The Influence Of Capital Account Openness On Financial Stability

Financial crisis has been put a great influence on the financial stability in the whole world.Nowadays,more and more countries are aware of the importance of the stable financial circumstance to the economic development and establish specialized research institutes to explore the key factors impacting financial stability and then bring up the suggestions and policies.Among all the factors influencing financial stability,capital account openness plays a very essential role here.Capital account openness stands for an important part of financial openness,which can be seen as loosening up of capital flow and foreign direct investment.Compared with developed countries,there are a huge gap between macro-economic foundations and financial system stability for the developing countries.So there are more risks for developing countries to experience capital account openness.While nowadays,with the trend of RMB internationalization and Belt and Road Initiative,we need to open capital account more and more.At the same time,the economic development in China has experienced �New Normal�,more pressure on economic growth,industry transformation and upgrade,and more difficulties with macro leverage control,financial stability has gradually become the important factors to speed up economic growth.Nowadays,we are undergoing the key development and reform stage,so it is a very essential research topic about the impact of capital account openness on financial stability,its transmission mechanism,and relative institutional design.Prior research never focused on the transmission mechanism of capital account openness on financial stability on the perspective of institutional quality and achieved different empirical results respectively.While there are huge differences in the effectiveness of capital account openness between developed countries and less developed countries.Lack of close mathematical analysis and theoretical transmission research,it would lead to insufficient analysis about the factors to affect financial stability.So it is of significant meaningfulness to study the extent of capital account openness and the influence of capital account openness on financial stability and then construct capital account openness optimization design plan on the institutional background to boost financial stability full of Chinese characteristics and to offer some suggestions about preventing systematic risks.So exploring the Influence of capital account openness on financial stability based on Institutional quality perspective has the theoretical and practical meaningfulness respectively.The research could not only develop the transmission mechanism theoretical model but also offer the references about preventing financial crisis.The practical meaningfulness about this paper is to examine the relationship among institutional quality,capital account openness and financial stability and put forward specific and concrete policy suggestions on institution establishment to improve financial stability.This paper first constructs a general equilibrium model theoretically to illustrate the reasons for the differentiated effects of capital account openness on financial stability based on institutional quality and to know better about the transmission mechanism process.In details,we construct a general equilibrium model theoretically including three agents: household,firm and government.Households could consume at different time and invest in domestic or foreign bonds.Firms can be divided into middle suppliers and final suppliers to pursue cost minimization and profit maximization with the financial support from domestic financing and foreign direct investment.The aim of the government is to achieve financial stability,which is representative of government bond interest ratio and government bond price respectively.We can use political stability as the institutional quality substitute indicator.The equilibrium of market is determined by the relationship between demand and supply.The logic of the economic system is: government is responsible for the institution establishment of capital account openness,which influences foreign direct investment and capital flow,which influence the behaviors of households and firms,and eventually financial stability.Based on the above logic,we will analyze the transmission mechanism theory in details and offer the theoretical support for the follow-up research.Secondly,the paper focuses on the thresholds effectiveness of institutional quality on the influence of capital account openness and financial stability.It is divided into three parts.The first part is to explore the thresholds effectiveness of institutional quality;the second part is to choose the indicators and set up the model;the third part is to bring in the panel threshold model to explore the institution characteristics,the thresholds measurement,and then the thresholds effectiveness.Then,based on the World Bank Worldwide Governance Indicator(WGI)and IMF Financial Soundness Indicator(FSI),empirical evidence contributes to this literature by employing panel thresholds model and a unique data set of 1.21 million data collected from 214 countries during the period from 1996 to 2017,which is consistent with our theoretical predictions.The main results show that institutional quality is the essential threshold elements about capital account openness facilitating financial stability.Under the threshold,capital account openness will impose on negative influence;while above the threshold,capital account openness is good for foreign savings inflow to improve domestic financial stability.Moreover,it is a long-standing process to raise institutional quality.So the government should take responsibility about the initial conditions and assess the financial openness environment to facilitate the institutional quality and relieve the financial risks.Thirdly,based on the statistical model with interaction terms and institutional quality elements we study the impact of capital account openness and institutional quality on financial stability.We try to study the long-term influence of non-economic institution on financial stability.Based on economic equilibrium and a unique big data set of 1.21 million data collected from more than 200 countries from World Bank Worldwide Governance Indicator(WGI)and IMF Financial Soundness Indicator(FSI)during the period from 1996 to 2017,we try to explore the reasons about the influence of capital account openness on financial stability from the perspective of institutional quality respectively,such as regulatory quality,rule of law,control of corruption,voice and accountability,political stability and absence of violence,government effectiveness according to developed countries and less developed countries.Our primary results are as follows.On one thing,we should pay more attention to the institution establishment during the process of capital account openness to create a stable institutional environment.On the other hand,capital account openness would bring out different shocking effect because of different economic foundation.Last,non-economic institution establishment is a long-term systematic engineering,which cannot be achieved at a short time.We should try our best to construct a systematically complete,scientifically regulatory and effectively operating institutional system to maintain financial safety and prevent financial risks.Finally,based on technical results we extract some policy suggestions for the government authorities to promote financial stability.Therefore,our research would improve the theoretical model of the transmission mechanism of capital account openness on financial stability and offer theoretical support for capital account openness institution system to boost financial stability.Research of the effect of capital account openness on financial stability on the perspective of institutional quality contributes a lot to construct a systematically complete,scientifically regulatory and effectively operating institutional system to maintain financial safety and prevent financial risks.Based on our national conditions,we bring up the suggestions about the influence of capital account openness on financial stability in institutional quality perspective,such as regulatory quality,rule of law,control of corruption,voice and accountability,political stability and absence of violence,government effectiveness.In details,as for regulatory quality,we should establish macro�prudential regulatory mechanism and crisis prediction and management mechanism respectively.Then we should reinforce financial regulation diversification and improve savings insurance institutions.We still need to promote international policy coordination and regulation cooperation.On the other hand,as for rule of law,we are supposed to establish specific laws related with financial institutions,improve financial regulation laws and impel property protection laws individually.As far as control of corruption been concerned,we should establish anti-corruption incentive scheme within financial industry.At the same time we should set up stable and competitive reform plan in banking industry to lower bad loan ratios and improve foreign direct investment structure and development environment.Besides this,we still need to keep the industry upgrading optimization to maintain reasonable surplus in current account.Then,we should confront all kinds of shocks actively,for example,high inflation etc.We still need to pay more attention to financial products and service of private sectors in banks and more communication with private sectors to promote financial development and maintain financial stability.Based on our research we recommend the government should propose some ways forward to construct a systematically complete,scientifically regulatory and effectively operating institutional system to maintain financial stability and financial safety.