Volatility almost doubled in the three years post-global financial crisis compared to the three years preceding the crisis. [3] Volatility has since remained elevated. Third, large and volatile capital flows can create some serious trouble for EMEs. What flows in can flow out as easily, and such reversals can be disruptive for EME financial markets which are typically not deep enough to smoothly intermediate the flows. Capital flows can induce exchange rate fluctuations that are disconnected from macroeconomic fundamentals. There is growing empirical evidence that capital flows to EMEs have grown in importance as a driver of exchange rate movements. [4] In particular, capital flows can cause cyclical deviations to exchange rates beyond movements driven by the current account of the balance of payments. In the face of large and volatile capital flows, a freely floating exchange rate can become a shock amplifier rather than a shock absorber. [5] Capital flows can trigger financial stresses or exacerbate domestic financial vulnerabilities. Strong capital inflows risk fuelling domestic credit and asset price bubbles, heightening risks to macro-financial stability in EMEs. A recent MAS study found that a 1% appreciation of the US Dollar is associated with net capital outflows of 0.3% of GDP for EMEs in the following quarter. [6] Fourth, large and volatile capital flows are here to stay. Ageing populations and slower productivity growth in the advanced economies suggest that the natural rate of interest, r-star, is likely to remain low, making the search for yield and resultant capital flows persistent rather than episodic.

Higher provisioning and, especially, the non-recurring adjustment to goodwill, both as a result of the expected downturn in economic conditions on account of the pandemic, were the main causes of lower profits. The losses were concentrated at the two banks with the largest international presence but profits decreased by two thirds at the other banks. In any event, banks’ recurring business has only been affected modestly to date and this is being offset partly by an adjustment to operating expenses and, consequently, they continue to gain in efficiency. 11  Therefore, the price-to-book (P/B) ratio — which compares listed banks’ market capitalisation and their book value — contracted notably in Spain, as in other European countries, by declining to levels of around 0.4, although it subsequently recovered somewhat. 12  One way of illustrating the risks to financial stability posed by the current episode is through simulation exercises which assess prospectively banks’ resilience to adverse macroeconomic scenarios. Accordingly, the ECB conducted a so-called “vulnerability” analysis – to underline their limitations compared with the usual stress tests – in order to measure European banks’ resilience to the strains triggered by the coronavirus. The results published last July show some of the risks identified.7 Specifically, based on these results, the euro area banking sector overall is positioned to withstand pandemic-induced stress, although the reduction in banks’ solvency under the most adverse macroeconomic scenarios would be significant. Furthermore, the results of this exercise show significant heterogeneity across banks.