Financial integration and the Great Leveraging

This paper studies the joint dynamics of international capital flows and domestic credit and money growth. It finds a strong statistical relationship between cross‐border flows and the decoupling of these two variables—the Great Leveraging—a stylized fact documented for several economies in the past decades, due to faster credit than money growth, and associated with the expansion of banks nonmonetary liabilities. Results indicate that, in addition to the equity/debt breakdown, it is important to split capital flows according to the domestic recipient sectors: banking sector flows display, in general, a stronger correlation with the growth of credit and with its excess growth over money. Furthermore, the country's FX regime also plays a role, as money holdings tend to be less responsive to cross‐border capital flows in fixed FX regimes. In broad terms, this approach sheds light on the mechanisms through which the international banking activity might have consequences for the composition of the domestic aggregate bank balance sheet.