N°22-74: External Wealth of Nations and Systemic Risk

External imbalances played a pivotal role in the run-up to the global financial crisis, being an important underlying cause of the ensuing turmoil. While current account (flow) imbalances have narrowed in the aftermath of the crisis, net international investment position (stock) imbalances still persist. In this paper, we explore the implications of countries’ net foreign positions on systemic risk. Using a sample composed of 450 banks located in 46 advanced, developing and emerging countries over the period 2000-2020, we document that banks can reduce their systemic risk exposure when the countries where they are incorporated maintain creditor positions vis-à-vis the rest of the world. However, only the equity components of the net international investment positions are responsible for this outcome, whereas debt flows do not contribute significantly. In addition, we find that the heterogeneity across countries is substantial and that only banks located in advanced markets that maintain their creditor positions have the potential to improve their resilience to system-wide shocks. Our findings are relevant for policy makers who seek to improve banks’ resilience to adverse shocks and to maintain financial stability.