Global Financial Stability - Assignment Example

Sanam Mukhtar Presented to Topic Global Financial Stability March 15, 2008 Summary of Global Financial Stability Over the past decades, financial globalization symptoms have been observed in the growth of cross-border capital flows. It includes debt securities, cross border lending and deposits, foreign Direct Investments (FDI) and foreign purchases of equity etc. For the supply of cross-border capital, banking sector played a vital role and remained a key intermediary. The growth findings between 1995 and 2005, in assets under management of institutional investors such as pension funds, insurance companies increased from $ 21 trillion to $ 53 trillion. In between 2001 to 2005, The international portfolio assets of United States grew from $2.3 trillion to $ 4.6 trillion. Finding also revealed a decline in home bias and increased investments into alternative vehicles such as hedge funds. It also revealed official sector growth in asset management by Emerging Market official sector and sovereign wealth funds, at the end of year 2005, managing assets predicted to have more than $ 6 trillion. Individual banks, hedge funds, insurance and pension funds face unreliable constraints that affect their investment allocation as they have different objectives. As openness to foreign intermediaries has been growing worldwide, emergence of conglomerates combining banking, securities, assets management etc in one organization have also been made possible by deregulation. Mature market economies and emerging have been affected by institutional globalization. The upward trend has been observed since 1995 in the ratio between global cross-border capital flow and world GDP. Oil producer countries have become large investors in financial instruments, such as bonds and equities. Sovereign wealth funds make such investments directly or by placement of funds with external investment managers. Market estimates reveal that these funds manage over $ 1.4 trillion. Consolidation of the industry has been directed by Merger and Acquisition (M & A); ongoing securitization and the expansion of derivatives markets has allowed institutions to transfer within and across the borders. Institutional globalization affects both, emerging and mature markets economics because some emerging market – based financial institutions operate on international level. We shall be discussing globalization of banking with insurance aspect in detail. Over the period of 1997 to 2000, financial institutions in developing countries grew increasingly attractive as M& A targets. Two priorities to help the potential risk from institutional globalization are ; supervisors need to collaborate ever more closely in the oversight of cross-border institutions. The second priority is; authorities require to continue the procedures to improve crisis management with the counterparts with whom they share the greatest overlapping responsibilities and interests. While the jurisdiction of supervisors and regulators remain domestic, at odds with the scope of activities of global institutions, these practical steps can go some way towards addressing the challenges to financial stability posed by institutional globalization. Favorable conditions in macroeconomics and in technology innovations may persuade investors to take on new risks. Favorable conditions and growth encourage investors to attempt further in order to attain higher returns. Emerging Market (EM) countries offer the prospect of faster businesses and profit growth. The prospect of closer economic integration with the European Union have been a driving force for a number of European countries. Few European countries are most likely to increase long-term savings such as insurance industry etc, due to their demographic or socioeconomics trends. When it comes on the most active and efficient financial institutions in chasing an international pressure, banks are the most active sector. The share of banking assets under foreign control increased from 25 percent in 1995 to 58 percent in 2005 in Eastern Europe. While in Latin America, share increased from 18 percent to 38 percent of total bank assets. But the internationalization of banking in Africa, Asia, and the Middle East increased quite slowly. The overall supply of cross-border capital has become more diverse and stable. Since 1974, regional factors are considered more important than the global factors. Liquidity factors of a country and at global level, both are vital determinants of the direction and volatility of capital outflows. The supply of international capital has become more diverse along several dimensions. All asset classes have been affected. The growth rate in capital flows along with constant large global imbalances suggests that an unexpected correction cannot be ruled out. Mature market economies and emerging have been affected by institutional globalization trend because some emerging market-based financial institutions operate internationally and the former are frequently important as host countries. Increasing globalization of financial institutions brings benefits in terms of financial stability and financial sector development and efficiency. Presence of foreign banks in the Emerging Markets seem more strong than traditional domestic banks. Presence of international banks has brought several benefits such as, greater efficiency, good impact on macroeconomic and open access to capital flow. This also gives local domestic banks a tough time and local banks strive to meet quality standard to survive in the market. Foreign banks provide stability in host country financial crises, it reveals higher level of credit growth and lower lending instability then their domestic counterpart. In developing countries with low income, the importance of developing country foreign bank is 47 percent in terms of numbers and 27 percent in terms of assets. While developing country banks invest in small countries where industrial country banks are unwilling to go. Because as industrial country banks have competitive advantage dealing in developing countries, similarly, developing country banks have a competitive advantage dealing with countries whose institutional framework is weak. Refer to 2000 available data, 0.7 percent of life insurer and 2.2 percent of non-life insurance, total world premia represented cross-border insurance business. due to the life insurance product differentiation at the national level, lower capital requirement for life insurance company start-up etc, lower global concentration in life insurance is observed than in banking. Another reason for this, is the fact that economies of scale in life insurance extend only to national operations. It has also been said that the non-life insurance sector is considered more global than the life insurance sector because of the pricing of liabilities and also with regards to the ability to lay off risk at global aspect. But the experience has progressed quite slowly than in other insurance segments due to the limited availability of cross-country data. European domiciled reinsurers have been large net recipients of risk from the rest of the world. When it comes to stability of institutional globalization, various reasons are behind this. Wernerfelt and Montgomery (1988) found that cross-industry diversification has a negative effect on firm value (measured by Tobin’s q or a similar measure), a result that has been confirmed by a number of subsequent studies and has come to be known as the diversification discount. The common explanation of this finding is that conglomerates suffer from structural and managerial weaknesses, while at the same time their risk-spreading qualities are of little value to investors who can diversify their portfolios. Cross-border diversification of financial institutions may be more beneficial than functional diversification due to two reasons. One reason would be; among countries, the diversification gains might be bigger is the imperfect correlation of economic activity. Secondly, general corporate finance literature on cross-border M & A strives to find that multinationals are valued at a premium relative to industry-matched standards. From various industries, Cross-border acquisitions of standards and targets result in a significant diversification discount. Cross-border diversification for individual banks is linked with higher market valuation as not only per measurements of accounting-based indicators but also as per market-based indicators. In a few regions, economies are becoming integrated, which reduces the stability-enhancing effects of international diversification. Foreign banks as compare to domestic counterparts, provide stability in host country financial crises, revealing higher levels of credit growth and lower lending instability. Globalization of financial institutions is considered to be beneficial in many ways such as stability and profitability of the individual institution but it might also be the case that financial systems are more prone to transmission across borders. Policymakers tend to maximize the benefits of institutional globalization while considering the potential risks. Policymakers make effective ongoing oversight of internationalized financial institutions possible in order to crises. Policymakers make arrangements to handle crises and shocks and to minimize spillovers. Effective host supervision about the ongoing condition of foreign bank affiliate is more important from their local point of view. As per universality based regime of insolvency, if a cross-border institution fails, all its assets and liabilities are transferred to the home country and the resolution takes place under the legal framework of that home country. Observation exhibits that ninety largest banks of world doing their business with the home country. Banks of North America and the Asia-Pacific region tend to be more domestically oriented, whereas European banks are far more internationalized on average, even aside from their large intra-European interests. The strategic focus of regional banks also varies considerably. Some banks have a strong presence developed markets within their region, while some concentrate on their activities in a selected group of countries within their region. The rest are conducting a large portion of their business in emerging markets. Extreme  value  Theory (EVT)  is  used  to  examine  the  scope  for  cross-border  spillovers  among  large  complex  financial  institutions. The  co-movements  between  extreme  events  can  be  analyzed  by  EVT. Increasing globalization of  financial institutions brings benefits by  the  mean  of financial  stability  and  financial sector  development  and  efficiency.   Problems  also  persist  in  globalization. For  example, if  banking  techniques  and  product  are  not  being  transferred  as  per  the  expectations  to  the  host  markets, the  parent  institution  might  face  loss  and  might  waste  capital. Risk management and adequate resources are very important to be properly conducted. The globalization trend towards financial institutions has been accelerating, especially for banking sector. But also present in the asset management, insurance, and reinsurance industries. Globalization has also improved the financial stability. But globalization can also lead towards complex broad ranging stages. Let us analyze the status of Qatar whose population is nearby 907,229 while the population growth rate is 2.38%,(Upto July, 2007 est). Till 2006, Purchasing power parity of Qatar was 26.37 billion dollars. GDP (Real Growth Rate) remained 7.1%, GDP per capita was 29,800 $. If we talk about GDP, composition by sector of Qatar, agriculture contribution was 0.1%, industry sector remained 77.2%, services were 22.6%. Estimated labor force till 2006 was 508,000. Imports was estimated $ 12.36 billion (f.o.b), while import commodities were mostly machinery, food, chemicals etc. Import partners for the year 2005 remained as below: Now let us analyze the major net capital import and net capital export of various countries. Please see below the major net exporters of capital in 2006: (Source: International Monetary Fund, World Economic Outlook database, as of March 21, 2007) Please see below the major net importers of capital in 2006: (Source: International Monetary Fund, World Economic Outlook database, as of March 21, 2007) Global Financial Stability Risks contributed to financial sector observation, that includes encouraging supervisory systems to adjust the financial environment at global aspect. It has been realized that if cross-border cooperation and coordination in enhanced, it will increase the advantages and benefits while justifying potential risks to financial stability. Works Cited Wernerfelt, Birger, and Cynthia A. Montgomery, Tobin’s q and the Importance of Focus in Firm Performance, American Economic Review, Vol. 78 (March) 1988. 246–50. Read More