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Analysts at the International Monetary Fund (IMF) are comparing current global financial conditions to the types of conditions that sparked the global financial crisis of 2008 – a crisis that stemmed from the US mortgage market.
The report shows that US-induced vulnerabilities are still present, representing a widespread economic threat.
Discussing the IMF’s “Global Financial Stability Report: Banks’ Dollar Funding: A Source of Financial Vulnerability,” lead author Adolfo Barajas says he and his team posed three questions to determine the impact of US dollar funding on banks around the world.
“Think of Japanese banks. So Japanese banks do a lot of dollar business. They face a funding shock in US dollars. Do we see reverberations of this in the Japanese banking system?
And the answer to that question was yes, we do see that. So that was the most direct question.
[adinserter block="1"]The second question was a little more indirect and not as obvious. We said, ‘Ok, given that same shock to funding costs, do we see strains in countries that borrow from Japan in dollars? Say Thailand, for example. Does it spread? Is there a spillover? And we found that indeed, when there are these shocks, they spread to other countries that are twice removed from conditions in the US…
The third question has to do with amplifiers and mitigators. So we said, given these shocks that have these negative effects, are there factors in the banking system, for example the Japanese banking system, that would amplify these effects or mitigate these effects. And some of these have to do with policy. Our main conclusion was yes.”
While Barajas says US dollar dominance is out of proportion to the size of the US economy, he believes it’s a perfectly effective way of spreading financial resources throughout the world, with merchants wanting to transact in US dollars and non-US banks providing the services to do so.
“The problem comes in when these activities, these assets, tend to be longer term – they’re loans – and they’re being funded on the short-term end. So it creates that mismatch.”
[adinserter block="1"]According to the report,
“Emerging markets that are recipient economies are particularly susceptible to declines in US dollar cross-border lending because they have limited ability to turn to other sources of US dollar borrowing or to replace dollars with other currencies. These results highlight the importance of controlling vulnerabilities arising from the US dollar funding of non-US banks.”
While the status quo remains in full force and effect with financial services relying heavily on US dollars as the only true viable means of conducting business, cryptocurrencies are designed to move money and value seamlessly and cheaply across borders, reducing friction and shrinking the need for large pools of foreign currencies around the world in order to settle transactions. These cryptocurrencies, particularly stablecoins, are challenging the very role of correspondent banks.
Powered by crypto entrepreneurs and developers that are building novel platforms outside of traditional banking, the DeFi (decentralized finance) movement is promising an entirely new system of global finance beyond governments, the US dollar or private corporations.
[adinserter block="1"]First movers Bitcoin and Ethereum are spurring the movement, along with several solutions that are emerging from leading players such as Ripple and Stellar to redesign the traditional flow of money.
You can check out the full report here.
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