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Structural policies can reduce financial fragility


12/06/2012 - The structure of a country’s external liabilities, as well as the extent and nature of its international financial integration, are key determinants of vulnerability to financial crises, according to the latest Economics Policy Paper from the OECD.

International capital mobility: Which structural policies reduce financial fragility? shows that a bias in gross external liabilities towards debt has raised crisis risk. The same holds for "currency mismatch" – the situation that arises when a country's foreign-currency denominated liabilities are large compared to its foreign-currency denominated assets.

The report, presented in the run-up to the G-20 heads of state summit in Los Cabos, Mexico,  is based on new empirical analysis of financial systems in both OECD and emerging economies over the past four decades. It shows that international banking integration has been a major vector of contagion, and even more so when cross-border bank lending was primarily short-term. Vulnerability to contagion has been lower when global liquidity has been abundant, underlining the importance of major central banks ensuring ample international liquidity at times of financial turmoil, according to the report.

Structural policies can increase financial stability, typically through their effects on the composition of the external financial account, or on the vulnerability to contagion-induced financial shocks. Lower barriers on foreign direct investment and lower product market regulations have increased financial stability, by shifting external liabilities from debt towards FDI. In contrast, tax systems that favour debt finance over equity finance have undermined stability, by increasing the share of debt, including external debt, in corporate financing.

Targeted capital controls on inflows from credit operations are shown to have reduced the impact of financial contagion, not least by shifting the structure of external liabilities. Stricter information disclosure rules or capital requirements and strong supervisory authorities have also reduced countries' financial crisis risk, according to the report.

OECD Economics Policy Paper No. 2, International capital mobility: Which structural policies reduce financial fragility?, is available here.

For further information, or interviews with the authors, contact the OECD Media Division (, +33 1 4524 9700).


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