The UK has a comparative advantage in financial services. But specialisation in this activity brings with it the challenge of the large gross capital flows that are linked to financial services exports.
The modern financial services industry allocates global capital flows through its balance sheets. Crudely speaking, profits correspond to a percentage over the value of flows, especially (volatile) banking flows, as banks arbitrage between assets and liabilities in different countries.
The chart captures this relationship by comparing the assets generated by banking flows (relative to GDP) – a measure of financial openness – with financial services exports (also relative to GDP). Countries which host international financial centres (the green dots in the chart), such as London for the UK (the red dot), are amongst the most open in the world.
Crucially, the chart is not capturing a mechanical effect. In the UK, for example, only one sixth of the statistical estimate for financial services exports is derived indirectly from international investment position statistics. The bulk of it is obtained from surveys conducted with banks. The estimate is also not affected by recent revisions to the UK national accounts.
International financial centres are compensated for providing essential financial services to the rest of the world. But the flipside is the need to absorb and manage the potential risks from volatile capital flows.
Note: Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees.