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Use of Capital Controls in the Banking Industry Assignment Help

Critically evaluate the case for and against the use of capital controls in the banking industry.

Your critical evaluation should be based on relevant theories and evidence that you have reviewed. Where appropriate, your arguments and justification should be supported using examples and illustrations.

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The primary aim of the paper is to critically analyze the use of capital controls for the banking industry. Capital controls are considered to be the residency-based measures that regulate governmental regulations. These are created to manage the financial flows into the country's capital account from capital markets. Government monetary policy possesses the ability to provide capital controls. However, the paper will provide relevant information regarding the benefit and pitfalls of using capital controls by the banking industry. It will discuss these aspects by using different examples of banks across the world.

Critical analysis

For the use of capital controls in the banking industry

Capital Controls are determined to be the measures adopted by either the central bank or government of an economy to manage the inflow and outflow of foreign capital within a country. The measures taken by the banking industry may be in the form of outright legislation, volume restrictions, tariffs and taxes. Most of the banking industry across the world makes efficient use of capital controls for protecting foreigners from buying domestic assets or restricting the use of foreign assets by domestic citizens. It is beneficial as it plays a significant role in the development of developing countries (Huang & Xiong, 2015). However, the outflow and inflow of foreign capital are considered to be a major factor of globalization. It also helps in providing stability and support by shifting it from intense fluctuations and decreasing the volatility of currency rates in a country. It can be said that when the restrictions are faced by domestic citizens, it is called as capital outflow control, whereas when the restrictions are faced by international citizens, it is known as capital inflow controls. Moreover, it can be seen that in the developing countries, the controls of the banking industry are stricter because of volatility and vulnerability of the capital reserves that are less in comparison with those sustained by developed nations (Burks, Cuny, Gerakos & Granja, 2018).

According to economic theory, the liberalization of capital control is determined to be beneficial for the banking industry across the world. It states the fact that liberalizing the global capital flows of the banking industry would benefit by gaining access to investment and cheaper credit from stability, promoting growth and developed markets (Palvia, Vähämaa & Vähämaa, 2015). As per the law of variable proportions, the actual return on capital would be greater in the industrialized nations where capital is considerably more uncommon than the poorer countries that possess less capital per employee. As a result, capital controls process to be beneficial as the new capital increases the availability of credits along with credit markets.

On the other hand, the standard theory states that capital may flow from countries that possess lower interest rates as compared to the countries with higher interest rates. It also states that within the banking industry with accurate capital mobility, the rate of interest must conjoin together. For instance, there is a difference in the rate of interest among the banks of Taiwan, South Korea and Brazil that is increased eventually after effective controls are created (Chiaramonte & Casu, 2017). Hence, the interest rates among these countries and the United States become less correlated.



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Figure: Monetary autonomy and capital controls: Taiwan

(Source: Mulyaningsih, Daly & Miranti, 2015)

The above figure presents a differentiation in the rate of interest for the United States and Taiwan. Different aspects of capital controls are indicated with arrows and text boxes. It shows that the controls on inflows do not create an impact on the differentials in the interest rate of 2009. While, after reverse needs and currency controls by the end of 2010, there was no similarity (Bremus & Fratzscher, 2015).

For example, Iceland's government implemented capital controls to stabilize and support the economy after the downfall of Iceland's banking system in 2008. However, Kaupthing, Landsbanki and Glitnir are the three major banks in Iceland who carried out assets that were ten times more than the GDP rate of the country (Scafarto, Ricci & Scafarto, 2016). After the implementation of capital controls, the currency exchange for tourist purposes was monitored strictly, and even the investment in foreign assets was unrestrained.

Another example, when the bailout allowance period of Greece ended in 2015, it implemented capital controls. Meanwhile, the European Central Bank refused to expand the Emergency Liquidity Assistance level that was stretched to help Greek banks. Thus, the government of Greece was enforced to stop the commercial bank's operations within the country for 20 days (Allen, Carletti, Goldstein & Leonello, 2015). From Greek banks to foreign banks, the substantial controls were put on bank transferals, and a limit of up to 60 euros was out on cash withdrawals. Currently, the Greek banks have entered into the global market by marketing covered bonds. They have also increased their bank deposits and boosted economic growth to a greater extent.

Against the use of capital controls in the banking industry

Most of the economists argued that the utilization of capital controls is against the working of a free market economy that is unable to gain sustainability. Thus, capital controls result in corruption and evasion for the banking industry to a greater extent. Mostly, the banking industry implements capital controls through illegal channels (Baskaya, Di Giovanni, Kalemli-Özcan, Peydró & Ulu, 2017). More often, the banking industry is supported by the bureaucrats who help them draft the appropriate accounting entry or relevant import invoice that may evade the law. As a result, capital controls are considered to be the wasteful, difficult and long practice related to political factors.

Furthermore, some of the analysts also believe that capital controls are difficult to enforce as it takes an excessive amount of time and the regulator's energy. It is also proved to be disadvantageous for the domestic banking system and investors. Whereas, without implementing capital controls the local banking system and investors may attain better risk-adjusted returns, invest in global markets and extend their portfolio. Absence of capital controls also benefits the banking industry in decreasing the borrowing rates in global markets. It decreases the ability of the banking industry to gain multifaceted benefits such as access to global networks, technology, and so on. Implementing capital controls possess high administrative costs. It does not possess a discretionary policy that may be beneficial for the banking industry (Diallo, 2018). While it may postpone the essential adjustments in policies based on financial globalization. The overall effects of capital control within the banking industry are difficult to measure as it proves to be beneficial for some countries and failure for other countries. Poorly organized rapid economic liberalization can increase the nation's vulnerability for such financial crisis. Thus, capital controls are difficult to manage and must be implemented temporarily to economic policies.

On the other hand, extensive use of capital control increases the cost of the banking system in the form of economic distortions. Such controls create a negative impact on the entire investment profile, such as global credit of a banking system. They also create risks for long-term flows like increasing funds on the global markets and inward foreign direct investment (FDI). For example, recently, the financing of the Greek banking system for oceangoing shipping has sharply reduced with extensive loans of approximately €8.2 billion during mid-2010 (Jha & Cox, 2015). As per the perspective of Bank of Greece, the balance-of-payments data over the shipping inflows are based on bank transactions data. However, since 2015, there has been a significant decrease in bank transaction data due to the implementation of capital controls. This may be improved after the successful removal of capital controls by the banking sector in Greece. The removal of capital controls by the Greek banking system may recover the GDP rate of the country both indirectly and directly.

It can be seen that the implementation of capital controls reduced the shipping receipts because of the loss of confidence level in the domestic banking industry. It has resulted in a shift of the shipping receipts into the global banks (Kostovetsky, 2015). The banking industry also faces challenges related to financing economic growth as it makes limited use of different toolbox. They also deal with the issues of minimizing the greater stock of non-performing loans. As a result, the implementation of capital controls made the banks to depend upon the central banks for financing purposes.


The paper demonstrated an understanding of the utilization of capital controls by the banking sector that helps in managing the inflow and outflow of global capital within developing countries. It has been observed that capital controls may be valid to the entire economy. However, the paper provided a critical analysis for and against the utilization of capital controls. It has been noticed that the implementation of capital controls created a positive influence on the Iceland banking system. Whereas, it has not only created a negative but also a positive impact on the Greek banking system.

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