How Capital Flows Affect Economy-Wide Vulnerability and Inequality: Flow-of-Funds Analysis of Selected Asian Economies

Abstract

In contrast to the situation that preceded the 1997–1998 Asian financial crisis, Asia today is a region with excess savings where corporate savings dominate. In the mid-2000s, the extent of liquidity was further amplified by massive capital flows, particularly bank-led flows. The flows were briefly interrupted by the global financial crisis, before debt-led flows began to dominate, following the Quantitative Easing (QE) policy in the United States. Using flow-of-funds data, this study determines that the surge in liquidity in Asian financial systems has changed the behavior of agents and institutions. The general trend shows that agent preferences for investing in financial instruments have increased as financial liberalization provides more opportunities to do so. This can have economy-wide repercussions, ranging from financial instability to widening income disparity and falling employment elasticity. In the banking sector, an increase in non-core sources of funding influences banks’ asset allocation, with loans increasing rapidly, escalating the risks of pro-cyclicality and asset bubble creation.