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Kenan Institute 2024 Grand Challenge: Business Resilience
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Market-Based Solutions to Vital Economic Issues
Research
Sep 28, 2022

Global Risk, Non-Bank Financial Intermediation, and Emerging Market Vulnerabilities

Abstract

The unprecedented increase in non-bank financial intermediation, particularly open-end mutual funds and ETFs, over the last two decades, accounts for nearly half of external financing flows to emerging markets exceeding cross-border lending by global banks. Evidence suggests that investment fund flows enhance risk-sharing across borders and provide emerging markets with access to more diverse forms of financing. However, a growing body of evidence also suggests that investment funds are inherently more vulnerable to liquidity and redemption risks during periods of global financial market stress, increasing the volatility of capital flows to emerging markets. Benchmark-driven investments, namely passive funds, appear particularly sensitive to global risk shocks such as tightening US dollar funding conditions relative to their active fund counterparts. The procyclicality of investment fund flows to emerging markets during times of global stress poses financial stability concerns with implications for the role of macroprudential policy.

Note: Research papers posted on SSRN, including any findings, may differ from the final version chosen for publication in academic journals.  


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