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7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
The world’s nancial assets—or the value o equity market capital ization,
corporate and government bonds, and loans—grew rom around $12 trillion
in 1980 to $206 trillion in 2007. Financial depth, which measures those assets
relative to GDP, rose rom 120 percent to 355 percent o global GDP over thesame period. But this rapid growth has stalled. Today the value o the world’s
nancial assets stands at $225 trillion, above the pre-crisis peak (Exhibi t E1). But
global nancial assets have allen by 43 percentage points relative to GDP since
2007—and by 54 percentage points i we exclude the recent rise in government
debt. Their annual growth was 7.9 percent rom 1990 to 2007, but that has
slowed to an anemic 1.9 percent since the crisis.
eiit e1
Global financial assets have grown to $225 trillion, but growth has slowedsince 2007
Global stock of debt and equity outstanding1
$ trillion, end of period, constant 2011 exchange rates
3035
3942 42 41 42 42
18
37
47
56
64 3648
54 47 50
19
2000
119
35
5 5
18
95
75
26
14
1990
56
23
57
43
09
206
54
149
39
08
189
54
14
29
Securitizedloans
Corporatebonds
Financialbonds
Governmentbonds
Equity
2Q12
225
62
47
11
218
60
46
10
219
1.9
8.1
7.8
Non-securitizedloans
8
35
2007
206
50
138
32
06
185
46
30
2005
165
42
97
1.5
9.1
-0.7
4.8
9.2
SOURCE: McKinsey Global Institute Financial Assets Database; McKinsey Global Institute analysis
-5.5
1 Based on a sample of 183 countries.
1.9
10.7
5.1
15.9
5.5
8.3
8.0
8.1
Financial depth (% of GDP)
Compound annualgrowth rate (%)
2000–07
2007–2Q12
263 256 310 331 345 355 307 339 335 312 312
11 983
2
113 3
711
1013
1113
1113
The loss o momentum is not conned to the advanced economies2 at the heart
o the crisis. Emerging markets weathered the crisis well, but their nancial depth
is on average less than hal that o advanced economies as o 2012 (157 percento GDP compared with 408 percent o GDP). This gap was narrowing beore the
crisis, but it is no longer closing.
Some o the slowdown in the growth o global nancial assets represents a
healthy correction. Looking back, we can see that several unsustainable trends
propelled a large share o the pre-crisis gains. The most notable o these actors
was the increasing size and leverage o the nancial sector itsel.
2 We use the terms developed country , advanced economy , and mature economy
interchangeably throughout this repor t. We also use the terms emerging market, emerging
economy , developing country , and developing economy interchangeably.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
While Exhibit E1 oers an asset-class view o growth, our database allows us
to separate out the nancing available or di erent sectors o the economy:
households and non-nancial corporations, nancial institutions, and government.
This analysis reveals that the nancial sector generated more than one-third o
global nancial deepening prior to the crisis. Bonds issued by nancial institutionsto und lending activ ities and other asset purchases grew to $39 trillion by 2007—
roughly ve times the value o bonds issued by non-nancial companies.
One-quarter o nancial deepening beore the crisis was due to equity market
valuations rising above long-term norms—gains that were erased in the crisis.3
Initial public oerings and new equity raising have allen signicantly since the
crisis. Another actor adding to nancial deepening during this period was
a steady rise in government debt—a trend that is sustainable only up to a
certain point.
Financing or households and non-nancial corporations accounted or just
over one-ourth o the rise in global nancial depth rom 1995 to 2007—an
astonishingly small share, given that this is the undamental purpose o
nance. Since then, nancing or this sector has stalled in the United States, as
households and companies have deleveraged.4 Despite the lingering euro crisis,
however, nancing to households and corporations in Europe has continued
to grow in most countries, as banks have stepped up domestic lending while
reducing oreign activities.
The risk now is that continued slow growth in global nancial assets may hinder
the economic recovery, stifing business investment, homeownership, and
investment in innovation and inrastructure. Our analysis suggests a link between
nancing and growth, showing a positive correlation between nancing or the
household and corporate sectors and subsequent GDP growth. A continuation o
current trends could thereore slow the economic recovery.
cross-border capITal flows declIne
Cross-border capital fows—including lending, oreign direct investment, and
purchases o equities and bonds—refect the degree o integration in the global
nancial system. While some o these fows connect lenders and investors with
real-economy borrowers, interbank lending makes up a signicant share. In
recent decades, nancial globalization took a quantum leap orward as cross-
border capital fows rose rom $0.5 trillion in 1980 to a peak o $11.8 trillion in2007. But they collapsed during the crisis, and as o 2012, they remain more than
60 percent below their ormer peak (Exhibit E2).
As with nancial deepening, i t is impor tant to disentangle the di erent
components o growth and decline in capital fows. In the decade up to 2007,
Europe accounted or hal o the growth in global cap ital fows, refecting the
increasing integration o European nancial markets. But today the continent’s
nancial integration has gone into reverse. Eurozone banks have reduced cross-
border lending and other claims by $3.7 trillion since 2007 Q4, with $2.8 trillion
3 We measure equity valuations by changes in the price-to-book ratio o listed companies. Aso early 2013, some major stock market indices were nearing or had surpassed their pre-
crisis peaks. However, equity market capitalization relative to GDP is still below the 2007 level
globally and in most countries.
4 See Debt and deleveraging: Uneven progress on the path to growth, McKinsey Global
Institute, January 2012.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
o that reduction coming rom intra-European claims (Exhibit E3). Financing rom
the European Central Bank and other public institutions now accounts or more
than 50 percent o capita l fows within Europe. With hindsight, it appears that
capital mobility in Europe outpaced the development o institutions and common
regulations necessary to support such fows.
eiit e2
SOURCE: International Monetary Fund (IMF) Balance of Payments; Institute of International Finance (IIF); McKinsey GlobalInstitute analysis
1 Includes foreign direct investment, purchases of foreign bonds and equities, and cross-border loans and deposits.2 Estimated based on data through the latest available quarter (Q3 for major developed economies, Q2 for other advanced and
emerging economies). For countries without quarterly data, we use trends from the Institute of International Finance.
Cross-border capital flows fell sharply in 2008 and today remain more than
60 percent below their pre-crisis peak
12
10
8
6
4
2
0
-61%
4.6
2011
5.3
6.1
1.7
2.2
2007
11.8
2000
4.9
1990
1.0
1980
0.5
Global cross-border capital flows1
$ trillion, constant 2011 exchange rates
% of
global
GDP
4 5 13 20 68
2012E2
eiit e3
Since 2007, Eurozone banks have reduced foreign claims by $3.7 trillion,$2.8 trillion of which was intra-European
240
-438
-781
-2,752
-140
-771
-665
-1,176
-3,732
1,732
1,382
509
1,182
5,665
291
1,609
2,033
Change
$ billionCompound annualgrowth rate (%)
8,737
Eurozone bankclaims on:
SOURCE: Bank for International Settlements; McKinsey Global Institute analysis
1 Includes banks from Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Netherlands, Portugal, and Spain.2 GIIPS comprises Greece, Ireland, Italy, Portugal, and Spain.
Consolidated foreign claims of Eurozone reporting banks(includes loans and other foreign financial assets)1
By counterparty location, constant 2011 exchange rates
4Q99–4Q07
GIIPS2
Other Eurozone
United Kingdom
Other Western Europe
Total Western Europe
United States
Other developed
Developing countries
Total
$ billionCompound annualgrowth rate (%)
3
-7
-9
-5
-7
-9
13
11
16
12
13
13
6 -9
-814
4Q07–2Q12
-1417
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
foreign investment assets(excluding FX reserves)100%= $7.8 trillion
14
31
42
12
Bonds
Equity
FDI
Loans
1.5 3.0
1 Foreign investment assets of developing countries in other developing countries.2 Foreign investment assets of developing countries in advanced economies.NOTE: Numbers may not sum due to rounding.
5 A oreign subsidiary is a legally incorporated entity in the country and has its own capital
base, while oreign branches do not. Over the past our years, cross-border lend ing through
branches in Europe has declined twice as much (in both dollar and percentage terms) as
oreign lending through subsidiaries.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
Foreign direct investment (FDI), dened as investment that establishes at least a
10 percent stake in a oreign entity, has maintained better momentum than cross-
border lending since the crisis. Although we estimate that FDI fows declined by
15 percent in 2012, they accounted or roughly 40 percent o global capital fows
that year. This refects in part the continued expansion o multinational companiesas they build global supply chains and enter new consumer markets—and since
many major non-nancial corporations currently have large cash reserves, there is
room or them to assume an even greater role as providers o capital, especially
within their own supply chains. The growing share o FDI in global capital fows
may have a stabilizing infuence: our analysis shows that it is the least volatile type
o capital fow in emerging markets and developed countries alike, as companies
and investors typically make such commitments as part o a multiyear strategy.
By contrast, cross-border lending, which dominated capital fows in the years
leading up to the crisis, tends to be shor t term and can dr y up quickly.
There is a bit o positive news to be ound in the world’s ar smaller capital fows:global current account imbalances have declined some 30 percent rom their
peak when measured relative to global GDP. Although the current account decits
and surpluses in dierent countries did not directly spark the nancial crisis, they
did contribute to rapid growth in debt in some countries. In Europe, most o the
periphery countries that were later at the center o the euro crisis ran large and
growing current account decits rom 2000 to 2008—decits that have been
reduced sharply since then. Similarly, the current account decit in the United
States has shrunk by roughly 40 percent since its peak in 2006. Maintaining these
smaller imbalances in the uture would reduce one source o risk and volatility in
the global nancial system.
The paTh forward: Two scenarIos for Global
fInancIal MarKeTs
With the ramications o the nancial crisis still unolding and new regulations
being implemented, two starkly di erent utures are possible. In one, the world
remains on its current trajectory, with little nancial market development and
subdued capital fows. Although such an outcome may reduce the risk o a
uture nancial crisis, slower economic growth may become the new normal. An
alternative scenario would involve a “reset” o the nancia l system that corrects
past excesses while enabling nancial deepening and globalization to resume.
si 1: fii giti tt
I current trends continue, the value o nancial assets relative to GDP would
remain fat or even decline by 2020. This would refect ongoing deleveraging o
the household, corporate, and nancial sectors in advanced economies, despite
a continuing rise in government debt. It would also refect no urther nancial
deepening in developing countries. The retrenchment o global banks could lead
to a loss o competition and expertise in the nancial sectors o some smaller
countries, driving up the cost o borrowing, and bank lending would be a smaller
source o nancing in advanced countries. Wi thout robust cross-border capital
fows or the presence o securitization and corporate bond markets to provide
alternative channels, borrowers in these regions could ace a credit crunch.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
In this scenario, cross-border capital fows would not regain their pre-crisis
peak or many years. Europe would stay on i ts current course—with no
breakup, but only slow progress toward a banking union ramework—and the
continent’s cross-border activity would continue to wane. Banks would ocus
on domestic activities and enter only those geographies where they have aclear competitive advantage. Investors would nd limited options or entering
potentially high-growth emerging economies; oreign capital would shy away
rom shallow markets in these countries that lack transparency and enorcement.
Savers around the world would nd it more dicult to diversiy their portolios
geographically, potentially harming returns.
Sharp regional dierences could emerge in the availability o capital. Some
regions with high savings rates would nd themselves with surplus capital, and
a shortage o good investment opportunities in these countries could potentially
result in lower returns or investors and savers. By contrast, other countries
(including some advanced economies and many emerging markets) would ndcapital in shor t supply, constraining growth.
The crisis underscored the need or greater prudence and stabili ty. But in ghting
the last battle, it is easy to lose sight o new hazards that lie ahead. The current
path runs the risk o choking o the nancing needed or investment in business
expansion, inrastructure, housing, R&D, and education. In a more credi t-
constrained world, all companies would need to consider how and where to raise
capital.6
si 2: fii giti t
With the right actions by nancial institutions and policy makers, the world couldtake a more balanced approach to nancial market development and globalization
that would support economic growth. This scenario hinges on putting in place a
solid global regulatory ramework to correct the excesses o the pre-crisis years.
This includes well-capital ized banks, a clear plan or cross-border resolution
and recovery, improved macroprudential supervision, and mutual condence
and cooperation among national regulators. A revitalized system would include
healthy competition among an array o nancial intermediaries and institutions
that serve both borrowers and savers. Foreign capital would fow to where there
are investment needs.
In this scenario, countries would pursue opportunities or sustainable nancial
deepening, such as the expansion o corporate bond markets. In many countries,
even the largest companies get most o their debt unding rom banks rather than
capital markets. But as banks reduce leverage and in some cases need to reduce
the size o their balance sheets, shi ting some o this credit demand to bond
markets would be benecial. Our ca lculations suggest there is room or corporate
bond markets to grow by more than $1 trillion i large companies in advanced
economies were to shit 60 percent o their debt unding to bonds—and
signicant additional growth could come rom emerging markets. This is only a
rough estimate o the scale o the opportunity, and a shit o this magnitude would
take years to play out. However, we can already see that corporate bond issuance
has increased signicantly in all regions o the world since the nancial crisis.
6 For more on this topic, see Farewell to cheap capital? The implications o long-term shits in
global investment and saving, McKinsey Global Institute, December 2010.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
Developing nations also have signicant room to deepen their nancial markets.
On average, equity market capitalization is equivalent to 44 percent o GDP in
developing countries, compared with 85 percent in advanced economies. Credit
to households and debt o corporations combined is only 76 percent o GDP in
emerging markets, compared with 146 percent o GDP in advanced economies.McKinsey research has estimated that small and medium-sized enterprises
(SMEs) in emerging markets ace a $2 trillion credit gap, and 2.5 billion adults
around the world lack access to banking services.7 I developing nations converge
to the average nancial depth currently seen in advanced economies over the
next two decades, their nancial assets could grow rom $43 trillion today to more
than $125 trillion by 2020.8
Cross-border capital fows would post steady growth in this scenario. But
instead o reopening the foodgates o volatile short-term lending and interbank
lending, portolio fows o equity and bond purchases and FDI would become
larger components o international capital fows, enhancing stability. Investorswould be able to gain much greater exposure to growth and diversication in the
emerging world.
This al ternative scenario could result in a system that provides nancing or
innovation and investment without sacricing stability—i policy makers can
balance these two goals. Without the proper regulatory ramework in place, a
return to rapid growth in nancial assets and cross-border capital fows leaves
the world vulnerable to the risk o yet another crisis—and all the collateral damage
that would entail.
navIGaTInG The new landscapeWhether nancial globalization retreats or resets, the post-crisis world demands a
new and more nimble approach to public policy, banking, and investing. Decision
making is more complex in a time o uncertainty, but the ideas below oer a
starting point.
Policy makers: Resetting nancial globalization
It will take concerted eor ts by both national and international policy makers
to move to the alternative scenario o a healthier global nancial system. The
ollowing proposals would help to restore condence and widen access to capital,
setting this process in motion.
Complete the current agenda or global regulatory reorm. The 2008
nancial crisis and the subsequent euro crisis brought home the dangers
o unsustainable nancial deepening and capita l fows. Healthy nancial
globalization cannot resume without robust and consistent saeguards in
place to provide condence and stability. Much is riding on the successul
implementation o regulatory reorm initiatives that are currently under way.
These include work ing out the nal details and implementation o Basel III,
developing clear processes or cross-border bank resolution and recovery,
7 See Two trillion and counting: Assessing the credit gap or micro, small, and medium-size
enterprises in the developing world , McKinsey & Company and the International FinanceCorporation, October 2010, as well as Alberto Chaia, Tony Goland, and Rober t Schi,
“Counting the world’s unbanked,” The McKinsey Quarterly , March 2010.
8 We created several scenarios or emerging market nancial asset growth, based on dierent
assumptions about GDP growth rates and exchange rates. See also The emerging equity gap:
Growth and stability in the new investor landscape, McKinsey Global Institute, December 2011.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
building robust macroprudential supervisory capabilities, and, in the Eurozone,
establishing a banking union.9
Consider the hidden costs o closed-door policies. Openness to oreign
investment and capital fows entails risk, as the global nancial crisis andsubsequent euro crisis demonstrated, but it also brings clear benets. Tightly
restricting oreign banks and capital infows may reduce the risk o nancial
contagion and sudden reversals o capital, but it also limits the benets that
oreign players can bring to a nancial sector, such as greater capital access
and competition. The right answer or each country will depend on the size
and sophistication o its domestic nancial sector and the strength o its
regulation and supervision. But the objective o building a competitive, diverse,
and open nancial sector deserves to be a central part o the policy agenda.
Build capital markets to meet the demand or credit . Capital markets are
good sources o long-term nance—and they can provide crucial alternatives
as banks scale back their activities. Most countries have the basic market
inrastructure and regulations, but enorcement and market supervision
is oten weak. Standardized rating systems, clearing mechanisms, and a
solid regulatory oundation are necessary prerequisites. Underlying the
development o both equity and debt capita l markets are robust corporate
governance, nancial reporting, and disclosure o companies seeking to tap
these markets. When these elements are in place, a nancial system is better
equipped to attract capital and deploy it productively.
Create new nancing mechanisms or constrained borrowers. In an era
o bank deleveraging, unding or large investment projects, inrastructure,
and SMEs may be in short supply in many countries. But policy makers could
promote the development o new nancial intermediaries and instruments
aimed at lling gaps in the current landscape. Public-private lending
institutions and innovation unds, inrastructure banks, small-business lending
programs, and peer-to-peer lending and investing platorms can increase
access to capital or underserved sectors. These actions will become more
urgent in an increasingly credit-constrained world.
Promote stable cross-border fows o nance. Regulatory eorts have
ocused on containing the dangers o cross-border lending. By contrast,
there has been relatively little discussion o unlocking what could be a major
source o stable, long-term capital and higher returns at lower risk or saversand investors. Many public pension unds and insurance companies have
strict geographic restrictions on their investment portolios; these are meant
to encourage investment at home, but they limit the potential returns and
diversication that might come rom seeking out growth in emerging markets.
Designed to contain risk, they actually concentrate it by increasing domestic
exposure. In addition to allowing the international diversication o port olios,
policy makers can look at removing legal barriers to oreign ownership and
oreign direct investment, creating new channels (such as mutual unds) or
retail investors in emerging markets, and creating cross-border resolution
mechanisms or nancial institutions and companies.
9 Three elements are under discussion in establishing a banking union in the Eurozone: common
supervision o banks, common deposit insurance, and common authority or resolving ailing
banks. The European Central Bank is expected to assume supervisory responsibility or the
largest banks in the Eurozone in 2014.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
Use big data to improve inormation fows and market monitoring. Poor
inormation and data collection hampered the ability o nancial institutions
and regulators to recognize and act on the accumulation o unsustainable debt
and leverage, opaque connections among institutions, and the concentration
o risk. Healthier, deeper, and more open nancia l markets require moregranular and timely inormation rom market par ticipants. Policy makers can
draw on new analy tic tools being deployed in the private sector to gather
and analyze vast quantities o inormation and more closely monitor potential
market risks.
G k: sig i m
The uture direction o the global nancial system depends in part upon actions
by policy makers that will take years to realize. Nonetheless, certain elements o
the landscape are becoming clear and will require new approaches.
First is a more selective ocus on geographies and new operating models abroad.New regulations and shareholder pressures call into question the benets o
pursuing a global banking model, and banks have already begun the process o
exiting some geographies.
Foreign operations may need new organizational models. The “sudden stop”
problems associated with oreign lending—particularly the risks o oreign
“suitcase” lending—have become clear to recipient countries, and national
regulators are moving to impose new capital requirements and other controls on
the banks that operate within their jurisdictions. Whether banks operate through
branches or subsidiaries, there will be a greater emphasis on local deposits, local
unding sources, and engagement with local regulators.
In the slow-growth environment that characterizes most advanced economies,
cost eciencies take on new impor tance. On this ront, there is wide variation in
perormance across banks within the same country and across countries. This
challenge does not call or simple budget cutting wi thin departments, but rather
end-to-end process redesigns to streamline back-oce unctions and operations.
Lending may not grow aster than GDP in advanced economies, but it will always
remain a core product—and some banks may benet rom a renewed emphasis
on relationship-based lending. This will require sharpening undamental credit-
assessment skills that were deprioritized during the peak o the bubble. Basic
lending also presents a major opportunity in emerging economies, especially
or those institutions that can nd viable models to tap underserved mortgage
markets, other consumer lending, and SME lending.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
In addition, banks may consider acting more as conduits o capital rather than
leveraging their own balance sheets to provide capital. Such a shit may involve
ocusing on underwriting, advisory services, and other ee-based activities.
The potentia l or la rge-scale expansion in global bond markets wil l open new
opportunities. Banks can act as brokers between institutional investors andborrowers, providing credit-assessment skills and deal-sourcing capabilities. They
may also be at the oreront o new platorms or capital raising and lending, such
as online peer-to-peer markets.
Finally, institutions that weathered the nancial crisis well (such as those in
emerging economies and some regional banks in advanced markets) will nd new
opportunities to gain market share where the largest global banks are exiting.
This shi t is already playing out in Asian trade nance, as regional banks pick up
business rom retreating European banks.
Ititti it: Gtig t i t- The challenge or insti tutional investors in the coming years wi ll be to navigate
uncertain, volatile nancial markets and nd new sources o returns. Low yields
and sluggish growth are the realities in mature economies, while emerging
markets are expected to produce 70 percent o global GDP growth through
2025.10 Shallow, illiquid nancial markets in these countries can deter oreign
institutional investors, however. Private equity investing, or partnering with local
banks and investors, can get around these limitations. Some pension unds are
considering direct deals with oreign companies, but they will need to develop
new skills and possibly new organizational models in order to do so.
In advanced economies, institutional investors will need to identiy new sourceso alpha, or returns that are uncorrelated with broader market movements. This
could come rom several sources: or instance, pursuing market-neutral strategies
that hedge a variety o long and short positions, or cultivating superior inormation
and insights into specic sectors that enable identication o underpriced
companies or uture growth opportunities. Building these skills will be a
ormidable task and require major investments.
Despite these challenges, the shiting nancial landscape will present institutional
investors with new opportunities. Estimates show that by 2020, nine major
economies alone wil l need to nance $18.8 trillion annually in long-term
investment to achieve moderate levels o economic growth.11 With banks in a
deleveraging mode, this could be a pivotal moment or institutional investors,
whose pools o patient capital could nance inrastructure and other types o
investment. With the appropriate policy changes, investors such as pensions
and sovereign wealth unds with long time horizons could command liquidity
premiums, earning extra returns or providing longer-term unding.
10 Winning the $30 trillion decathlon: Going or gold in emerging markets, McKinsey & Company,
August 2012.
11 Long-term nance and economic growth, Group o Thir ty, February 2013. Also see
Inrastructure productivity: How to save $1 trillion a year , McKinsey Global Institute,
January 2013.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
Ater decades o strong momentum, the world is now experiencing a long,
uncertain pause in nancial market development and nancial globalization. We
could be entering a period in which banks and investors are less likely to venturebeyond their home markets, or we may be witnessing the start o a new and
more sustainable phase in the history o nancial globalization. Policy makers will
play an important role in shaping the outcome—and banks and investors need a
fexible strategy or operating in a new and changing environment.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
Ater decades o surging steadily higher, the value o global nancial assets12—
including equities, government and corporate bonds, securitized assets, and
loans—took a sharp tumble with the 2008 crisis. Today the global total has
surpassed its pre-crisis level, but the brisk growth posted rom 1990 to 2007
has ended.
With hindsight, we can now re-examine the benets o nancial market
development and take a more nuanced look at the sources o growth beore
2007. Our analysis reveals that much o the apparent nancial deepening in the
decade beore the crisis in advanced economies13 was in act due to leverage in
the nancial sector itsel. Less than 30 percent o the growth in nancial assets
relative to GDP was rom nancing or the private sector. Some o the changes
now under way represent a healthy correction o past excesses.
The loss o momentum, however, is not conned to the advanced economies at
the heart o the crisis. Emerging economies weathered the crisis with surprising
resilience, but their nancial depth continues to lag ar behind that o advanced
economies—and they are no longer closing the gap. In most cases, nancial
assets in these countries have not expanded at a pace commensurate with GDP
growth in recent years. Indeed, developing countries seem to be on an entirelydierent path, with large banking systems, smaller equity markets, and little bond
issuance. Policy makers in some emerging economies have long questioned the
benets o nancial-sector development—a skepticism that has now spread to
advanced economies.
But continued muted growth in nancial markets could jeopardize business
investment and dampen economic recovery. While risks were underpriced prior
to the crisis, it is now possible that excessive conservatism will set in. In emerging
economies, the ailure to develop capital markets may hinder business expansion
and inrastructure investment, as well as crowding out SMEs in the market or
bank lending. Global nancial markets currently present a complex picture, withno clear orward momentum. This chapter dissects the disparate trends at work.
12 See the appendix or more detailed denitions.
13 We use the terms developed country , advanced economy , and mature economy
interchangeably throughout this repor t. We also use the terms emerging market, emerging
economy , developing country , and developing economy interchangeably. See the technical
appendix or a ull list o countries in each category.
1. Global nancial markets stall
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
Global nancia l depth—that is, the value o the world’s nancial assets relative
to GDP—grew rapidly between 1980 and 2007, refecting the expansion o credit
and equity markets. New inormation technologies, online trading platorms, and
increasingly sophisticated credit models enabled new orms o lending, capitalraising, and trading o risk. The globalization o nance also played a role (see
Box 1, “The link between nancial deepening and nancial globa lization,” later in
this chapter).
Worldwide, the value o nancial assets increased rom around 120 percent o
GDP in 1980 to 355 percent o GDP at the peak in 2007.14 China, India, and other
major emerging markets, while undergoing economic transormations o historic
proportions, experienced steady but modest deepening, but the outsized gains
were in advanced economies. By 2007, nancial assets had grown to 417 percent
o GDP in advanced economies and 199 percent o GDP in emerging markets.
But that era o growth has come to an abrupt halt. Four years ater the crisis, the
value o the world’s nancial assets reached $225 trillion as o the second quar ter
o 2012 (Exhibit 1). But global nancial assets have posted an anemic 1.9 percent
annual growth rate since 2007, compared with annual growth o 7.9 percent rom
1990 to 2007. The recovery remains ragile and uneven, although pockets o
growth exist. Corporate bond issuance is up strongly since the crisis, or instance,
and lending continues to expand in emerging markets.
eiit 1
Global financial assets have grown to $225 trillion, but growth has slowed
since 2007Global stock of debt and equity outstanding1
$ trillion, end of period, constant 2011 exchange rates
3035
3942 42 41 42 42
18
37
47
56
64 3648
54 4750
19
2000
119
355 5
18
95
75
26
14
1990
56
23
57
43
09
206
54
149
39
08
189
54
14
29
Securitizedloans
Corporatebonds
Financialbonds
Governmentbonds
Equity
2Q12
225
62
47
11
218
60
46
10
219
1.9
8.1
7.8
Non-securitizedloans
8
35
2007
206
50
138
32
06
185
46
30
2005
165
42
97
1.5
9.1
-0.7
4.8
9.2
SOURCE: McKinsey Global Institute Financial Assets Database; McKinsey Global Institute analysis
-5.5
1 Based on a sample of 183 countries.
1.9
10.7
5.1
15.9
5.5
8.3
8.0
8.1
Financial depth (% of GDP)
Compound annualgrowth rate (%)
2000–07
2007–2Q12
263 256 310 331 345 355 307 339 335 312 312
11 983 2
113 3
711
1013
1113
1113
14 We dene global nancial assets as the market capitalization o equities, outstanding values
o government and corporate bonds and other debt securities, securitized assets, and loans.
We do not include the notional value o derivatives or the value o physical assets such as real
estate. See the appendix or more detai l.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
Relative to GDP, global nancial assets have allen by 43 percentage po ints
since 2007—and by 54 percentage points i we exclude the rise in government
debt. This is true not only in the deleveraging advanced economies, but also in
emerging markets, where growth in nancial assets has ailed to keep pace wi th
GDP growth in recent years (Exhibit 2). Progress in catching up to the level o nancial depth seen in advanced nations remains elusive: bank lending continues
to expand, although not notably aster than GDP in most countries, and equity
markets go through large swings in valuations.
eiit 2
Emerging markets have low financial depth—and they are no longer
closing the gap with advanced economies
SOURCE: McKinsey Global Institute Financial Assets Database; McKinsey Global Institute analysis
Emerging markets’ financial depth is low
Debt and equities as % of GDP, 2Q12
… and is not catching up
Emerging markets as
% of global
38
3735
32
31
28
19
19
18
17
15
16
0
3
6
9
12
15
18
21
24
27
30
33
36
39
2Q1210080604022000108
126
131
148
151
153
226
408
CEE and CIS1
Latin America
Africa
India
Other emerging Asia
Middle East
China
Advanced economies
(average)
Financial assets
GDP
1 Central and Eastern Europe and the Commonwealth of Independent States.
Does this pause matter? A ter all, the crisis originated in countries with some
o the world’s largest, deepest, and most sophisticated nancial markets—and
that observation has raised undamental questions in the minds o policy makers
about the desirable role, size, and structure o the nancial sector. Some skeptics
see little value in the nancial innovations o the past decade,15 and mainstream
economists have questioned whether a dramatic expansion o the nancial sector
is warranted.16 Assessing the pre-crisis sources o nancial deepening, and the
link between private-sector credit and economic growth, provides some acts that
shed light on this question.
15 Paul Volcker, or instance, amously quipped that the last useul nancial innovation was the
ATM (see “Paul Volcker: Think more bold ly,” Future o Finance report, The Wall Street Journal ,
December 14, 2009).16 See, or example, Jean-Louis Arcand, Enrico Berkes, and Ugo Panizza, Too much nance?
IMF working paper number WP/12/161, June 2012; Paul Krugman, “The market mystique,” The
New York Times, March 26, 2009; and Lorenzo Bini Smaghi, member o the Executive Board
o the ECB, “Has the nancial sector grown too large?” speech presented at the Nomura
Seminar, April 15, 2010.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
The MajorITy of pre-crIsIs fInancIal deepenInG was
noT susTaInable
Financial deepening can come rom many sources. Expanded access to credit
or households and businesses, more equity market listings by companies, and
bonds issued to nance inrastructure projects are examples o heal thy nancialdeepening. But nancial depth can also be infated by such unproductive actors
as equity market bubbles or unsustainable increases in debt and leverage. Overall
growth in the value o nancial assets does not automatically coner a positive
eect on the real economy. Looking back, we can see that several unsustainable
trends propelled most o the nancial deepening that occurred prior to the crisis,
in both advanced and develop ing economies. Chie among these actors was the
growing leverage and size o the nancial sector itsel. Some o what appeared
to be robust growth produced exuberance at the time but ultimately proved to
be illusory.
Our database allows us to analyze separately the nancing available ordierent sectors o the economy: households and non-nancial corporations,
nancial institutions, and government. This analysis reveals that the nancial
sector accounted or 37 percent o global nancial deepening prior to the crisis
(Exhibit 4). Bonds and other debt securities issued by nancial institutions to
und their lending activities and other asset purchases grew at an annual rate
o 11 percent between 1995 to 2007, reaching $39 trillion by 2007—roughly ve
times the total bonds issued by non-nancial companies and larger even than the
sovereign bond market in 2007.
eiit 4
Most of the increase in financial depth prior tothe crisis was due to financial system leverage
and equity valuations
NOTE: Numbers may not sum due to rounding.
SOURCE: McKinsey Global Institute Financial Assets Database; McKinsey Global Institute analysis
34
Global
financialdepth, 1995
256
Global
financialdepth, 2007
355
Growing
components
133
33
(25%)
49(37%)
14(10%)
37
(28%)
Effect of
regional GDPmix change
Changes in global financial depth, 1995–2007
Equity and debt of different sectors as % of GDP(…) = % of total increase
31
29
58 86
13Emergingmarkets
5
11
WesternEurope 132-3 49 57
United States 154-6 52 77
Financial deepening for select regions
Change in financial depth, 1995–2007(percentage points)
Equity valuation
Financial
Government
Households and corporations
Rising equity market valuations accounted or 25 percent o the increase in global
nancial depth between 1995 and 2007.17 While part o this may have refected
companies’ improved earnings prospects, infated investor expectations as well
17 We measure equity market valuations using price-to-book ratios.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
as alling interest rates were also at play as valuations exceeded long-term norms.
These gains were erased in the crisis, although equity markets have since climbed
back.18 Yet another actor adding to nancial deepening during this period was
a steady rise in government debt around the globe. Government bonds grew
at annual rates o 7 percent over the period (to $32 trillion). This growth can besustainable—but only up to a certain point.
Financing or households and non-nancial corporations accounted or just over
one-ourth o the rise in global nancial depth between 1995 and 2007. This is an
astonishingly small share, given that this is the undamental purpose o nance.
It is even more surprising given that this sector’s share includes large increases
in the volume o mortgage lending during the housing bubble in several la rge
economies, such as the United States, the United Kingdom, Canada, Spain, and
Austral ia, to mention a ew.
a correcTIon Is now under way—buT ITMay overshooT
Given the magnitude o the global credit bubble, some o the decline in global
nancial depth refects a necessary correction and deleveraging. The picture
across asset classes and regions is mixed.
Global equity market capitalization, or instance, rose over the decade up to
the crisis but has since declined sharply. Despite the recovery o some major
stock market indexes at the time we published this repor t, global equity market
capitalization relative to GDP remains 42 percentage points below its 2007
level. In contrast, government bonds have grown signicantly across advanced
economies in the post-crisis period (Exhibit 5). There has been a $15.4 trillionglobal increase in government debt securities since 2007.19 While government
debt may und vital physical and social inrastructure (and create jobs), the current
trend in government debt threatens uture economic growth in many countries. A
signicant body o research reveals that government debt in excessive o certain
thresholds slows GDP growth and signicantly increases the risk o a sovereign
deault.20
Another la rge por tion o the decl ine in nancial depth (22 percentage points)
is due to the growing contribution o emerging markets to global GDP. These
nations have much shallower nancial markets than advanced economies, and
thus their increasing GDP weight lowers globa l nancial depth. This is not justa technical point—it is a refection o the act that nancial market development
has not kept pace with economic development in much o the world. Financial
depth in China, or example, is just 226 percent o GDP, only hal the level seen in
the United States or Japan and ar behind Western Europe and other advanced
countries as well (Exhibi t 6). Very ew developing countries have robust corporate
18 As o early 2013, some major indexes (most notably in the United States) were nearing or
had surpassed their pre-crisis peaks, but equity market capitalization relative to GDP is still
markedly lower than in 2007 globally and in most countries.
19 This gure represents the increase in government bonds outstanding. Total government debt
(which also encompasses loans) has increased by about $23 trillion since 2007, according tothe IMF.
20 See Carmen Reinhart and Kenneth Rogo, This time is dierent: Eight centuries o nancial
olly , Princeton Universi ty Press, 2011; and Stephen G. Cecchetti, Madhusudan S. Mohanty,
and Fabrizio Zampolli, The real eects o debt, Bank or International Settlements working
paper number 352, September 2011.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
Deleveraging o the nancial sector has contributed only a negligible amount
to the overall decline in global nancial depth, but there are sharp regional
dierences in how this trend is playing out. The United States has reduced
outstanding nancial-sector debt securities by $1.5 trillion rom 2007 to the
second quarter o 2012, refecting a decline in asset-backed securities, a shittoward using deposits to und bank balance sheets, and the collapse o several
large broker-dealers unded mainly through debt.22 In contrast, nancial-sector
debt in Europe has increased by $2.6 trillion over the same period. This partly
refects a shit rom interbank borrowing and wholesale unding to longer-term
bonds to und bank activities. It may also refect less pressure to restructure
operations and unding sources, and less emphasis on raising more deposits.
The provision o debt and equity nancing to households and corporations since
the crisis shows signicant regional di erences. Europe, despite its ongoing euro
crisis, has seen nancing to all parts o the economy expand since 2007. This
refects an increase in nancia l institution bonds, noted above, but also growth inloans to households and corporations rom domestic banks. This trend is seen
in most European countries, a lthough some—notably the United Kingdom—have
seen little growth in household and corporate unding. In sharp contrast, nancing
has declined to all sectors in the United States except the government (Exhibit 7).
eiit 7
Since the crisis, financing to all sectors has grown
in Europe—a trend not seen in the United States
SOURCE: McKinsey Global Institute Financial Assets Database; McKinsey Global Institute analysis
Changes in financial depth
Equity and debt as % of GDP
NOTE: Numbers may not sum due to rounding.
0
United States
37
454
2011
3314
28
2007
499
0
Western Europe
367354
38
2011
1812
21
2007
Financial sector
Equity valuation
Households and corporations
Government
22 This data is rom the US Federal Reserve Bank and the European Central Bank. For more on
the pace o deleveraging in dierent countries, see Debt and deleveraging: Uneven progress
on the path to growth, McKinsey Global Institute, January 2012.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
A continued stall ing o nancing or households and corporations as well as
excessive growth in government debt beyond sustainable levels could have
negative implications or global recovery. A large body o academic literaturehas examined the relationship between nancing and economic growth, with
most empirical studies nding a positive correlation.23 More recent research
has ound that nancial development contributes to growth, but only up to a
point.24 As noted above, empirical research also reveals that government debt
above a certain threshold (such as 90 percent o GDP) has a negative impact on
economic growth.
Our database o global nancial assets enables us to examine the link between
nance and growth and o er new evidence. In contrast to other studies, our
dataset allows us to look at debt and equity in dierent sectors o the economy
and to dene private-sector nancing more precisely. (See the appendix ormore detail.)
We start by looking at a simple correlation between debt and equity nancing or
households and non-nancial corporations and GDP growth in the ollowing year.
We nd a strong positive correlation or both mature economies and developing
countries, as shown in Exhibit 8.
eiit 8
The decline in financial depth matters:
GDP growth is correlated with private-sector financing
X axis: Household and corporate debt and equity as a share of GDP annual change (t-1) Y axis: Nominal GDP growth (t) (%)
1 Emerging markets excluding China shows correlation of 0.66 and a slope of 0.20.NOTE: Not to scale.
SOURCE: McKinsey Global Institute Financial Assets Database; McKinsey Global Institute analysis
-4
-2
0
2
4
6
302520151050-5-10-15-20-25-30-35-40
0
5
10
15
20
302520151050-5-10-15-20-25-30-35-40
-4
-2
0
2
4
6
8
-50 -40 -30 -20 -10 0 10 20 30 40
-4
-2
0
2
4
6
-30 -25 -20 -15 -10 -5 0 5 10 15 20 25 30
World United States
Western Europe Emerging markets1
0.64
0.09
0.83
0.13
0.81
0.23
0.70
0.07
Correlation
Slope of regression line
23 See, or example, Ross Levine, “Finance and growth: Theory and evidence,” in Handbook o
economic growth, Philippe Aghion and Steven Durlau, eds., rst edition, volume 1, Elsevier,
2005; Thorsten Beck, Asli Demirgüç-Kunt, and Ross Levine, Financial institutions and markets
across countries and over t ime: Data and analysis, World Bank policy research workingpaper number 4943, May 2009; and Thorsten Beck et al., Financial structure and economic
development: Firm, industry, and country evidence, World Bank policy research working paper
number 2423, June 2000.
24 Stephen G. Cecchetti and Enisse Kharroubi, Reassessing the impact o nance on growth,
Bank or International Settlements working paper number 381, July 2012.
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In the United States, or instance, our analysis suggests that every increase o
10 percentage points in nancing or households and corporations relative to
GDP is correlated with a 0.7 percent increase in GDP growth in the ollowing
year. In emerging markets, the correlation o nancing and growth is higher, at
2.3 percent o GDP growth or every 10 percentage point increase in householdand corporate nancing. This refects the lower level o nancing in these
economies and the act that they have very large nancing needs associated with
industrialization and urbanization.
The positive relationship between pr ivate-sector nancing and GDP growth also
holds i we use a multivariate regression on panel data with xed e ects to control
or other actors that contribute to economic growth. We test the relationship
between the change in nancing (debt and equity) to non-nancial corporations
and households in one period and real GDP growth in the subsequent year. We
control or other actors that may infuence GDP growth, including population
growth, human capital development, political and macroeconomic stabil ity, andopenness to trade, though clearly other actors such as expectations or uture
growth could also drive correlation. In these regressions, we also allow or the
possibility that nancing has a positive correlation to economic growth, but only
up to a certain point. We nd that nancing has a signicant positive correlation
to real GDP growth in all model specications. We also nd that the eect is
nonlinear, with excessive levels o nancing hindering growth, although not until
very high levels. The results are shown in the appendix.
In addition, we nd a positive but weaker correlation between GDP growth and
change in debt issued by the nancial sector in the previous period. This refects
the role o the nancial sector in providing credit or investments that contribute to
growth. Consistent with other research, our analysis nds a negative correlation
between rising government debt and GDP growth.
Given the results o this analysis, we thereore conclude that while correlation
does not always imply causation, slow growth in nancing to the household
and corporate sector could risk dampening economic growth. The impact may
be due to inhibiting drivers such as homeownership, household consumption,
and business spending on commercial buildings, plants, machinery, equipment,
and sotware. This is a particularly acute concern in emerging economies,
where underdeveloped nancial systems leave borrowers with limited options,
especially or long-term nancing, and exclude many people rom even basic
banking services.
* * *
The bursting o a worldwide credit bubble has removed some o the excesses
that drove rapid nancial deepening beore the crisis, but in its wake, the new
normal has yet to be clear ly established. For now, growth in global nancial assets
remains a mixed picture, especially in mature economies, and markets lack a
clear direction orward. It remains to be seen whether the world can resume
nancial deepening and manage to do so within a more stable ramework and at
a more measured pace. Policy changes discussed later in this report could move
the world in that direction.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
In most minds, the word globalization evokes international trade rather than
nance. But in our interconnected economy, capital moves fuidly across national
borders—and in act, capital fows have grown even more rapidly than the volume
o global exports over the past three decades.
Cross-border capital fows—including lending, oreign direct investment (FDI),
and purchases o equities and bonds25—are a key metric that refects the degree
o integration in the global nancial system. These fows link together national
nancial markets and allow borrowers and savers rom di erent countries to
connect. In recent decades, nancial globalization took a quantum leap orward
as cross-border capital fows grew aster than global GDP, rising rom $0.5 trillion
in 1980 to a peak o $11.8 trillion in 2007.
But these fows are now more than 60 percent below their ormer peak (Exhibit 9).
This sharp drop has cast uncertainty over the uture evolution o nancial
globalization. Understanding the drivers o growth—and decline—in cross-border
capital fows is essential. While some o these fows connect lenders and investors
with real-economy borrowers, interbank lending has accounted or a signicant
share. We nd that most o the recent decline can be attributed to Europe and to
a pullback in cross-border lending (Exhibit 10). However, all advanced economieshave seen a signicant reduction in capital infows and outfows (Exhibit 11). By
contrast, developing countries and oreign direct investment have held steadier.
Global capita l fows are unlikely to regain the highs o 2007 in the near term,
but beyond that, the uture remains an open question. History shows that
nancial globalization is not a linear process (see Box 2, “The rst age o nancia l
globalization: 1860–1915”). We could be entering a period in which banks and
investors are less likely to venture beyond their home markets, creating a more
balkanized nancial system with constrained access to credit and higher costs o
borrowing in some countries. Savers would nd ewer opportunities to diversiy
globally. Or—given the right policy actions—we may simply be witnessing the starto a new phase in the ongoing development o nancial globalization.
25 See the appendix or more detailed denitions. Because o data restrictions, the sections o
this chapter that discuss cross-border bank claims and bi lateral investment reer to changes
in the stock o oreign assets rather than to fows. These distinctions are also discussed in
greater detail in the appendix.
2. Cross-border capital fowsdecline
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
SOURCE: International Monetary Fund (IMF) Balance of Payments; Institute of International Finance (IIF); McKinsey GlobalInstitute analysis
1 Includes foreign direct investment, purchases of foreign bonds and equities, and cross-border loans and deposits.2 Estimated based on data through the latest available quarter (Q3 for major developed economies, Q2 for other advanced and
emerging economies). For countries without quarterly data, we use trends from the Institute of International Finance.
Cross-border capital flows fell sharply in 2008 and today remain more than
60 percent below their pre-crisis peak
12
10
8
6
4
2
0
-61%
4.6
2011
5.3
6.1
1.7
2.2
2007
11.8
2000
4.9
1990
1.0
1980
0.5
Global cross-border capital flows1
$ trillion, constant 2011 exchange rates
% of
global
GDP
4 5 13 20 68
2012E2
eiit 10
-1.8
(28%)
-4.8
(72%)
-0.7
-2.6
-0.4
-1.4
-3.3
-0.5-0.3
-6.6
-0.1-0.5
-0.6
-0.8
-1.9
All types of capital flows have declined since 2007, and
cross-border lending accounts for half the total drop
Change in total cross-border capital flows, 2007–11
$ trillion, constant 2011 exchange rates
2.0 0.80.1 2.2 5.3
SOURCE: IMF Balance of Payments; McKinsey Global Institute analysis
1 Includes primarily loans, currency and deposits, as well as a small share of trade credit. Excludes operations of foreignaffiliates.
NOTE: Numbers may not sum due to rounding.
Foreign directinvestment
Equitysecurities Debt securities Loans1
Total change,2007-11
Capital flows, 2011
$ trillion
Rest of the world
Western Europeand United Kingdom
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
Cross-border capital flows have declined significantly in most regions
since 2007
SOURCE: IMF Balance of Payments; McKinsey Global Institute analysis
1 The United Kingdom is removed from Western Europe in this chart to avoid double counting.2 Asia excluding China and developed Asian countries (Hong Kong, Japan, Singapore, South Korea, and Taiwan).
Change in total capital flows (inflows + outflows by region), 2007–11
%32
-3
-24
-30
-39-41
-49
-60
-67
-82
AfricaChinaLatinAmerica
JapanEmer-ging
Asia2
Other devel-
oped
MiddleEast
CEEand CIS
UnitedStates
WesternEurope1
UnitedKingdom
3.3 9.9 3.8 1.0 0.5 2.1 0.4 1.1 1.1 0.20.6
0.6 3.2 1.5 0.5 0.3 1.3 0.3 0.9 1.1 0.20.6
Total capital flows ($ trillion)
2007
2011
In this chapter we examine the trends in nancial globalization using a variety o
metrics: cross-border capital fows, the stocks o oreign investment assets and
liabilities o countries (which represent the cumulative sum o capital fows), and
the current account balances o countries (which refect a nation’s capital infowsminus outfows).
One bit o good news today is that global current account imbalances—or
the sum o surpluses and decits in di erent countries—have declined some
30 percent rom their peak when measured relative to global GDP. Although these
imbalances did not directly cause the nancial crisis (as many observers eared
they would), the imbalances did contribute to growing indebtedness and credit
bubbles in some countries. Smaller imbalances in the uture would reduce one
source o risk and volatility in the global nancial system.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
b 2. The rst age of nancial globalization: 1860–1915
The rise o cross-border investing in recent decades is not the rst time
the world has seen a signicant burst o nancial globalization. Indeed, the
Second Industrial Revolution coincided with a new era o capital mobil itythat extended roughly rom 1860 to 1915. Foreign investment assets rose to
55 percent o GDP in the major European economies (Exhibi t 12).
eiit 12
Two eras of financial globalization
1 From 1825 to 1938, our country sample includes Canada, France, Germany, Japan, Netherlands, the United States, theUnited Kingdom, and other European countries. The sample expands as data becomes available. By 1990, the number of
countries increases to 79.
SOURCE: IMF Balance of Payments; Federal Reserve Flow of Funds; US Treasury; Obstfeld and Taylor (2004); McKinsey
Global Institute analysis
Global foreign investment assets
% country sample GDP1
0
20
40
60
80
100
120
140
160
180
20001975195019251900187518501825
This wave o nancial global ization refected European investment in
colonies and ormer colonies.1 As the British Empire reached its peak,
Great Britain alone accounted or hal o the oreign assets o the period.
These investments helped und the industr ial ization and urbanization that
transormed recipient nations such as Canada, Australia, and Argentina.2
But the ending o the rst age o nancial globalization provides a cautionary
tale. Two world wars and a global depression not only brought this period
o integration to a halt but also ushered in six decades o tightly restrictedcapital fows and pegged oreign exchange rates. Foreign investment
assets as a share o GDP in the major economies did not regain their earlier
peak until 1990. Today it is unclear whether nancial globalization wil l
rebound or whether we will enter a similar period o more insular national
nancial markets.
1 Maurice Obsteld and Alan M. Taylor, Global capital markets: Integration, crisis, and
growth, Cambridge University Press, 2004.
2 Charles W. Calomiris, A globalist maniesto or public policy , Institute o Economic
Aai rs, 2002.
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But today it appears that Europe’s nancial integration proceeded aster than the
development o an institutional ramework to monitor and address the impact o
such fows. As capital moved seamlessly across borders, interest rates converged
across the Eurozone. For countries in the periphery, this meant a substantial
decline in borrowing costs that unleashed an unsustainable bubble.27
In countrieslike Spain and Ireland, which had underdeveloped residential and commercial
real estate sectors, lower interest rates ueled a lending boom and contributed to
real estate bubbles. In Greece, the decline in interest rates enabled public-sector
spending and mounting government debts. The result—plain to see ar in advance
o the current euro crisis—was very large and unsustainable current account
decits in those countries unded by oreign capital infows.
In the a termath, Europe’s nancial integration has gone into reverse. Eurozone
banks have reduced cross-border lending and other cla ims by $3.7 trillion since
the ourth quar ter o 2007, with $2.8 trillion o that reduction coming rom intra-
European claims (Exhibit 14). Our calculations suggest that ha l o the decline inoreign claims came rom a drop in cross-border interbank lending. The rest is
attributed to sales o oreign corporate bonds, government bonds, and equities.
eiit 14
Since 2007, Eurozone banks have reduced foreign claims by $3.7 trillion,$2.8 trillion of which was intra-European
240
-438
-781
-2,752
-140
-771
-665
-1,176
-3,732
1,732
1,382
509
1,182
5,665
291
1,609
2,033
Change
$ billion
Compound annual
growth rate (%)
8,737
Eurozone bank
claims on:
SOURCE: Bank for International Settlements; McKinsey Global Institute analysis
1 Includes banks from Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Netherlands, Portugal, and Spain.2 GIIPS comprises Greece, Ireland, Italy, Portugal, and Spain.
Consolidated foreign claims of Eurozone reporting banks(includes loans and other foreign financial assets)1
By counterparty location, constant 2011 exchange rates
4Q99–4Q07
GIIPS2
Other Eurozone
United Kingdom
Other Western Europe
Total Western Europe
United States
Other developed
Developing countries
Total
$ billion
Compound annual
growth rate (%)
3
-7
-9
-5
-7
-9
13
11
16
12
13
13
6 -9
-814
4Q07–2Q12
-1417
The retrenchment o European banks abroad has been matched by an increase in
domestic activity. Banks that received public rescues have aced an expectation
to increase home-market lending. As a result, domestic lending and purchases o
domestic bonds in the Eurozone have increased by $3.8 trillion since the ourth
quarter o 2007, more than o setting the contraction in banks’ oreign assets
27 From 1995 to 2007, ten-year bond yie lds decreased by 7.5 percentage points in Spain, 7.3
percentage points in Portugal, 7.5 percentage points in Italy, and 14.5 percentage points
in Greece.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
(Exhibit 15).28 Overall, their balance sheets have grown since 2007. This explains
the somewhat surprising nding in Chapter 1 that nancial assets relative to
GDP have grown since 2007 in most European countries, despite the lingering
euro turmoil.
eiit 15
The decline in cross-border bank claims in Europe has been
offset by growth in banks’ domestic assets
SOURCE: European Central Bank; McKinsey Global Institute analysis
1 Not all parts of bank balance sheet included in totals. Claims by foreign subsidiary banks are also excluded in this chart.2 Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Netherlands, Portugal, and Spain.
33.6
4Q07 4Q12
35.2
Other foreign
0.9
0.4
0.4
Eurozone
1.2
0.6
0.6
Domestic
3.8
-0
1.9
1.9
Change in bank assets (equities, debt securities, and loans)1
of Eurozone banks,2 4Q07–4Q12
$ trillion, constant 2011 exchange rates
Equity
Bonds
Loans
Percent change
since 4Q0717 -24 -16 5
Other types o cross-border capital fows into European nations have declined
sharply since 2007. FDI infows and oreign purchases o equity and bonds
declined by 74 percent, rom an annual volume o almost $3 trillion in 2007 to
$780 billion in 2011. Early estimates indicate that FDI fows into Europe continue
to decline, tumbling some 35 percent in 2012 over the previous year as the euro
crisis has dragged on. The seamless fow o capital across national borders
has slowed to a trickle. Flows rom the European Central Bank and the national
central banks o the Eurozone member states now account or more than
50 percent o capital fows in the region (Exhibit 16).
The GIIPS countries at the heart o the euro cris is—Greece, Ire land, Italy,
Portugal, and Spain—have been hit particularly hard as cross-border nancing
has dried up. Private creditors have retreated; over the past three years, oreign
investors have withdrawn on net more than $900 billion rom these countries.
Currently, ocial suppor t rom the European Central Bank is the main orm o
capital fowing into these countries (Exhibit 17), although there is some evidence
that private capital fows to the GIIPS picked up in the nal months o 2012.
28 According to data rom the European Central Bank, the balance sheet assets o banks in
11 Eurozone nations have grown rom $33.6 trillion at the end o 2007 to $35.2 trillion by
the second quar ter o 2012. The growth is seen across most Eurozone countries, includ ing
France, Italy, the Netherlands, and Spain. Germany is a notable exception.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
1 GIIPS comprises Greece, Ireland, Italy, Portugal, and Spain.2 European Financial Stability Facility/ European Stability Mechanism.3 Measured as changes in TARGET2 liabilities of GIIPS central banks, less the portion associated with EFSF/ESM.4 Calculated based on data up to 3Q12.
SOURCE: Eurostat; individual central banks’ balance sheets; McKinsey Global Institute analysis
Composition of Eurozone-17 average quarterly
cross-border capital inflows%; $ billion, constant 2011 exchange rates
303
-71%
2012E4
48
35
16 1
2007
1,026
99
<1
ECB bond purchases
EFSF/ESM2
Intra-Eurosystem lending3
Private and other flows
Official flows to the GIIPS1
eiit 17
In the GIIPS, central bank flows are the main sourceof capital, as private creditors and investors
have withdrawn more than $900 billion
SOURCE: ECB; individual central bank balance sheets; Eurostat; press releases; McKinsey Global Institute analysis
-151
-481-284
203
312
07
1,259
5
1,190
2006
1,195
-9
1,268
3Q123
432
17
11
686
48
10
392
14
09
253
46
08
166
157
255
249
470
Eurosystem flows1
Private flows
IMF
1 Includes inflows via EFSF/ESM, bond purchase programs, and the TARGET2 system.2 GIIPS comprises Greece, Ireland, Italy, Portugal, and Spain.3 Non-annualized total inflows up to 3Q12.
GIIPS2 capital inflows$ billion, constant 2011 exchange rate
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
Beyond the immediate imperatives o navigating the crisis, the Eurozone—and
the EU more broadly—aces a more undamental question: is the pursuit o ull
nancial integration still a primary goal, or will indiv idual nations turn inward?
While the current retrenchment seems prudent in the ace o the euro crisis, it
has the potential over time to raise the cost o capital, limit competition, andconcentrate risks within countries.
Global banKInG Is In flux
Outside o the Eurozone, which has seen a sharp reduction in cross-border bank
claims, the picture o global bank retrenchment is more mixed. Banks in the
United Kingdom have actually increased oreign assets,29 while those in other
European countries have seen a decline (Exhibit 18). Banks in the United States,
Canada, and Australia have all increased their cross-border assets—but their
expansion is not substantial enough to ll the gap le t by retreating European
banks. In aggregate, total cross-border bank claims have allen by $2.9 trillion
since 2007.
eiit 18
US and other developed-country banks have expanded
foreign assets—but not enough to fill the gap left by
European banks
SOURCE: Bank for International Settlements; McKinsey Global Institute analysis
Advanced-economy banks’ cross-border claims, by nationality of bank
$ trillion, constant 2011 exchange rates
3
8
8
-1
0.70.5
3.4
7.4
2007
2.8
Australia
Canada
United States1
2Q12
3.2
0.71.0
3.2
Japan2
8.1+0.7
17.1
-3.6
Other Western Europe
United Kingdom3
Other Eurozone
GIIPS
2Q12
2.73.6
4.0
7.5
2.8
2007
20.7
3.0
11.0
3.0
-2
-8
7
-6
2
-4
1 In 2009, US banks added a large amount of off-balance assets bank on their balance sheets. To ensure comparabilitybetween 2007 and 2Q12 figures, the data in the exhibit assumes these assets were on bank balance sheets in both periods.
2 In nominal $, Japanese bank foreign claims increased by $0.8 trillion between 2007 and 2Q12.3 In nominal $, UK bank foreign claims increased by $0.3 trillion between 2007 and 2Q12.
Europe Other developed countries
Compound annualgrowth rate,2007–2Q12 (%)
29 The increase in the cross-border assets o UK banks results rom two eects: rst, growth in
the assets o the oreign subsidiaries o UK banks, such as Standard Char tered, and second,
use o a constant exchange rate across the period.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
With new regulations on capital and liquidity and pressures rom shareholders
and regulators to reduce risk, banks are winnowing down the geographies and
business lines in which they operate. Commercial banks have sold more than
$722 billion in assets and operations since the star t o 2007; oreign operations
make up almost hal o this total (Exhib it 19). European banks account or morethan hal o these asset sales. For instance, since 2009 HSBC has undertaken at
least 70 divestitures, worth more than $25 billion, in 32 countries. Crédit Agricole
has divested at least 27 operations across 15 countries. O course, some banks
have also purchased assets that others are selling. Since 2009 Scotiabank has
made ten acquisitions in Latin America, including the Brazilian operations o
Commerzbank and the Chilean operations o RBS. On net, European banks
have been net sellers o assets, while banks rom the United States and other
advanced economies have been buyers o assets.
eiit 19
Global banks have divested at least $722 billion of assets since 2007,with more than half coming from European banks
1 Includes retail and commercial banks. Deal value of some divestitures not reported.2 We found data on 23 divestiture deals of Swiss banks. The six deals with values total less than $1 billion.
SOURCE: Dealogic; McKinsey Global Institute analysis
722.1 (3,450)
120.0 (1,296)
167.6 (655)
434.5 (1,499)
21.0 (44)
24.4 (222)
43.1 (234)
77.3 (215)
79.9 (208)
161.8 (308)
Nationality Examples
Total
Rest of world
TotalWestern Europe2
Cumulative deal value$ billion (number of deals)
Cross-border % of cumulativedeal value
Divestitures, January 2007–December 20121
UnitedStates
France
Italy
Spain
UnitedKingdom
Germany
55
62
45
14
52
63
51
42
26
45
Belgium
Banks remaining active in oreign markets are encountering a changed regulatory
landscape. During the crisis, many countries ound their own taxpayers bailing
out banks that ailed due to oreign operations, or insuring depositors rom ailed
oreign institutions. As national regulators move to contain these risks, their
actions could slow the bank-induced share o cross-border capital fows (see
Box 3, “Shiting models o oreign lending”).
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
Cross-border banking grew rapidly in the years preceding the nancial crisis, with
annual fows o lending and deposits rising rom $1.6 trillion in 2000 to $5.6 trillion
in 2007. This rise in activi ty was accompanied by dierent methods or conductingsuch activities—and vast dierences in how they were regulated.
In general, there are three orms o cross-border banking. At one end o the
spectrum is the subsidiary model, in which banks set up a separate legal entity
in the host country. Such subsidiaries have their own balance sheets and need to
be separately capitalized or the activities they are per orming. Branch lending is
done via a local oce established in the recipient country, while “suitcase” lending
is conducted rom a nancial institution with little or no physical presence in the
country. The branch and suitcase lending models a llow oreign institutions to use
their balance sheets in one nation to lend to corporations or households in another.
The regulatory approach to each o these orms o cross-border lending var ies
across countries. Many national regulators do not regulate lending per se but require
only a banking license or taking deposits or other activities. Some require a banking
license or consumer lending, and a ew also regulate wholesale cross-border
lending. An analysis by the global law rm Cliord Chance nds that the majority
o countries in a 43-country sample had no explicit regulations on oreign entities
or cross-border suitcase lending to domestic corporations. This enabled rap id
growth in cross-border lending, since suitcase lending does not require physical
inrastructure in the borrower jurisdiction. In most countries, regulatory barriers
or the establishment o branches were quite low or reputab le banks prior to the
nancial crisis. The European Union even went one step urther: its “passporting”rules allow its banks to establish branches and conduct all banking activities,
including taking deposits, in other member states. By contrast, countries such as
Saudi Arabia have barred most types o oreign lending and grant only restricted
banking licenses to oreign banks.
The rules regarding suitcase lending have not changed much s ince the nancial
crisis. Most markets allow it because the lender o last resort is clear: it is the home
country. But some countries have imposed restrictions with the goal o avoiding
“sudden stops” in which cross-border lending by oreign banks dries up in times o
stress and accelerates a crisis.
However, regulators across the globe are tightening the rules or oreign activities
conducted through branches and subsidiaries. These moves include concentration
limits, higher capital and liquidity requirements, and stricter regulatory oversight with
less reliance on home supervisors. The recent trend o “subsidiarization” has seen
many regulators increasingly requiring oreign banks to access their markets only
through subsidiaries. In the United Kingdom, or example, there have been 22 net
closings o branches since 2007, with two net additiona l subsidiaries. Several oreign
banks in the United Kingdom, including banks rom China, Cyprus, and Ireland,
recently converted their operations rom branches to subsidiaries. The recent US
Federal Reserve Foreign Banking Organization proposals,1 i implemented, would
require banks to create subsidiaries in cer tain circumstances, and would require
branches o overseas banks to maintain assets in the United States.
1 See details rom the Federal Reserve at http://www.ederalreserve.gov/newsevents/press/
bcreg/20121214a.htm.
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Exerting tighter regulatory control over oreign banks entails a trade-o.
Subsidiaries allow host regulators to apply their own standards to oreign banks,
minimizing the risk o capital fight and the chance o local taxpayers bearing
the cost o a bailout. However, because subsidiaries need to be capitalized and
unded separately, this leads to “trapped pools o capital and liquidit y.” Thisreduces the overall banking group’s lending capacity and limits the ability to use
deposit overhangs in one country or lending in another. It also raises the cost to
banks o operating in a country and may erode economies o scale. As a result,
oreign banks may decide not to enter some smaller and more restrictive markets
at all, thus limiting competition and also potentially depriving local borrowers
rom tapping international markets. The impact is already visible. Over the past
our years, cross-border lending through branches in Europe has declined two
times more than oreign lending through subsidiaries.
In light o these and other new regulatory trends, the benets o global expansion
or large banks seem to be waning. While a oreign presence may continueto benet banks and host countries alike, it will be undertaken on a more
selective basis going orward. This will require banks to adopt new strategies
and organizational structures, and it will open the door or new intermediaries to
gain share.
developInG counTrIes are on a dIfferenT TrajecTory
In contrast to the stalling o nancial integration in Europe and other advanced
economies, developing countries have continued to see strong capital infows.
The rise o these nations as a orce in nancial global ization has expanded
the web o countries now linked into world markets and has introduced
new dynamics.
Capital ows into developing countries remain strong
In 2012, some $1.5 trillion in oreign capital fowed into emerging markets, near
or above the 2007 pre-crisis peak or many regions (Exhibit 20). These countries
attracted 32 percent o global capital fows in 2012, up rom just 5 percent
in 2000.
Several trends explain the continued growth o oreign investment in emerging
economies. One is the improved macroeconomic and political stabili ty in
many o these countries, which has led to upgraded credit ratings and robust
GDP growth.30 In addition, aced with historically low interest rates in matureeconomies, global investors are seeking higher yields in emerging markets.
Corporations also provide signicant capital to emerging economies, as they
seek to tap new consumer markets and create global supply chains.31 In 2012,
oreign direct investment accounted or 53 percent o capi tal infows to emerging
economies, compared with 30 percent in mature markets (Exhibit 21).
30 For example, see recent MGI reports on the economic perormance o Indonesia and o
Arican nations (The archipelago economy: Unleashing Indonesia’s potential , September 2012,
and Arica at work: Job creation and inclus ive growth, August 2012).
31 Urban world: Cities and the rise o the consuming class, McKinsey Global Institute, June 2012,
and Winning the $30 trillion decathlon, McKinsey & Company, August 2012.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
Capital inflows to developing economies totaled $1.5 trillion in 2012and are near the pre-crisis peak
SOURCE: IMF Balance of Payments; Institute of International Finance; McKinsey Global Institute analysis
Global capital inflows to developing countries, by region
$ trillion, 2011 constant exchange rate
1.6
1.4
1.2
1.0
0.8
0.6
0
China
Latin America
Middle East
CEE and CIS
Other emerging Asia
Africa
112000 05 07 09
1.8
2012E1
0.4
0.2
9 14 46 27
30
64
39
23
24
31
11
2
-16
4
8
-25
5
Compound annualgrowth rate (%)
2000–07 2007–12E
% of globalflows
0.2 0.20.3
0.5
0.7
1.0
1.6
1.0
0.8
1.51.4
32
1.5
1 Estimated based on data through Q2 2012. For countries without quarterly data, we use trends from the Institute of International Finance.
eiit 21
Foreign direct investment is a much larger share of capital inflows
to emerging markets than to developed countries
1 Estimated based on data through the latest available quarter: Q3 for major developed economies, Q2 for other advanced andemerging economies. For countries without quarterly data, we use trends from the Institute of International Finance.
2 Includes primarily loans, currency, and deposits, as well as a small share of trade credit.
SOURCE: IMF Balance of Payments; Institute of International Finance; McKinsey Global Institute analysis
Cumulative capital inflows, 2007–12E1
%; $ trillion, 2011 constant exchange rate
10
33
11
6
Bonds
31
Loans2
Equity
FDI
100% =
Developed economies
23.9
26
Emerging markets
7.8
28
56
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Foreign capital fows into developing countries could become vastly larger in
the years ahead. Collectively, these nations account or 38 percent o global GDP
but only 7 percent o oreign investment in equities and bonds, 13 percent o
global oreign loans outstanding, and 27 percent o total FDI. Despite the strong
long-term growth prospects in these markets, investors around the world areunderweight in assets o developing countries in their port olios. To understand
the potential scale o uture investment, consider that i global investors adopted
a GDP-weighted asset allocation model, oreign investment in the stock and bond
markets o developing nations would increase veold, rising by $14 trillion.
Many barriers stand in the way o signicant growth in oreign investments in
emerging economies, o course. As noted in Chapter 1, developing countries
have much shallower nancial markets than mature economies. The lack o
well-developed nancial market inrastructure has limited capital fows, in part
by limiting the assets available to oreign investors. We estimate, or example,
that only about hal o equity shares in developing countries are reely traded—compared with about 85 percent in advanced economies. To benet rom the
strong growth prospects o emerging markets, oreign investors will need to nd
new channels or gaining exposure to these economies.
Capital ows out of developing countries are diversifying beyond
fx
Capital fows out o developing countries have grown even more rapidly than
infows, totaling $1.8 trillion in 2012 (up rom $295 billion in 2000; Exhibit 22).
Central bank oreign exchange (FX) reserves have been the astest-growing
component o oreign investment rom developing countries, accounting or
roughly 45 percent o the total stock o oreign assets (Exhibit 23). The remainderconsists mainly o FDI and cross-border loans rom commercial and development
banks. In some regions, particularly the Middle East, portolio investments in
oreign equities and bonds by sovereign wealth unds and wealthy individuals are
also signicant.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
SOURCE: IMF Balance of Payments; Institute of International Finance; McKinsey Global Institute analysis
2.4
2.2
2.0
1.8
1.6
1.4
1.2
1.0
0.8
0.6
0.4
0.20
2012E104 102000 02 0806
Total inflows
Total outflows excluding reserves
Total outflows including reserves
Emerging markets’ capital outflows are even larger than inflows,at $1.8 trillion in 2012
6 18 48 38 20Africa
109129
Other
emergingAsia 16021
139
CEE andCIS
27357 216
LatinAmerica
279100 179
Middle East 309133 177
China 643359 284
Other outflows
FX Reserves
Emerging markets arenet providers of capital$ trillion,2011 constant exchange rates
Capital outflows by region, 20121
$ billion
34
31
24
-5
-2
2
Compoundannual growthrate (%)
2000–07 2007–12
% of globalflows
1 Estimated based on data through Q2 2012. For countries without quarterly data, we use trends from the Institute of International Finance.
eiit 23
Central banks account for 45 percent of developing countries’
foreign investment assets
1 Foreign investment assets of developing countries in other developing countries.2 Foreign investment assets of developing countries in advanced economies.
SOURCE: McKinsey Global Institute Bilateral Foreign Investment database; McKinsey Global Institute analysis
Stock of total foreign investment assets of developing (South) economies
$ trillion, nominal exchange rates
28 11
16 8
25 9
4.3
1.3
4.4
05
5.5
4.6
1.5
4.9
04
4.4
5.1
1.7
1.7
1.0
0.4
2000
2.6
1.8
1.3
0.5
0.3
0.8
1.6
03
3.5 3.5
3.0
1.4
02
3.0
4.41.0
2.3
01
2.8
06
7.5
2011
14.4
1.7
0.7
2.2
10
13.3
07
10.0
2.6
5.9
6.5
09
0.3
11.5
1.5
0.7
5.6
08
10.2
0.3 5.9
1.9
South–North2
South–South1
South–North central banks’ FX reserves
Compound annual
growth rate (%)
2000–07 2007–11
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1 Foreign investment assets of developing countries in other developing countries.2 Foreign investment assets of developing countries in advanced economies.NOTE: Numbers may not sum due to rounding.
The motivations behind “South-South” investments may di er rom those
driving investors and companies in advanced economies. China’s investments
in other emerging markets, or instance, are primarily linked to natural resources
and usually take the orm o FDI or cross-border lending. These have been
concentrated in Latin America and, to a lesser extent, Arica (see Box 4, “The rise
o Chinese outward FDI and lending”).
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
By contrast, Middle Eastern investment into other developing countries is
predominantly concentrated in the surrounding region. For example, about
70 percent o Kuwait’s FDI is in other Gul Cooperation Council, Middle Eastern,
or North Arican countries. This oten unds real estate development or the
expansion o companies within the region.
For some recipient countries, “South-South” capital represents a majorit y o
oreign investment. Thirty developing countries now receive more than hal o their
oreign direct investment rom other emerging markets, although these are mainly
very low-income or confict countries, such as Cuba, the Democratic Republic
o the Congo, Guinea, Niger, North Korea, and Sierra Leone. This unding oten
comes with dierent terms than investment rom advanced economies. In Arica,
or instance, a growing share o commodity deals now include the development
o inrastructure or schools. Many attribute this shit to the growing infuence o
China on the continent.
MulTInaTIonal coMpanIes conTInue To expand
ThrouGh foreIGn dIrecT InvesTMenT
Foreign direct investment, which we dene as investment that establishes at
least a 10 percent stake in a oreign entity, has been a growing component o
cross-border capital fows over the past 30 years, and more recently, its share
has increased signicantly as cross-border lending has declined. FDI continued
throughout the crisis and now accounts or roughly 40 percent o global capital
fows (Exhibit 26). We estimate that FDI declined by 15 percent in 2012, refecting
a continued retrenchment in Europe and uncertainty in the United States.
However, this trend is expected to reverse in 2013 and beyond. 32
eiit 26
Foreign direct investment continued through the crisis
and now accounts for 38 percent of total global capital flows
SOURCE: IMF Balance of Payments; Institute of International Finance; McKinsey Global Institute analysis
1 Estimated based on data through the latest available quarter : Q3 for major developed economies, Q2 for other advancedand emerging economies. For countries without quarterly data, we use trends from the Institute of International Finance.
Total global capital flows
$ trillion, constant 2011 exchange rates
FDI
4.6
1.7
2.9
2000
Equity, bonds,and loans
5.3
2.0
3.2
01
6.1
1.7
4.4
02
1.7
1.4
0.2
03
2.2
2.1
0
04
11.8
2.6
9.2
05
9.1
1.9
7.2
06
7.8
1.5
6.3
08
5.9
0.9
5.0
09
4.2
0.8
3.4
10
3.2
1.0
2.2
11
3.4
0.9
2.5
2012
4.9
1.7
3.3
07
34 27 31 18 14 19 21 22 98 86 39 3828FDI share of
total flows
%
32 See Global investment trends monitor , UNCTAD, January 2013.
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In contrast to cross-border lending, which can dry up quickly, FDI has consistently
proven to be the least volatile type o capital fow in emerging markets and
developed countries alike. This refects the long-term nature o such investment.
FDI is oten driven by multinational companies as they seek to develop resources,
build supply chains, or expand beyond saturated domestic markets to capturegrowth in developing economies. Companies do not undertake the decision to
expand overseas lightly, and they typically make such commitments as part o a
long-term, multiyear strategy. The growth o FDI also refects the rising infuence
o sovereign wealth unds and state-owned corporations.
The increased role o FDI in nancial g lobalization should have a stabi liz ing
infuence on cross-border capital fows. Our analysis, consistent with other
academic research,33 nds that oreign direct investment is the least volatile type
o cross-border capital fow. This is true in both emerging markets and advanced
economies, regardless o the specic time period examined (Exhibi t 27).
eiit 27
0.50.90.7
3.2
6.0
FDIEquityBondsLong-term
bank claims3
Short-term
bank claims2
FDI is the least volatile type of capital flow; short-term lending is
3 to 12 times more volatile
0.7
1.71.71.82.4
SOURCE: Bank for International Settlements; IMF; McKinsey Global Institute analysis
1 Coefficient of variation defined as standard deviation normalized by the mean; calculations are made on quarterly data.2 Maturity less than or equal to two years.3 Maturity more than two years.
Coefficient of variation of inward cross-border flows by maturity1
1Q00–4Q11
Emerging
markets
Developed
marketsHigher value
implies higher
volatility
Short maturity Long maturity
By contrast, cross-border lending has been the most volatile type o cap ital
fow over the past 20 years, with more episodes o large surges and reversals
than bond and equity fows, especially in emerging economies.34 This is in part
because cross-border lending tends to be very short-term: 56 percent o cross-
border loans have maturities o less than two years. During periods o stable
economic growth, short-term loans are typically rolled over upon maturity. But
in times o stress, banks can easily let the loans expire without replacing them,
thereby withdrawing their unding. Even longer-term loans are more volatile than
33 See, or example, Carmen Broto, Javier Díaz-Cassou, and Aitor Erce, “Measuring and
explaining the volatility o capi tal fows to emerging countries,” Journal o Banking & Finance,
volume 35, issue 8, August 2011.
34 See, or example, Kristin J. Forbes and Francis E. Warnock, Debt- and equity-led capital fow
episodes, NBER working paper number 18329, August 2012.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
nancial marketsWith the ull ramications o the 2008 cr isis still unolding and new regulations
waiting to be implemented, two starkly dierent utures are possible. In one,
growth in nancial assets remains anemic and the global nancial system
becomes more balkanized. While such a system may reduce the risk o a
global crisis, the world needs to make big investments to uel the next wave o
prosperity, and these may be constrained, potentially resulting in lower growth.
A better outcome would involve more sustainable growth and development o
nancial systems around the world. This would entail our essential components.
The rst is wide access to nancing through deep, liquid, and well-regulated
markets. Second, a range o institutions and channels should be in place in each
country to intermediate between borrowers and savers—not only a banking
system, but also capital markets, an insurance industry, and pension plans, to
name a ew. The third element is competition among institutions, which promotes
ecient operations and a lower cost o borrowing. Last—but certainly top o mind
ater 2008—a healthy nancial system should be stable and resilient enough to
ward o crises.
In the wake o the crisis, some have questioned whether openness is necessary
or a healthy nancial system. Clearly, oreign capital fows created volatility.But it is important to consider that nancial globalization can also urther the
goals outlined above (see Box 1 in Chapter 1 or more on this topic). Foreign
institutions and investors increase the availability o capital and orce local
players to raise their game. They impose discipline that compels local companies
to improve corporate governance in order to meet lending standards and
listing requirements. An open nancial system allows loca l companies to raise
capital in markets worldwide, and helps global savers and investors diversiy
their portolios.
This chapter paints sharply contrasting pictures o how the global nancial
system might evolve in the next ew years, analyzing the potential implications o continued stalling versus a successul reset o the system.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
The nancial cris is caused many observers—including some pol icy makers—to
question the economic and social utility o large, globally integrated nancial
institutions and markets. In one possible uture scenario, that skepticism
takes root.
Ocials in emerging economies have long worried that a large nancial sector
is a potential hazard, and in this scenario, they curtail urther nancial market
development. By 2020, as emerging economies account or a larger share o
global GDP, their lack o urther nancial deepening would reduce the global
ratio by around 25 percentage points. Investors would nd limited options to
diversiy by entering potentially high-growth emerging economies; oreign capital
would shy away rom shallow markets in these countries that lack transparency
and enorcement.
Advanced economies would exper ience lit tle i any additional nancial deepeningthrough 2020 in this scenario. Deleveraging o the private sector and the nancial
sectors would continue, while government debt may continue to rise as growth
remains subdued. More restrictive policies toward nance may take hold; there is
already movement in multiple EU countries toward implementing transaction taxes
on nancial trades.36
The retrenchment o global banks could lead to a loss o competition and
expertise in the nancial sectors o some smaller countries, driving up the cost o
borrowing, and bank lending would be a smaller source o nancing in advanced
economies. Without the presence o deep corporate bond markets and basic
securitization to provide alternative sources o unding, borrowers in these regionscould ace a credit crunch.
In this scenario, cross-border capital fows would not regain their pre-crisis peak
or many years. Europe would stay on its current course—with no breakup, but
only slow progress toward a banking union ramework—and the continent’s
cross-border activity would continue to wane.
The “retreat” scenario is one in which current trends continue. It points to a world
shaped by a high degree o risk aversion—one that may choke o the nancing
needed or investment in business expansion, inrastructure, housing, innovation
and R&D, education, and human capital development. A reduction in long-term
lending to corporations is already apparent in Europe; only corporate loans with
maturities o one year or less show positive growth.
Sharp regional dierences could emerge in the availability o capital: Developing
economies ace massive investment needs as they urbanize and industrialize,
but many will encounter a shortage o capital. Countries with high savings rates
would nd themselves with surplus capital but with too ew good investment
opportunities; savers and investors in these countries could ace lower returns.
36 As this report went to press, EU nance ministers approved plans or 11 member countries
(including Germany and France) to proceed with plans to impose transactions taxes on
securities and derivatives trades. In the United States, two members o Congress are
discussing introducing a similar measure or debate.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
I current trends continue, the value o nancial assets relative to GDP would
remain fat or even decline by 2020. Based on our analysis o the relationship
between nancing to households and non-nancial corporations and economic
growth, we estimate that the lack o nancial deepening in this scenario could
potentially reduce GDP growth by roughly 0.45 percentage points.37
The crisis underscored the need or greater prudence and stabili ty, but unless
current regulatory reorm initiatives succeed in restoring condence, there is a
possibility that the pendulum may swing too ar toward excessive caution. This
risks stifing the global recovery and creating a nancial system that ails in its
primary unction: providing a healthy fow o credi t to the real economy.
scenarIo 2: fInancIal GlobalIzaTIon reseTs
With the right actions by nancial institutions and policy makers, the world could
take a more balanced approach to nancial market development and globalization
that would support economic growth. This scenario hinges on putting a solidglobal regulatory ramework in place to correct the excesses o the pre-
crisis years. This includes well-capitalized banks, a clear plan or cross-border
resolution and recovery, improved macroprudential supervision, and mutual
condence and cooperation among national regulators. This alternative scenario
would also see Europe successully completing a banking union.38 Much is riding
on the major reorm initiatives that are currently under way on all these ronts.
Banks across advanced economies would strengthen their balance sheets and
resume prudent lending in this scenario, while emerging markets would develop
more robust nancial systems. With sound regulatory architecture in place to
provide stability, oreign capital would fow to geographies with major investmentneeds. But close macroprudential supervision would watch or potential asset
bubbles and dangers associated with very large current account imbalances.
In this scenario, countries would pursue opportunities or sustainable nancial
deepening, such as the expansion o corporate bond markets, which remain
underdeveloped in most regions. While the potential growth o these markets
has been discussed or decades without being realized, conditions are
changing. In Europe, net lending to corporations with maturities o greater than
ve years turned negative in 2012. Around the world, the largest companies
have increasingly turned to bond markets or debt unding: since 2008, annual
non-nancial corporate bond issuance has jumped to more than twice its pre-crisis level (Exhibit 28). This opens up a new and stable channel o nancing or
the largest companies (see Box 5, “The opportunity in corporate bond markets”).
37 See the appendix or details o our regression analysis.
38 Three elements are under discussion in establishing a banking union in the Eurozone: common
supervision o banks, common deposit insurance, and common authority or resolving ailing
banks. The European Central Bank is expected to assume supervisory responsibility or the
largest banks in the Eurozone in 2014.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
Structural and regulatory reorms would be needed to unleash this potential growth in corporate
bond markets. For many countries, this will be a long evolutionary journey. But South Korea’s
development o a corporate bond market a ter the 1997 crisis, or instance, shows thatsignicant progress can be achieved more quickly. The basic requirements o such a market are
well-known, including establishment o a yield curve, widespread credit ratings o companies,
sucient demand rom institutional investors, and the right regulatory ramework to enable a
private placement market (key to the high-yield bond market). Establishing a corporate bond
market may also be more easible where a country already has a developed equity market,
since corporations that list on stock markets already meet nancial disclosure standards.
eiit 29
More than 80 percent of corporate bond issues are from companies withover $500 million in annual revenue
1 Size measured by 2011 revenue; revenue figures not available for 523 of 2,816 issuers, which are excluded from the firm sizecount; 99 subsidiaries of larger companies excluded from data.
SOURCE: Dealogic; McKinsey Global Institute analysis
10 667 17
79 192
<156
40
10
18 2,66742
3,10235
Cumulative corporate bond issuance, 2006–11%; number of issuesBy firm size1 By issue size
Investmentgrade
High yield
UnitedStates
WesternEurope
2011 revenue ($) Size of issue ($)
17
10
843 32
50 401
60
47
15
23 50130
1,98926UnitedStates
WesternEurope
Over 2 billion
500 million–2 billion
100 million–500 million
Under 100 million
Over 500 million
100 million–500 million
Under 100 million
eiit 30
Developed economies have room to further developcorporate bond markets
SOURCE: Capital IQ; McKinsey Financial Assets Database; Dealogic; McKinsey Global Institute analysis
1 Includes short-term and long-term loans and leases.2 Measured as difference between current bond share and 60% to 80% bond share.
Developing nations have signicant room to deepen their nancial systems, and
this scenario sees them making solid progress. Our database o global nancial
assets shows that equity market capitalization is only 44 percent o GDP in
emerging economies,39 while bonds o non-nancial corporations make up
4 percent o debt nancing on average, and the value o securitized loans is lessthan .5 percent o GDP. Credit to households and debt o corporations is only
76 percent o GDP in emerging markets compared with 146 percent o GDP in
advanced economies, indicating a great deal o room to increase credit to this
sector. Past McKinsey research has estimated that SMEs in emerging markets
ace at least a $2 trillion credit gap.40
There is also tremendous scope or providing ormal banking ser vices to the
currently 2.5 billion “unbanked” people around the world. Greater nancial
inclusion would help many o the world’s poorest households access a ordable
credit, accumulate savings, and improve their living standards, while accelerating
nancial deepening.41
In this scenario, we assume that by 2030, developing countries reach South
Korea’s current nancial depth. This refects the time needed to build the right
ramework and cultivate a domestic base o institutional investors to spur
demand. I that progress is achieved, the average nancial depth o these
countries would increase rom 157 percent o GDP today to 237 percent o GDP
by 2020. This translates into growth o nancial assets rom $43 trillion as o mid-
2012 to more than $125 trillion by 2020—representing signicant opportunities or
banks, investors, and other nancial intermediaries around the world.42
While cross-border lending is unlikely to return to the heady peaks seen beore
the crisis, this scenario would see modest growth rom today’s levels. But instead
o reopening the foodgates o volatile short-term lending and interbank lending,
portolio fows o equity and bond purchases and FDI could become larger
components o international capital fows. As global investors pursue higher
growth and greater diversication, these infows into emerging markets could
rise sharply. Deeper, more liquid markets would not only attract this investment
but would also reduce the associated risk. This scenario could see nancial
globalization and nancial deepening working together in a virtuous cycle, with
more sustainable capital fows that enhance the eciency, liquidity, and stability
o a country’s nancial system.
As large corporations seek to tap into the world’s astest-growing consumermarkets and access cheaper sourcing or their supply chains, FDI continues to
increase in this scenario. Corporations across advanced economies currently
have large cash reserves, and they may assume an even greater role in the years
ahead as providers o capital, especiall y within their own supply chains. This
would reduce volatility in cross-border fows, as FDI is typically part o a multiyear
39 This considers only publicly traded shares.
40 Two trillion and counting, McKinsey & Company and the International Finance Corporation,
October 2010.
41 Alberto Chaia, Tony Goland, and Robert Schi, “Counting the world’s unbanked,” TheMcKinsey Quarterly , May 2010.
42 We created several scenarios or emerging market nancial asset growth, based on dierent
assumptions regarding GDP growth rates and exchange rate movements. See also The
emerging equity gap: Growth and stability in the new investor landscape, McKinsey Global
Institute, December 2011.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
growth strategy. I annual FDI infows were to remain at 3 percent o GDP or
developed economies and continue the post-crisis growth trend o 2009–11 in
emerging economies, the global total o FDI infows would rise rom $2.0 trillion in
2011 to $4.8 trillion in 2020.
Portolio investments in oreign equities and bonds could also continue to grow.
Today, oreign investors own 30 percent o the world’s equities and bonds, but
that share varies across countries (Exhibit 31). Developing countries collectively
account or 38 percent o global GDP but, as noted in Chapter 2, are recipients
o less than 7 percent o the globa l stock o oreign investment in equities and
bonds. Institutional investors around the world could change this dynamic, but
their ability to do so depends on whether restrictions are eased on the geographic
composition o pension and insurance por tolios. Cross-border fows could also
accelerate i more vehicles are created to help retail investors diversiy globally.
eiit 31As of 2011, 30 percent of global financial assets
were owned by foreign investors
SOURCE: McKinsey Global Institute Financial Assets Database; IMF Balance of Payments; McKinsey Global Institute analysis
Equity and debt securities by ownership, 20111
%; $ trillion, 2011 constant exchange rates
1 Includes market capitalization of listed equities and governments, financial, and non-financial corporate debt securities.2 Securities held by foreign entities.3 Central and Eastern Europe and the Commonwealth of Independent States.
Global total By region
18
2923 23
17 148
47
7177 77
83 8692
Other devel-oped
10.8
MiddleEast andAfrica
3.8
CEE andCIS3
26.7
NorthAmerica
5.1
WesternEurope
53.5
EmergingAsia
2.6
LatinAmerica
42.9
35
11
2228 30
89
7872 70
2011
145.5
2007
142.8
2000
80.3
1990
31.5
Intra-Europe
Foreign2
Domestic
This al ternative scenario results in a system that provides nancing or innovation
and investment without sacricing saety—i policy makers can balance these two
goals. Without the proper regulatory ramework in place, a return to rapid growth
in nancial assets and cross-border capital fows leaves the world vulnerable to
the risk o yet another crisis—and all the collateral damage that would entail.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
way. Some banks are narrowing their ocus to business lines in which they
have a competitive advantage, while selling or reducing their presence in
non-core businesses. Others are adopting a more regional strategy, ocused
on building scale and shared back-oce operations in specic regions while
closing ar-fung branches. Overall, we expect to see more diversity in thebusiness strategies pursued by the world’s largest banks.
Foreign operations need to become more local, less global. The “sudden
stop” problems associated with oreign lending—and particularly the risks
o oreign “suitcase” lending—have become clear to recipient countries.
Responding to the vulnerabilities revealed by the nancial crisis and the euro
crisis, national regulators in some countries are moving to contain risk by
raising capital requirements and exerting more control over the oreign banks
that operate within their jurisdictions. Banks operating in oreign markets will
have to be prepared to engage more deeply with local regulators and policy
makers, and will need to build much stronger ties to the local market than mayhave been required in the past. Raising deposits and other unding locally will
be advantageous whether operating a oreign branch or subsidiary.
Expand where others are in retreat. Some regional and national banks
outside o Europe are well-positioned to capture market share where big
global banks are exiting. This could be a transormational opportunity or
new players to expand in their home markets and even sustain healthy cross-
border regional lending. In Asia, or instance, smaller banks rom the region—
and large ones rom Japan—have stepped in to ll the gap in trade nance
ormerly provided by European banks. ANZ (Australia and New Zealand
Banking Group) has undertaken nine acquisitions in recent years, including
purchasing the Taiwanese bank operations o RBS and the Australian
investment operations o ING. Since 2009, TD (Toronto-Dominion) Bank has
undertaken 17 nancial-sector acquisitions, including the banking operations
o three ailed Florida-based banks (in a deal assisted by the Federal
Deposit Insurance Corporation), and the lending arm o Chrysler. In the next
ew years, expect to see signicant movement in the banking league tables in
many regions.
Mind the gaps. Some types o borrowers—or example, SMEs or
inrastructure projects—ace unding shortages in the new landscape. Banks
can make use o their corporate relationships and underwriting skills to play
a acilitation role. For instance, some banks may be well-positioned to match
up institutional investors with borrowers that need long-term equity or debt
unding, or to arrange syndicated loan deals on behal o large institutional
investors. This broker role could prove critical, as many large institutional
investors are seeking ways to earn a premium or providing patient capital but
lack the skills to source deals d irectly, evaluate risks, and negotiate prices (see
below). Banks may also have an opportunity to partner with governments in
creating dedicated public-private lending institutions, with public subsidies or
particular types o lending. In addition, there is enormous potential growth in
corporate bond markets, although this avenue may require new operational
models and cost structures. Finally, banks can harness the furry o interest in
new peer-to-peer web por tals or both lending and equity raising, ocusing on
models such as aggregating and selling business invoices or providing SMEs
with working capital. Expanding the range o services oered would allow
banks to grow their customer base.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
Institutional investors ace new challenges in earning returns in this new era. They
will need new strategies to navigate uncertain, volatile nancial markets amid
subpar economic growth. At least our elements merit consideration.
Go direct in emerging markets. With slower growth becoming the norm in
advanced economies in recent years, emerging markets will produce more
than 70 percent o global GDP growth through 2025.47 Gaining exposure to
this supercharged growth and achieving greater geographic diversication
is essential or investors, but there is no clear-cut ormula or capturing this
opportunity. The shallow, illiquid nancial markets in emerging economies will
remain a barrier to oreign institutional investors. Providing direct equity—or
debt—unding to emerging-market companies can circumvent this problem.
Private equity unds are one way to invest directly in emerging markets—
and providing promising companies with expertise in addition to capital cantake their growth to the next level. The share o private equity capital raised
or unds that target investments in emerging markets has grown steadily,
rising rom just 5 percent in 2000 to 15 percent in 2010. Many expect this
gure to grow much larger. The largest institutional investors may also
have opportunities to invest directly in companies. For instance, a group o
sovereign wealth unds has joined one o Canada’s largest pensions to invest
nearly $2 billion in Brazil’s largest investment bank. Although pursuing direct
deals will require signicant new skills and organizational structures, some are
going this route. Banks could play a valuable role in brokering such deals.
Transorm research capabilities to spot opportunities. The term emerging market is almost meaningless today, given the wide range o countries with
diverse macroeconomic and political situations it encompasses. There are
many attractive opportunities beyond the BRICs. But identiying the countries
and sectors in which to invest adds up to a daunting research task—and
most large institutional investors have not invested enough in developing this
capability. The models that work or analyzing companies and risk in advanced
economies will have to be reconsidered. A local presence may be required to
develop a sophisticated understanding o business norms and an appreciation
o the risks. Local partners can identiy oppor tunities and help gain access to
deal fow.
Find new sources o alpha in advanced economies. Given the lower growth
outlook in advanced economies, institutional investors will not be able to rely
on market momentum (or beta) or growth. They will need to identiy new
sources o alpha, or returns uncorrelated to the broad market movements.
Identiying these sources will require careul analysis and a consideration o
each institution’s capabilities. For investors with strong quantitative skills,
market-neutral strategies that hedge a variety o long and shor t positions
might be attractive. Others may cultivate superior inormation and insights into
specic sectors that enable identication o underpriced companies or uture
growth opportunities. Building these skills will be a ormidable task and require
major investment.
47 Winning the $30 trillion decathlon, McKinsey & Company, August 2012.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
These technical notes provide more detail on some o the deni tions andmethodologies employed in this repor t. We address the ollowing points:
1. Denition o nancial assets
2. Country classications
3. Financial deepening by sector
4. Correlations between nancing to the household and corporate sectors and
economic growth
5. Denitions o cross-border investments and capital fows
6. Volatility o cross-border capital fows
1. defInITIon of fInancIal asseTs
Our denition o nancial assets includes securitized and non-securitized loans,
corporate and government bonds as well as other xed-income debt securities,
and the equity market capitalization o listed companies. We exclude cash,
nancial derivatives, and deposits, as well as physical assets such as real estate
and gold. We also exclude the equity in privately held companies. We take theview o unds raised by households, corporations, and governments, regardless
o the nationality o the holder o the asset. For instance, our measure o US
corporate bonds captures bonds issued by US-resident companies, not the value
o corporate bonds owned by US investors. Full denitions, including our method
o valuing these assets, are listed below:
Non-securitized loans: The ace value o on-balance-sheet loans by banks
and other nancial institutions to households, non-nancial corporations, and,
in some cases, governments. Non-securitized loans include both shor t-term
and long-term loans. We exclude interbank lending, as we consider this a
unction o intermediation.
Asset-backed securi ties: Loans moved o balance sheet by banks,
packaged into outstanding mortgage- or asset-backed securities. We report
the ace value o these securities.
Corporate bonds: Short- and long-term bonds issued by non-nancial
corporations, including commercial paper. We value bonds at their book or
ace value and include all bonds issued in local and oreign currencies.
Financial bonds: Short- and long-term bonds issued by banks and other
nancial institutions. We value bonds at their book or ace value, and include
all bonds issued in local and oreign currencies. In addition to bonds, we
include other nancial debt securities such as mortgage-backed securities or
asset-backed securities at their market value.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
In Chapter 1 we discuss the correlation between nancing provided to
households and non-nancial corporations and GDP growth. The simple bivariatecorrelations shown in Exhibit A5 demonstrate a positive relationship between the
two variables: the change in nancing to this sector (relative to GDP) in one period
is positively correlated with aster GDP growth in the next period. This relationship
holds or advanced economies and emerging markets, although the impact
o additional nancing on GDP growth is much higher in emerging markets. In
emerging markets, every 10 percentage point increase in nancing or households
and corporations raises GDP growth by 2.3 percentage points, compared with
0.7 or the United States or 0.9 or Western Europe.
eiit a5
The decline in financial depth matters:GDP growth is correlated with private-sector financing
X axis: Household and corporate debt and equity as a share of GDP annual change (t-1)
Y axis: Nominal GDP growth (t) (%)
1 Emerging markets excluding China shows correlation of 0.66 and a slope of 0.20.
NOTE: Not to scale.
SOURCE: McKinsey Global Institute Financial Assets Database; McKinsey Global Institute analysis
-4
-2
0
2
4
6
302520151050-5-10-15-20-25-30-35-40
0
5
10
15
20
302520151050-5-10-15-20-25-30-35-40
-4
-2
0
2
4
6
8
-50 -40 -30 -20 -10 0 10 20 30 40
-4
-2
0
2
4
6
-30 -25 -20 -15 -10 -5 0 5 10 15 20 25 30
World United States
Western EuropeEmerging markets
1
0.64
0.09
0.83
0.13
0.81
0.23
0.70
0.07
Correlation
Slope of regression line
We urther test this relationship by using multivariate regression analysis tocontrol or other variables that may explain real GDP growth. These include
population growth, human capital development, political and macroeconomic
stability, government spending, and the openness o an economy to trade. We
also allow or a non-linear relationship between nancing or the real economy
and GDP growth by introducing a quadratic term on nancing to households
and corporations. The model is estimated using panel data or 112 countries
using annual observations rom 1990 to 2011. We use xed eects to allow or
a country-specic error term component. Exhibit A6 shows the dependent and
independent variables used in our regression analysis.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
Working-age population growth (% change) Positive Positive Yes
Human capital (% change) Positive Positive Yes
Political and macroeconomic stability index Positive Positive Yes
Government spending Ambiguous Negative Yes
Openness of an economy to trade Positive Positive Yes
Dependent
variableAnnual growth rate for real GDP
Dependent and independent variables used in
regression analysis
Independent
variables
SOURCE: McKinsey Global Institute analysis
Primary variablesof interest
Expected
sign of
coefficient
Estimated
sign of
coefficient
Statistically
significant?
(99% level)
All variables measured by country, 1990–2011
The multivariate regression with a quadratic orm model we use is:
∆RGDP(t,t-1)
= K0
+ K1FDRE
t-1+ K
2FDRE
t-12 + CV
t,t-1+ u
i,t
ui,t
= v i,t
+ μ i
The denit ion o each var iable is as ol lows:49
K 0
is a constant term.
∆RGDP(t,t-1)
is the real GDP growth rate between years t-1 and t, expressed in
percentage points.
FDRE t-1
is the nancing to households and non-nancial corporations
relative to GDP at year t-1 (i.e., lagged or one year). This is expressed in
percentage points.
FDRE t-1
2 is the quadratic component o nancing to households and
non-nancial corporations. This variable allows or a nonlinear relationship
between nancing and growth. In particular, i the benets diminish as
households and non-nancial companies accumulate more debt, then the sign
on this coecient would be negative.
49 The data sources are as ollows: RGDP variable = International Monetary Fund, McKinseyGlobal Growth Model; FDRE = McKinsey Global Insti tute Financial Assets Database; POP =
World Development Indicators, International Labour Organisation; HCAP = McKinsey Global
Growth Model; GS = World Development Indicators, McKinsey Global Growth Model; PR =
Political Risk Services (PRS) Group; TR = World Development Indicators, McKinsey Global
Growth Model.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
is the growth o the working-age population, dened as people
within the 15-64 age range. We express this variable in percent.
— ∆HCAPt,t-1
captures improvements in the human capital o a country.
Human capital is dened as employed population multiplied by
average years o education. We then calculate its improvements with the
growth rate between the years t-1 and t in percentage points.
— GStis the government spending in year t. We express this variable as
percentage o the country GDP in the same year.
— PRtis the political and macroeconomic risk index at year t measured. This
variable is an index developed by the Political Risk Services (PRS) Group
with a range o 0 to 1, where a higher value indicates less risk. It measures
political risk by ollowing 17 risk components that capture turmoil,
investment restrictions, restrictions on oreign trade, domestic economic
problems, and international economic problems.
— Finally, TRtrefects the openness to trade o a country at year t. It is
calculated as the sum o imports and exports, expressed as percentage
o GDP.
The error term u i,t
consists o two parts: the random error (v i,t
), and the individual
eect, or time invariant eect ( μ i ).
This model per orms very wel l in explaining the real GDP growth o a country,
and the amount o nancing to households and corporations is a signicant
explanatory variable. We also nd a diminishing benet to nancing over time, as
shown by the negative (although very small) coecient on the quadratic term.
The estimated coec ients are shown in Exhibit A7. The basic model, shown in the
let column, shows a positive relationship between the level o nancing to the real
economy and the country’s GDP growth rate. On average, a 10 percentage point
increase in nancing is associated with 0.12 percentage point aster real GDP
growth. The negative sign in the quadratic term indicates that the relationship
eventually becomes negative, although that turning point comes only when
nancing o corporations and households reaches 300 percent o GDP—higher
than observed in most countries in our sample. Finally, we test the robustness
o this model in two ways. First, we perorm orward stepwise estimation o the
coecients and nd that the linear and quadratic term coecients are signicant
in all specications. Second, we test the model or the independent variable GDP
per worker and obtain similar results.
These results are generally similar to that o previous academic research. (For
instance, see the papers by Levine, 2005; Cechet ti and Kharroubi, 2012; andBeck et al., 2009.) Our analysis adds to this literature in that we use a larger
sample size o countries and a more precise metric or nancing or households
and corporations. Much o the previous work relies on a metric o private-sector
debt provided by the World Bank in the World Economic Indicators, but this
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
The term cross-border investments as used in this report includes oreign
nancial assets and liab ilities. It excludes real estate and other physical assets.
Foreign nancial assets are oreign-issued nancial assets owned by the
households, companies, or government o the country. The ve types o oreignnancial assets correspond to capi tal outfows, as dened above. They are FDI,
equity securities, debt securities, loans and deposits, and oreign exchange
reserve assets owned by a country’s central bank or other monetary authority.
Foreign nancial liabilities are nancial assets that are issued by a country and
owned by oreign investors. The our types o oreign liabilities are the same as the
capital infows dened above: FDI, equity securities, debt securities, and lending/
deposits. Exhibit A9 shows total global oreign nancial assets rom 1990 to 2011.
eiit a9
The stock of global foreign investment assets reached $101 trillion in 2011
07
6
19
75
06
15
05
60
20
13
11
12
4
2000
31
11
56
72
95
18
832
3 1
1990
11
6
16
25
09
85
14
23
93
08
7
29
20
10
17
31
20
6
1 12
1
5
14
17
94
19
32 Loans1
Bonds
Equity
FDI
Foreignreserves
2011
101
32
20
14
26
9
10
99
31
20
8
16
24
Compound annualgrowth rate%
Global foreign investment assets$ trillion, end of period, nominal exchange rates
20.8
16.0
15.6
16.4
19.4
17.0
SOURCE: IMF Balance of Payments; McKinsey Global Institute analysis
9.9
7.5
-4.2
-0.2
1.4
2.0
1 Includes primarily loans, currency and deposits, as well as a small share of trade credit.NOTE: Excludes assets from offshore financial centers. Numbers may not sum due to rounding.
2000–07 2007–11
55 67 101 131 142 153 139 148 149 145
As % of GDP
bit itmt tt
We have also built a database o bilateral investment relationships that showsthe cross-border investments between individual pa irs o countries and regions.
It contains data on the oreign assets owned by investors in more than 140
countries and includes investments across more than 200 countries and
territories. The assets tracked include equity securities, debt securities, FDI,
and loans and deposits. This database shows the investments o country A in
country B and the investment assets o country B in country A. We built this
database based on data rom the IMF’s balance o payments, the Bank or
International Settlements, the IMF’s Coordinated Portolio Investment Survey,
the IMF’s Coordinated Direct Investment Survey, the OECD, national sources,
and the Heritage Foundation’s China Global Investment Tracker. We identiy
oshore nancial centers in our bilateral investment relationships database assmall economies with large infows and outfows o capitals. These include Aruba,
as the coverage o counterparties expands to more than 200 countries and
territories, essentially covering the entire world. The BIS consolidated statistic
thereore contains detailed and comprehensive inormation on the global reach
o banks in advanced economies.
6. volaTIlITy of cross-border capITal flows
In Chapter 2 we analyze the volatility o cross-border capital fows. We nd that
oreign direct investment, equities, and bonds are more stable than oreign
lending, and especia lly cross-border lending. This relationship holds or both
emerging and advanced economies.
We relied on bank claims data rom the BIS and on FDI, bond, and equity data
rom the IMF’s Balance o Payments statistics. For FDI and portolio debt and
equity, we used quar terly data on inward capital fows rom 2000 to 2011 or 28developed countries and 120 emerging countries. The BIS data report oreign
bank claims as stocks rather than fows, so we estimate fows by taking the
dierence in claims rom the perspective o the borrower; these data are available
or more than 200 countries.
To measure volatil ity, we calculate the coecient o variation, dened as the
sample standard deviation divided by the sample mean. This coecient is widely
used in the academic literature because it allows or comparison across samples
with dierent means, as is the case with capital fows o dierent asset classes. In
the analysis shown in the chapter, we sum together all capital fows to emerging
markets and those to advanced economies separately, and calculate the standarddeviation and mean or each series using quarterly data.
Our analysis, discussed in Chapter 2, shows that FDI is the least volatile type
o capital or both emerging markets and developed countries, while short-term
bank claims are the most volatile. Furthermore, when we look at capital fows
reversals (fows turning rom positive to negative) and surges (fows increasing by
at least two standard deviations), we conrm that bank claims show the largest
requency o all reversals and surges (Exhibit A11).
We nd that cross-border lending is also the most volatile type o fow when
we look at individua l countries. Exhibit A12 shows the results or three sample
countries: South Korea, Brazil, and South Arica. In all three, cross-border lending
fows are signicantly more volatile than other cap ital fows. There are exceptions,
however. India, or example, is a noticeable exception, as it shows a higher
coecient o variation or bond fows than bank lending fows (5.3 vs. 1.2) since
2009. These results are consistent with the academic literature, which nds that
cross-border bank lending is the most volatile t ype o fow.50
50 See, or instance, Forbes, Debt- and equity-led capital fow episodes, August 2012.
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?
Bank flows have more episodes of capital reversal and surges
than other asset classes
Events of capital flow reversals and surges, by type of asset
Number of instances based on quarterly data, 2000–11
1 Defined as an inflow that is at least two standard deviations higher than the average quarterly inflows five years leading to
the surge.2 Bank net acquisition of cross-border loans (~80%) and other debt assets (~20%) in emerging and developed economies.NOTE: Sample includes 29 developed markets and 120 emerging markets.
SOURCE: Bank for International Settlements; International Monetary Fund; McKinsey Global Institute analysis
188
416304
444
Bank claims
account for
49 percent of
capital
reversal
episodes in
2000–11, and
29 percent of
capital surges
1198411470
287
765
1,043
2,405
516221239
454
Emerging
Developed
Reversal Surge1
FDI
Equity
Bonds
Bank claims2
eiit a12
Bank claims are the most volatile type of cross-border
flow for selected countriesCross-border capital inflows to select countries, by type of asset
$ billion, nominal exchange rates
SOURCE: Bank for International Settlements; International Monetary Fund; McKinsey Global Institute analysis
1 Foreign bank net acquisition of cross-border loans and other debt assets in select countries.2 Calculated on the quarterly inflow to South Korea, Brazil, and South Africa.NOTE: Not to scale.
-80
-60
-40
-20
0
20
40
4Q114Q104Q094Q084Q07
-60
-40
-20
0
20
40
60
4Q114Q104Q094Q084Q07
-15
-10
-5
0
5
10
15
4Q07 4Q08 4Q09 4Q10 4Q11
South Korea Brazil
South AfricaCoefficient of variation, 4Q07–4Q112
0.43
2.84
1.11
4.56
Bonds
Equity
FDI
Bank claims1
7/29/2019 McKinsey Global Institute Financial globalization: Retreat or reset?