Definition of Recent Changes in Global Financial Markets

The decade of eighties witnessed unprecedented changes in financial markets around the world. The seeds of these changes were however sown in the 1960s with the emergence of Euromarkets, which were a sort of parallel money markets, virtually free from any regulation. This led to internationalization of the banking business. This market grew vigorously during the seventies and pioneered a number of innovative funding techniques.

The outstanding feature of the changes during the eighties was integration. The boundaries between national market as well as those between and offshore markets are rapidly becoming blurred leading to the emergence of a global unified financial market. The financial system has grown much faster than real output since the late seventies. Banks in major industrialized countries increased their presence in each other’s countries considerably. Non-resident borrowers on an extensive scale are tapping major national market such as the US, Japan, Germany. Non-resident investment banks are allowed access to national bond and stock markets. The integrative forces at work through the eighties have more or less obliterated the distinction between national and international financial markets. Today both the potential borrower and the potential investor have a wide range of choice of markets.

In addition to the geographical integration across market there has been a strong trend towards functional unification across the various types of financial intuitions within the individual markets. The traditional segmentation between commercial banking, investment banking, and consumer finance and so on, is fast dis-appearing with the result that nowadays “everybody does everything”. Universal banking intuitions/bank holding companies provide worldwide, a wide range of financial services including traditional commercial banking

The driving forces behind this spatial and functional integration were first, liberalization with regard to cross-border financial transaction and second deregulation within the financial systems of the major industrial nations. The most significant liberalization measure was the lifting of exchange controls in France, UK and Japan. Withholding taxes on interest paid to non-resident were removed, domestic financial markets were opened up to foreign borrowers and domestic and domestic borrowers were allowed access to foreign financial markets. Thus in the portfolios of investors around the world, assets denominated in various currencies became more nearly substitutable- investors could optimize their portfolios taking into consideration their estimates of return, risk and their own risk preferences. On the other hand, borrowers could optimize their liability portfolios in the light of their estimates of funding costs, interest rate and exchange rate risk and their risk preferences.

Deregulation involved action on two fronts. One was eliminating the segmentation of the market for financial services with specialized institutions catering exclusively to particular segments, and measures designed to foster greater competition such as abolition of fixed brokerage fees, breaking up bank carters and so forth. The other was permitting foreign financial institutions to enter the national markets and compete risks and their risk preferences.

The fever of liberalization and deregulation has also swept the various national stock markets. This is the least integrated segment of financial markets though in recent years the number of non-resident firms being listed on major stock exchange like New York and London has increased significantly.

Liberalization and deregulation have led to a significant increase in competition within the financial services industry. Spreads on loans, underwriting commissions and fees of various kinds have become rather thin. Another factor responsible for this is the tendency on the part of prime borrowers to approach the investors directly by issuing their own primary securities thus depriving the bank of their role and profits as intermediaries. This is a part of the overall trend towards securitization and disintermediation.

The pace of financial innovation has also accelerated during the last 10 to 15 years. The motive force behind innovation like options, swaps, futures and their innumerable permutations and combinations comes both from the demand side and the supply side. On the one hand, with the floating of exchange rates in 1973 a new factor was introduced main international finance; exchange rate volatility and the substantially higher interest rate volatility witnessed during the eighties led to demand for newer kings of risk management products which would enable investors and borrowers to minimize if not eliminate totally exchange rate and interest rate risks. On the supply side as the traditional sources of income for banks and investment banks such as interest, commissions, fees, before the competitors wised up to the fact and started offering which it is sometimes said the bankers themselves do not fully understand. The innovation mania has been made possible and sustained by the tremendous advance in telecommunications and computing technology.

Liberalization and deregulation of financial markets is on an ongoing process. From time t o time events and circumstances give rise to calls for re imposition of some controls and barriers to cross-border capital movements. Some governments resort to such measure to contain or prevent a crisis. Many economists have proposed taxation of certain capital account transitions- particularly short- term movements of funds- to throw sand in the excessively oiled machinery of global capital market”. The quality and rigor of banking supervision in many developing countries needs considerable improvement.

In the western hemisphere, US and most of Europe have more or less free financial markets. Japan started the process around mid-eighties and most of the barriers have been dismantled though some restrictions still remain. In other parts of the world, countries like Singapore and Hong Kong already. Eastern Europe and third world have begun their economic reforms including freeing their financial sectors. Recent years have seen surge in portfolio investments by institutional investors in developed countries in developed countries in the emerging capital market in Eastern Europe and Asia. A large number of companies from developing countries have successfully tapped domestic markets of developed countries as well as offshore markets to raise equity and debt finance.

The explosive pace of deregulation and innovation has given rise to serious concerns about the viability and stability of the system. Even such as the LDC debt crisis and the 1987 stock market crash in the 1980s the east Asian currency crisis and the tenets following the Russian debacle including the fall of LTCM, a giant hedge fund in the 1990s have underscored the need to redesign the regulatory and control apparatus which will protect investors interest make the system less vulnerable to shock origination in the real economy, will protect investors interest make the system less vulnerable to shocks originating in the real economy, will enable location and containment of crises when they do occur without unduly stifling competition and making the markets less efficient in their role as optimal allocates of financial resources. Increasing inter-depended implies convergence of business cycles and hence less resilience in the global economy. Disturbances following a local financial crisis tend to spread throughout the global system at the “speed of thought” making the policy makers task extremely difficult.

International bodies such as the IMF have already begun drawing up blueprints for a new architecture for the global financial system. Extensive debates will follow among economists, finance experts and policy makers before the blueprints are translated into new structures.