Financial Globalization

In our contemporary period, the financial markets of different countries are becoming increasingly intertwined. This is due largely to the fact that many financial institutions are now going worldwide in its operations. Such financial institutions (hereafter, referred to as FIs) include Citigroup, Fortis, HSBC, Deutsche Bank and Royal Bank of Scotland. Although this can provide significant benefits, for example, in the form of easier and faster money transfer from one country to the next, this also entails significant risks, such as the adverse effect that the bank would entail on the economy of the country when it is incurring internal problems or is affected by a financial crisis in one of the countries where it is operating. Before proceeding to the benefits and risks of having a globalized financial system, this paper would first present the factors contributing to the globalization of finance, as well as the effect of such globalization on the economy and financial systems of various countries.

Hausler (2002) provided four main factors driving the globalization of finance: advances in information and computer technologies, the liberalization of national financial and capital markets, competition among the providers of intermediary services and the globalization of national economies. Advances in information and computer technologies enabled FIs from all around the world to communicate easily and carry-out transactions instantaneously. In addition, this also allowed them to obtain real-time news regarding their investments and other pertinent factors. Hausler (2002) explained that the liberalization of national financial and capital markets resulted to a tremendous increase in cross-border capital movements. He indicated that this is partly a response to the demand of having an intermediary for cross-border transfer of funds. Such demand is primarily driven by overseas workers who wanted to send remittances to their families. Finally, the increased competition among providers of intermediary services had spurred many FIs to seek profit outside the domestic market. According to Hausler, the increase in competition is due largely to regulatory authorities relaxing the rules on financial intermediation, which gave rise to numerous companies like money market mutual funds, investment brokers and insurance companies.

Hausler (2002) mentioned that the globalization of national economies enabled companies to conduct economic activities that span the entire world. He indicated that “today, the components of a television set may be manufactured in one country and assembled in another, and the final product sold to consumers around the world.” From a FI’s perspective, this means that they can have more flexibility by obtaining deposits from anywhere in the world and use those funds to finance the most promising investments that they could find. However, it is important to remember that despite of the many options available to an FI, it should guard itself against increases in risk arising from its diversified investments. Such risks include credit risks, interest rate risk, foreign exchange risk and sovereign risk.

The rise in a globalized financial system had severely weakened the ability of monetary authorities to control the value of a country’s currency in relation to others. In addition, it also created the problem of “capital flight,” where investors quickly withdraw their investments in one country at the first sight of economic trouble. Hence, countries that rely heavily on foreign investments to stimulate the economy should guard itself against news that would adversely affect the investors’ perception regarding the country. Finally, another problem posed by having a globalized financial system is that problems faced by FIs in other countries may negatively impact the country’s economy and financial system, as well. In 1997, the collapse of the Thai Baht as a result of the Thailand government choosing to float the baht led to the Asian financial crisis. A more recent and more severe predicament is the 2008 financial crisis, which had started in the United States and spread all throughout the globe. This is primarily due to the fact that most FIs from various countries had their investment in U.S. banks, particularly Lehman Brothers Holdings Inc. For this reason, the collapse of U.S. banks as a result of subprime mortgage lending spread the crisis throughout the globe.

Having a worldwide interconnected financial system can bring significant benefits to diverse parties. For companies, Hausler (2002) provided that a globalized financial system would enable them to obtain financing from various sources, which would lower their cost of funds and also address the risk of “credit crunch.” When domestic banks are short in funds, the cost of borrowing would normally rise. However, with a globalized financial system, companies can simply weigh the cost of borrowing from the domestic institutions against the interest rate provided by foreign FIs. In addition, companies could simply issue stocks, commercial papers or other securities to either the domestic or foreign market in order to obtain funds. Hence, a globalized financial system would exceptionally increase the bargaining power of companies in negotiating the terms of a loan with banks, which would decrease their cost of debt. For individuals, the globalization of the financial system would enable them to transfer funds from one country to another instantaneously. In addition, this would also help facilitate the purchase and sale of items through the internet, since there would be financial intermediaries that would ensure the fulfilment of the transaction. For countries, Schmukler, Zoido and Halac (2003) mentioned that the globalization of finance would develop the financial system of developing countries. They explained that this is due largely to “new sources of capital made available to developing countries and better financial infrastructure, which mitigate information asymmetries and reduce the problem of adverse selection and moral hazard.” In contrast, Schmukler (2004) provided that the increased competition due to the entry of international financial intermediaries would result to efficiency gains on the part of local FIs, as well as “push the country’s financial sector towards the international frontier.” Thus, globalization of finance is beneficial to individuals, companies and the country at large.

Although the globalization of finance provides significant benefit to different groups of people, it also poses enormous risks to various stakeholders. In fact, the 1997 Asian financial crisis and 2008 global financial crisis were some of the catastrophe that arose out of the interconnection between the financial sectors of numerous countries. For individuals and companies, the globalization of finance increases the insolvency risks of FIs, which could sweep-off majority of their investments on the said institution (except for the insurance provided by the government, such as the Federal Deposit Insurance Corporation in the United States and Philippine Deposit Insurance Corporation in the Philippines). Insolvency risks are often the result of one or more risks faced by the FIs that had severely worsened. Such risks, as earlier mentioned, include credit risks, interest rate risk, market risk, foreign exchange risk and sovereign risk. On the other hand, a country might get affected by the financial crisis faced by other countries, which may disrupt the growth of the country’s economy. Hence, even though the globalization of finance provides several important benefits, FIs and other stakeholders should be aware of the risks exhibited by such a system.

As a consequence of the increased dispersion of people to different countries, the interconnectedness of the world’s financial system is becoming more and more essential. Because of the increased demand for an international financial intermediary to facilitate the remittances of migrant workers, it can be anticipated that the globalization of the financial system of various countries would continue in the future. Governments, however, should be vigilant on the risks posed by such a system, as it could not only paralyze a country’s economic operation but it could disrupt the entire financial system all throughout the world. Hence, governments and regulatory agencies should impose guidelines and rules on banking and financial intermediation practices, such as the current restriction imposed upon U.S. banks to limit their investments to investment-grade bonds, maintain a certain minimum equity and mark-to-market the value of their investments (as of the date of the balance sheet). Hence, with the appropriate rules in place and increased coordination among countries, the risks possessed by such a system could be alleviated and, eventually, curtailed in the future.

References

Hausler, G. (2002). The Globalization of Finance. Finance and Development, 39(1). Retrieved from: http://www.imf.org/external/pubs/ft/fandd/2002/03/hausler.htm

Schmukler, S., Zoido, P. & Halac, M. (2003). Financial Globalization, Crises, and Contagion. Retrieved from: http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.200.3215&rep=rep1 &type=pdf.

Schmukler, S. (2004). Benefits and Risks of Financial Globalization: Challenges for Developing Countries. Retrieved from: http://siteresources.worldbank.org/DEC/Resources/Benefitsand RisksofFinancialGlobalizationSchmukler.pdf