Open capital account needs to have a closure lever to reduce import and transmission of financial instability

Abstract

In modern capital markets such as the options, futures, and stock market, capital moves at lightning speed across borders and jurisdiction, making the global financial system vulnerable to contagion. The root cause of this systemic and transmissible vulnerability is the existence of highly open capital account in many markets. More importantly, such open nature of capital account is poorly regulated, thereby, allowing huge sums of money to move across borders, digitally, and at fast speeds. Such open capital accounts manifest in two ways in the modern interconnected global financial system. First, advent of online and mobile devices trading apps allows cross border trading of stocks with fewer regulations on movement of foreign capital, and daily trading limit. Second, there is lax control on maximum amount of funds that can be moved for investment purposes in some countries. Existence of such light regulation meant that funds can move in or withdrawn at short notice, thereby, destabilizing financial markets or inducing what is a "credit crunch" effect. One way to partially mitigate this issue is to institute levers to control such cross-border movement of funds. One example is to only allow licensed trading representatives from local stock brokerages to trade foreign stocks on foreign exchanges for local customers. Another approach would be to cap the amount of money that can be transferred in or out of a local current account on a daily basis. These measures should help to partially close an open capital account with an operational lever.

Keywords: open capital account, cross border fund movement, credit crunch effect, online trading platform, cap on fund transfer