Development of Financial Services in Terms of Common Market - Research Paper Example

Table of Contents I. Introduction ……………………………………………………………… 3 a. Research Questions …………………………………………. 3 II. Reasons behind the Failure of Financial Services during the 1970s, 80s, and Early 90s ………………………………………… 4 a. 1970s ………………………………………………………….. 5 b. 1980s ………………………………………………………….. 7 c. 1990s ………………………………………………………….. 9 III. Development of Financial Services in terms of Common Market . 11 IV. Economic and Monetary Union ……………………………………… 13 V. Recent Initiatives to Correct the Errors in Financial Services for the Common Markets …………………………………… 15 VI. Critique behind the Impact of Financial Services Action Plan and the Lamfalussy Report on the Common Market ………… 16 VII. Conclusion ……………………………………………………………… 17 References …………………………………………………………………..… 19 - 22 Introduction Aiming to control the economic activities in each country, most of the financial sectors are heavily regulated by one or more legislations. To ensure that there is a strong financial service in each country, almost all countries have successfully established their own individual government agency which directly supervises the movements of business transaction within the financial markets. With regards to the significant changes that has occurred within the financial sector, this report will discuss about the development of financial services in terms of a common market followed by identifying the main reason behind the failure of financial services back in 1970s, 80s, and early 90s. Eventually, the impact of economic activities and monetary union in the development of financial services will be critically analyzed. Prior to the main discussion, reasons behind the need to create the “Financial Services Action Plan” (FSAP) and the “Lamfalussy Policy” will be tackled followed by discussing the impact of these two recent initiatives over the financial services in EU. As part of the main discussion, ways on how these two initiatives are affecting the common market will be highlighted. In line with this, whether or not the use of the monetary and economic union and/or national economic strategies is better in terms of strengthening the financial services in EU will be answered. Research Questions As a guide in completing the course requirement, the following research questions will be addressed: 1. Why did the financial services fall behind the development of the Common Market in 70's, 80's and early 90's? 2. What are the recent policy initiatives on financial services? Did it mark a steady progress in the development of the Common Market? 3. Considering the fact that during the 70's, 80's and early 90's financial services fell behind the development of the Common Market, what has been recently achieved (not achieved) in the new policy initiative? Reasons behind the Failure of Financial Services during the 1970s, 80s, and Early 90s The performance of the central bank is often link with the economic activities of a nation. When analyzing the failure of financial services during the 1970s, 80s, and early 90s, is best to study the limitations within the banking system since banks are the central receiver of payments coming from different industrial and private sector. Crude oil is considered as a basic commodity within an industrialized country. The available supply of crude oil significantly affects the success and failure of economic activities of a nation. Since economic failure would eventually result to financial failure, it is also important to tackle the issues that could hinder the economic progress within the European Union. Aside from analyzing the major factors that could affect the economic performance of the European Union, financial regulation and bank supervision are among the two important topics that could enable us to prevent the high incidence of systemic risks. In line with this, the information that should be highlighted when studying the weaknesses of the banking system lies behind the strategies these financial institution had been using to promote liquidity including the maturity if the local banks’ assets and liabilities. For instance: In times of a serious economic crisis, some of the debtors may intentionally or unintentionally leave the bank after filing a bankruptcy1. This particular financial practice significantly affects a lot of other depositors in terms of losing bulk of their personal savings. 1970s Back in 1920s, monetary exchange was made out of issuing coins of silver, nickel, and bronze as British coins. Because of the series of war that occurred before 1970s, the Bretton Woods which is composed of the World Bank and the International Monetary Fund (IMF) was publicly introduced in order to rebuild the post-war economy and promote the international economic cooperation between 43 countries around the world2. In 1970s, the local banks are not capable of developing and implementing an independent monetary policy that could protect the financial institutions in times of economic failure. It was the duty of the Bretton Woods to fix the financial errors that took place four decades ago. Under the Bretton Woods system, the fixed value of the U.S. dollar was made against the gold reserves in the United States back in 1960s3. Because of the problem in the supply of the gold reserves as a result of industrialization and international trading including the disequilibrium in the foreign exchange rates, decimalisation of currencies – also known as the par value system or the Bretton Wood System was introduced back in 19714. After the Vietnam War and oil price shocks which took place during the early 1970s, the Nixon Shock which represented by the sudden deterioration in the U.S. gold reserves made the U.S. dollar holders alarmed with the stability of their financial investment5. To avoid further harm in the financial investments as a result of practicing a fixed exchange rate and converting the U.S. dollar with its gold reserves, the IMF decided the need to end the Bretton Woods system6. As part of allowing the foreign exchange rate to float, inflationary effects coming from the economic activities outside Europe can be avoided. Europe had to face serious economic and social challenges because of the oil crisis which took place in 19737. To protect the financial stability in Europe, the European Council decided to establish the “zone of monetary stability” back in 19788. As part of promoting a monetary union among the EU participating countries, the monetary stability initiative aimed at avoiding too much fluctuation between the foreign currencies of each participating countries. Europe’s decision to set up the European Monetary System (EMS) in 1979 was a good initiative in terms of promoting its plan to establish the zone of monetary stability. Basically, promoting the movements of goods and services within the internal market alone is a good economic practice since limiting the trading activities within European Union can lead to a healthier and a stronger financial service. 1980s The financial difficulties which took place in 1980s were because of the oil crisis which took place back in early 1970s. Because of the high interest rate that was imposed on petroleum9, a lot of countries all over the world started to fail paying off their foreign debt obligations. To enable most countries to boost their economic activities, countries like Mexico had to borrow from the commercial banks. However, the increasing interest rate imposed on them to prevent the increasing inflation rate result to the development of foreign debt crisis10. Because of the practice of global trading, the economic and financial crisis felt by a country could lead to a domino effect to its nearby countries and countries all over the world. Specifically the financial crisis experienced by Mexico in 1982 became a major global concern11. In line with this, it was noted that the major Latin American debt crisis started out of the Mexico’s inability to pay their foreign debts12. Known as the Black Monday, there was a major crash in the stock markets back in 1987. Started in Hong Kong (45.8%), problems related to stock market spread throughout Europe / United Kingdom (26.4%) and the United States (22.68%) including Australia (41.8%), Spain (31%), and Canada (22.5%)13. In line with this, there were some economists explained that the root cause of the Black Monday started out of ‘program trading’14. 1990s Another major financial development problem was the Asian financial crisis which occurred back in 1997. In the past, Thai baht was pegged to the U.S. dollar for a long period of time15. After the Thai government decided to make the Thai baht float, the continuous devaluation of the Thai baht made Thailand unable to control their foreign debt. As a result of the Thai baht collapse, the said financial crisis spread throughout the different parts of Japan and Southeast Asia including Hong Kong, Indonesia, Laos, Malaysia, Philippines and South Korea16. The impact of the Asian Financial Crisis on the economic and financial standing of Brunei, China, India, Taiwan, Singapore, and Vietnam were less affected as compared to Hong Kong, Indonesia, Laos, Malaysia, Philippines and South Korea17. It remains a fact that the global financial difficulties in the past has resulted to the strong need to strengthen the price stability among the EU Members18. Between 1980s and 1990s, financial deregulation has been effective in terms of making the financial sector perform better in terms of properly allocating the available capital19. In line with this, the decision to deregulate the financial sector has made most of the financial investors more diversified which lowers down the investment risks without the need to sacrifice the expected high return on investment. With regards to globalization, the act of deregulating the financial sector also made the financial flow within the global markets more successful. Development of Financial Services in terms of Common Market For a long period of time, the development of financial services in terms of common market aimed to provide financial stability as well as consumer protection. During the 1970s, the development of financial services was focused on maintaining financial stability. Because of the economic stagnation that occurred during 1970s, the issue on developing financial efficiency arises. Back in 1980s, almost all of the western countries have successfully imposed considerable regulation for the financial sector specifically in general as well as on international financial transactions. In line with this, the imposed regulations were focused on highlighting some of the restrictions with regards to foreign exchange and the fixed income market20. Given that banks are the central distribution of a country’s payment system, financial regulation and strict supervision of the banks’ daily financial activities were implemented as part of the major financial regulation. Aiming to avoid the financial crisis that has occurred during the great depression back in 1930s, these regulations prevent the occurrence of financial transactions that could cause threats to the macroeconomic stability which could seriously affect the small-time customers. To increase the efficiency within the financial sector, there were a lot of western countries that has decided to implement a major deregulation of financial institutions between 1980s and 1990s. Because of the increasing importance of the financial market towards the success of an economy, financial regulations were implemented to improve the development of financial services within a common market. In general, an efficient financial sector is expected to stimulate the economic growth within a common market. This can be done by smoothening the process of conducting a business or financial transaction, encouraging more people to invest than to save money in banks, and/or continuously allocating capital from time to time21. Given the fact that there are quite a lot of investors who are continuously searching for financial investments that can provide a high expected return on investment (ROI) with low risk of losing their financial investment, these investors are more likely to invest their capital to companies and other forms of financial investment that are promising and highly profitable. Economic uncertainties could happen along the way. Based on the history of financial development, it has been noted that economic uncertainties could significantly affect the financial stability and efficiency within a common market. Because of the presence of economic uncertainties within the financial market, securities markets are left with no other choice but to continuously evaluate, collect, and distribute information like financial prices to the public in order to help the financial investors make a better judgement on what they will do with their investments. Between 1970s to late 1990s, there were quite a lot of changes in the financial regulation that occurred within the western economies. These changes made it a challenge for financial institutions to hold back the existing financial regulations. In line with this, there is an increasing need to improve the existing financial regulations because of the presence of global trading. Economic and Monetary Union Started in 1951, a total of six European states came into an economic agreement forming the European Union (EU). Today, there are 27 countries across European continent as members of the EU22. These countries include: Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, and the United Kingdom23. Back in January 1999, the use of ‘Euro’ (€) was launched in the world money markets. Except for the United Kingdom, Sweden, and Denmark, Euro has become the unit of exchange for the EU states. In line with this, the initiative of the European Commission was to coordinate the economic policies and set a monetary integration among the European Union24. In 2007, the goal European Commission was proven to be very successful. Having implemented the ‘Euro’ (€) currency back in 1999 was actually a strategy used by the European Union in achieving their purpose of making the inter-regional and inter-state trading much easier25. In terms of trading within a wider domestic market, the inter-regional policy of the European Union resulted to the increase in the power of every EU members. It also resulted to the development of more employment opportunity for the local people. Given the huge domestic market of the European Union, the members of EU was able to gain more strength which attracts many of the World Trade Organization (WTO) members to deal with the European Union26. Likewise, the gross domestic product (GDP) of European Union has been constantly increasing between the years 1998 to 2000. The increasing size of the European Union as a single market has been sustained by a collective European trade policy aside from its more than forty-years of experience in negotiating with international trade agreements has enable the EU to become a close competitor of the United States in terms of the international trade negotiation27. Based on the 2006 OECD report on the Foreign Direct Investment that flows in and out of OECD countries, the total inward Direct Foreign Investment has reached a total of US$430.5 billion while the outward Foreign Direct Investment has totalled to US$ 557.1 billion in 200528. Since a ‘single currency’ has been imposed on the Eurozone countries; the members of the European Union can use only one monetary policy for all. It means that only ‘one’ interest rate will be implemented by the European Central Bank (ECB) to all members of EU. In case of an economic problem, the national government is therefore deprived of using the monetary policy (monetarism) to solve any economic issues. This leaves them the option to control over the fiscal policy instead. Aside from the political issue attached with having a single currency, economic and monetary union can be beneficial for the participating countries in terms of inter-trading opportunities, currency stability and having a transparency in the costs of goods and services29. Recent Initiatives to Correct the Errors in Financial Services for the Common Markets Intended to increase the financial efficiency in Europe, the EU Council of Economics and Finance Minister publicly announced the importance of Lamfalussy report on March 200130. Basically, the main purpose of developing the Lamfalussy report is to hasten the development of necessary reforms behind the financial regulation and supervision. In line with this, the European government were able to immediately implement the necessary changes that were made behind the financial service regulation within the European Union. By publicly introducing and implementing the Lamfalussy report, it was possible for the European Union to avoid going through a long process of developing related EU laws. On the other hand, the Financial Markets Action Plan (FMAP) in European Union serves as the framework for changing the existing financial regulations within the EU nations31. As part of the FMAP, some of the identified measures that could enable the European Union to create a single and more efficient market for the financial services were noted. Since the necessary measures were already identified in details, it was made easier for the European Union to implement the necessary changes which were projected in the European Union action plan back in 2004. Critique Behind the Impact of Financial Services Action Plan and the Lamfalussy Report on the Common Market Although it is clear that the public introduction of FSAP and Lamfalussy Report were developed to correct the errors in the financial services for the common markets, there are still some flaws that can be noted with regards to these two recent initiatives since the efficiency problems within the financial services in the common markets in European Union are not limited to European Union alone. In general, changes in the market environment are unavoidable. For this reason, the authorities behind the development of financial sector within the common market should take note of the economic reasons behind the development of a financial regulation and/or supervision32. Because of the presence of globalization, there is a strong need for European Union nations to develop a more efficient regulation which is applicable outside the boundary of European Union. Although it is easy to declare the need to harmonize the securities regulation, harmonizing the existing securities regulation is very difficult to accomplish because of the presence of financial agreements between EU and other foreign countries. Likewise, harmonizing the existing securities regulation may not be possible since it would limit the competition that could arise between two or more regulatory regimes. Conclusion Each year, there are different factors related to economic and financial difficulty around the world could significantly affect the financial development of the European Union. Among the global financial failure that has affected the financial development in Europe includes: (1) the failure of the Bretton Woods (1970s) and oil price shock (1973) which resulted in the development of Nixon Shock; (2) imposing high interest rates to avoid inflation and the financial crisis in Mexico (1982) which resulted to the development of Latin American debt crisis; and (3) the Asian financial crisis which took place in 1997. Monetary and economic union and the promotion of national economies has its own advantages and disadvantages in terms of solving the economic and financial challenges European Union are currently facing. With monetary and economic union, EU members are able to easily increase the market opportunity of the local businessmen. As a result of a more promising economic and financial standing, EU members are able to easily attract more business opportunities from outside the EU nation. On the other hand, the promotion of national economies can have more advantages as compared to economic and monetary union in the sense that the economic and financial failure of one EU member will not affect the economic and financial standing of a well established EU member. Since monetary and economic union has its own limitations, there is a need to continuously improve the existing FSAP and Lamfalussy Report in order to correct the errors in financial services for the common markets of EU members. *** End *** References ADB. (2003). Retrieved November 21, 2009, from Key Indicators of Developing Asian and Pacific Countries. Table 29: External Debt and Debt Service Payments (US$ million): http://www.adb.org/Documents/Books/Key_Indicators/2003/pdf/rt29.pdf Agarwal, J. (1996). Impact of Europe Agreements on FDI in Developing Countries. International Journal of Social Economics , Vol. 23, No. 10/11, pp. 150 - 163. Alvarez-Ramirez, J., Alvarez, J., Rodriguez, E., & Fernandez-Anaya, G. 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