Financial Globalization

Executive Summary

During the past two decades, financial markets around the world have become increasingly interrelated. Financial globalization has brought considerable benefits to national economies and to investors, but it has also changed the structure of markets, creating new risks and challenges for market participants and policymakers. The international marketplace continues to present opportunities for companies. But change is constant and prudent so companies must work to minimize their risks while maximizing their opportunities. The International marketplace can offer considerable financial returns to companies conducting business but there are risks that have to be considered such as trade, foreign exchange, cash management, cross border financing, investment, and multi currency requirements. Especially, financial institutions (seeking a return on their capital, both financial and intellectual), who have developed the product engineering skills and innovation necessary to undertake cross-border financial activities.

This paper will attempt to explain the roles of the financial institutions in the global economy while also looking into the future of the financial services industry over the next decade and speculating as to how the industry is likely to change. Finally, I will examine how these changes might impact the stakeholder relationships my organization has with financial institutions.

1. Globalization

To understand the role financial institutions play in the global economy it is important to first understand the nature of the global economy and the term globalization.

Globalization is the process by which countries' economies become increasingly interwoven. This happens with the increased flow of goods (trade), foreign direct investment, money (finance), and/or people (migration). While globalization is not new, the speed, depth, and scope of the changes on the globalization are novel by technology. Also new to the mix is the enormous power of International Financial Institutions (IFIs) and global trade groups such as the World Trade Organization (WTO) to set the rules of the global economy. (Holmes 2005)

Financial institutions play a vital role in the global economy. They are generally referred to as IFIs, a generic term given to all financial institutions operating on an international level. IFIs range from development entities such as the World Bank and the European Bank for Reconstruction and Development (EBRD), to monetary authorities such as the International Monetary Fund (IMF). These organizations provide loans to governments for large-scale projects, as well as for restructuring and balance of payments (on condition that they make specific changes IFIs believe will boost economic growth). (Holmes 2005)

2. International Financial Institutions

While each organization came into existence under different circumstances, each is vital to economic growth around the world and to the global economy. For example, the World Bank, also known as the International Bank for Reconstruction and Development (IBRD), provides loans and development assistance to middle and lower-income countries with a stated aim of reducing poverty. Loans generally have a five year grace period and must be repaid over a period of 15-20 years. The Bank obtains most of its funds through the sale of bonds in international capital markets. Though not a profit- making organization, it has earned a net income from its loans every year since 1948. (Holmes 2005)

The EBRD was established in 1991 when Communism was crumbling in central and Eastern Europe, and ex-Soviet countries needed support to nurture a new private sector in a democratic environment. Today the EBRD uses the tools of investment to help build market economies and democracies in 27 countries from central Europe to central Asia. (About the EBRD, 2005)

The IMF "is an organization of 184 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty." (About the IMF, 2005).

Beyond these IFIs there are smaller financial institutions within countries and regions which are also essential to the global economy. Most countries have their own banks and banking systems, and many have stock, bond, foreign exchange, derivatives and commodities markets. Each of these markets is a potential area for investment in an increasingly interconnected global economy.

3. Late 1990's Asian Financial Crisis

Over the past 20 years we have witnessed the global economy evolving, becoming increasingly more interdependent. The Asian financial crisis of mid-1997, which additionally exposed many flaws in Asian financial institutions, illustrates this well.

The Asian crisis affected currencies, stock markets, and other asset prices of several South East Asian economies. Triggered by events in Latin America, Western investors lost confidence in East Asia securities and pulled money out, creating a snowball effect. Many economists, like those within the Cato Institute, believed the Asian crisis was created not by market psychology or technology (which actually represents a more efficient form of capitalism through the ability to acquire information cheaply and more quickly), but by macroeconomic policies that distorted information, which in turn created volatility that attracted speculators. What some have called "herd mentality" was merely the result of speculators behaving rationally, noting the fraudulent currency policies (fixed exchange rates attempting to be defended by their government) which speculators assumed could not be sustained. Such economists believe this crisis was the result of unsustainable macroeconomic/protectionist policies which create the very "market" imperfections they were originally designed to correct (Asian financial crisis, 2005). The crisis showed how interlinked all the economies of the world had become, and was of particular interest to the U.S. government for several reasons.

First, attempts to resolve the problems were led by the IMF with cooperation from the World Bank and Asian Development Bank, and pledges of standby credit from the U.S. Exchange Stabilization Fund. Second, financial markets are interlinked. What happens in Asian financial markets also affects U.S. markets. Third, Americans are major investors in the region, both in the form of subsidiaries of U.S. companies and investments in financial instruments. Fourth, the currency turmoil affects U.S. imports and exports