Global Issues Seminar Series: Financial Stability Stijn Claessens World Bank and University of Amsterdam October 25, 2006 World Bank 1
Slide 1: Outline • Anatomy – Global financial integration is a long-run trend – But more two-way diversification in the 21 st century • Dynamics – Globalization, deregulation and technology • Actions – International financial architecture: approach & players • Consequences – In a narrow sense and broader sense – The challenge: balance of influences World Bank 2
Slide 2: Anatomy: Long-run trends in financial integration (according to Obstfeld) • Stylized facts (ca. 1860 -2000): 3
Slide 3: Anatomy: price and quantity metrics • Deviations from covered interest parity 4
Slide 4: World total foreign assets and liabilities 1970 -2003 5
Slide 5: Two-way diversification accelerated in the 21 st century • Massive 2 -way diversification differentiates the current from the earlier period of globalized capital markets • In the 19 th century, most flows were “development” rather than “diversification” flows • This phenomenon finds one expression in the fact that today, most capital flows from rich to other rich countries • In the 19 th century, there was a relatively greater flow from rich to poorer World Bank 6
Slide 6: Anatomy: Foreign assets, then and now World Bank 7
Slide 7: Dynamics: Three Major Forces • Globalization – All product markets and financial markets • Technology – Telecommunications, Internet • Deregulation – Capital account & financial services liberalization World Bank 8
Slide 8: Globalization and Technology • Globalization – Increased economic integration in all aspects – Greater specialization and economies of scale – Resulting in greater trade, also in financial services, through both capital flows and cross-border entry • Technology – Facilitating remote delivery, better telecommunications – Providing new distribution and access channels – Revamping industrial structures for financial services, by allowing entry of non-bank entities (telecoms/utilities) World Bank 9
Slide 9: Deregulation • Product, market and geography – Integrated banks offering a broad array of services – Entry of new providers. Increased (foreign) presence in many markets, more cross border FDI, M&A, etc. activity 10
Slide 10: Actions: Overview • General changes in development policies: Washington consensus being revisited, also in international finance • Financial crises in 1990 s (Mexico, East Asia, Brazil, Russia) start debate on international financial architecture • Approach keeps market orientation, but adds: – Focus on enhancing attractiveness and stability of emerging markets for developed countries’ investors – Reduced risk of spillovers to the global economy • Has been called new international financial architecture World Bank 11
Slide 11: IFA has focused on standards and enhanced surveillance • Introduced many (new) standards – Basle Core 25 Principles of Banking Supervision; OECD Corporate Governance; Fiscal/Monetary Transparency; National bankruptcy procedures, etc. Newly added: Anti. Money Laundering and Counter Terrorist Financing – Altogether more than 60 standards, of which 12 core • Strengthened national financial systems especially • Overseen by World Bank/IMF • Conducted through FSAP/ROSC process and regular surveillance World Bank 12
Slide 12: The proposals were largely shaped by developed countries • G-7 and G-10 institutions, private and public, dominate discussions and control agenda setting • Strong financial sector lobbying and liberalization bias maintained • Emerging markets’ influence in IMF, World Bank, BIS etc. already limited and remained so • G-20 newly created, but role/input unclear • Few emerging markets represented in Financial Stability Forum World Bank 13
Slide 13: The onus has consequently been on poor countries to adapt • Policy reflects investors’ preferences, not national development objectives • Openness to foreign financial institutions encouraged, constraints of capital mobility discouraged • Standards constrain national autonomy, but not developed countries’ and investors’ choices • One-size-fits-all solutions do not always work • Extensive legal and institutional adaptation faces political constraints World Bank 14
Slide 14: Consequences in a narrow way… • New institutional changes, such as Sovereign Debt Reduction Mechanisms (SDRM) failed in part due to lack of support from emerging markets • Financial crises have not been avoided, e. g. , Argentina, Turkey. Other near misses • Solutions continue to be ad-hoc, e. g. , Argentina • Risks remain still considerable • Countries continue to adopt own solutions, e. g. , foreign exchange reserves very large in Asia World Bank 15
Slide 15: Foreign Exchange Reserves: Asia (U. S. $ billion) World Bank End-97 End-01 Latest 16
Slide 16: Consequences in a broader way… • Policies not developed with development needs in mind, leading to inappropriate policies • Insufficient attention to longer run difficulties of adjustment and institutional/legal adaptation • G-7/G-10 private sectors better represented than developing countries in international organizations/fora • Legitimacy of the system affected, bad as well as good elements questioned. E. g. , external monitoring, standards, review and sanctions can help countries adopt first best, but requires legitimacy to be acceptable World Bank 17
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