variable. So it measures the financial stability in recent years objectively;(4)In the process of analyzing the impact of international capital flows on financial stability, it takes the economic cycle, fiscal and monetary policy as well as their interactions into account. It also investigates the different effects of international capital flow on financial stability arises from different economic cycle.The shortcomings lies on,(1) the perspective can be further expanded. This is reflected in the following two aspects: Firstly, it is reasonable to view bank as a representive to analyze the shock of international capital flow to financial institutions because the bank is dominant in finance in our country. But with the changes in China’s financial system, such as other financial institutions, insurance, trusts, etc. will improve and grow increasingly, they can affect the stability of financial stability also; Secondly, in the process of analyzing the impact of international capital flows on financial markets, it takes Shanghai and Shenzhen stock markets for example. However, financial markets including the bond market, foreign exchange market, gold market, etc., it can also be analyzed from these areas.(2) This paper analyzes the impact of net international capital flows on financial stability. The international capital flow can be divided into international capital inflows, outflows by flow direction, can be divided into direct investment, portfolio investment, other investment accoding to its nature. Therefore, we can study the impact of international flow from other perspectives respectively, which will be the direction of the author.