The Process of the Globalization of Financial Markets - Coursework Example

International Finance and Globalization

Introduction

Over the last few decades, cross-border financial transactions have increased tremendously due to the rising trend of globalization. Many banks and financial institutions have expanded their operations globally and in this process, they have started to act as intermediaries channeling funds between borrowers and lenders of different countries (Kenawy, 2009). The securities market which was restrained to the national borders until the early 1980s have gained international access. New forms of securities like are designed and issued to the public which have gained immense attention of international investors (European Central Bank, 2016).

In the process of the globalization of financial markets, technological developments and financial innovations have played an important role (Lawlor, 2007). With the use of advanced technology, more amounts of financial data could be computed and recorded, which has resulted in more number of global financial transactions. Due to the integration of international financial markets, a range of new emerging financial products have been developed which are commonly known as derivative instruments. With the use of these products, the borrowers and lenders can hedge the risks that they are exposed to during international transactions (Lees, 2012a).

Financial globalization is aligned with the opportunities created by the rapid technological change and rising commercial needs. The financial markets have profitably adapted to these forces since the history of globalization (European Central Bank, 2016). However, due to certain global economic shocks like the stockmarket crash of 1987, the economic crisis of 1990s and many other economic crises in various nations, these have negatively positioned financial globalization and put it in question (Obstfeld and Taylor, 2005).The main purpose of this paper is to understand the process of globalization of financial markets since the early 1980s and evaluating the contribution of financial globalization towards the process of globalization as a whole.

Globalization of Financial Markets

The concept of globalization mainly focuses on the geographical dispersion of industries and services and networking of companies across the national borders. This emphasizes the shift of economic activities from the domestic corporations to various parts of the world (Mrak, 2005). The Globalization of financial markets is an integral part of the whole process of globalization. Although financial globalization has helped in improving the various financial markets across the world, it has also led to certain economic crises (Obstfeld and Taylor, 2005). Therefore, it can be understood that the globalization of financial markets is a very complex and imperfectly understood concept. Increasing levels of international trade in goods and services is evidently linked with increasing financial flows in the global market. If it is viewed from the microeconomic level, any international trade in goods and services will require international financial transactions like payments. This is linked with certain financial services like transactions through banks, foreign currency exchange and hedging in derivatives to reduce foreign exchange risk (Lees, 2012a). From the macroeconomic viewpoint, when a country is investing more capital in foreign markets instead of saving it; or a country is consuming more resources instead of producing it, then those countries might need to import more capital. This can only be facilitated with the globalization of financial markets (Mrak, 2005). Thus, the global net capital flows are often determined by various influencing factors like a nation’s GDP, savings, investment and so on (Kose et al, 2009). Due to financial globalization, many developing countries of Asia and Africa are now financially stable and sufficient enough to indulge into financial deals with developed countries like the U.S.

In order to understand the impact of globalization on the financial markets and how these markets have changed significantly, it is important to recognize the various types of financial markets and their main operations. In general, markets where financial instruments are exchanged and traded are called a financial market. The financial market consists of financial institutions like banks and it operates with financial instruments like money, stock, bonds, etc. The financial market is regulated by financial regulators of different countries (Darskuviene, 2010). There are many types of financial markets like the capital market consisting of stock market and bond market, the commodity market operating with commodities like gold, silver, etc, the money market operating with treasury bills, commercial papers, CDs, etc or the Forex market where foreign currencies are traded (Darskuviene, 2010). These financial markets of each country had witnessed a huge foreign exposure since the increasing trend of globalization. Out of these markets, the stock market is the most affected.

Capital Market Globalization

The stock exchanges of different countries have been forced to update, expand and consolidate their activities in order to align themselves with the global advances in business operations. Due to globalization, the stock market and the bond market are now more deregulated and there is less control from the government and financial regulators (Torre and Schmukler, 2007). Foreign exchange controls have been eliminated, restrictions on purchase of securities by foreign investors have been removed, tax imposition on foreign investors have been reduced and the foreign investment banks are now more involved in underwriting stocks and bonds in domestic markets (Sabri, 2006). Advancements in global telecommunications now facilitate the dealers and stock brokers across the world to exchange information on stock prices of various companies in different countries. This also helps the investors to monitor the global capital market and assess the risks involved with them (Torre, Gozzi and Schmukler, 2006). Maximizing return on investment has become a global objective, which has led to an increase in cross-border equity trading.

Globalization triggered the process of demutualization of many stock exchanges where companies started to list themselves with the sole purpose of raising capital (Lees, 2012b). In 1993, the Stockholm Stock Exchange was the first to demutualize itself and by 2004, 22 stock and derivative exchanges demutualized including the London Stock Exchange, NASDAQ, the Tokyo Stock Exchange and the Hong Kong Stock Exchange (Lees, 2012b). The clientele of stock exchanges like the investors, the facilitators (brokers), the listed companies and the shareholders, has become much diversified. This change in clientele role made it necessary for the exchanges to restructure themselves, giving control to different clientele groups (Lees, 2012b).

Internet-based stock market trading has become more popular in recent times and this has shattered geographic boundaries. This has helped interconnecting the global economy and increasing the sources of equity capital (Nasdaq, 2013). Society for Worldwide Interbank Financial Telecommunication (SWIFT) is an organization that has facilitated international trade by increasing cross-border interaction. SWIFT enables financial institutions across the world to exchange information about financial transactions in a standardized manner (Scott and Zachariadis, 2013).

The public and private investors now have complete access to purchase stocks on local and international exchanges. The stock exchanges are increasingly standardized for attracting international IPOs and foreign investors. According to research done by Ernst and Young in 2006, there were 51 stock exchanges available globally, out of which New York Stock Exchange (NYSE), London Stock Exchange (LSE) and Hong Kong Stock Exchange (HKSE) were actively involved in international IPOs and cross-border listing (The Levin Institute, 2008). The globalization of stock markets has increased the level of competition among the companies to list their stocks and it is also a competition for the investors to invest in the stock of a big foreign company (The Levin Institute, 2008).

Money Market Globalization

The banking industry has gone through a lot of changes over the last two decades. The rising trend of international trade made it absolutely necessary for the banking system to operate on a global basis (Chilumuri 2013). There had been a lot of changes in the banking regulatory system and a lot of advancements in banking information technologies. This has led to the integration of international financial markets and financial institutions. This also created a lot of opportunities for the banking industries across the world. The emergence of international banks increased the level of competition for the domestic banks (Bexley, Bond and Maniam, 2010).

The deregulation of banking acts and the integration of financial markets has created a more competitive environment for the banking system (Raluca, 2012). Organizations like SWIFT and SEPA have facilitated global financial transactions to a large extend. Single Euro Payments Area (SEPA) has integrated the payment system of European Union countries, which makes financial transactions in euro, whereas SWIFT facilitates global interbank transactions by connecting the financial institutions across the world. The member banks of SWIFT are classified under different categories, who have access to different levels of information and are permitted to different ranges of financial transactions (Scott and Zachariadis, 2013).

The globalization of banking industry started from the early 1990s, when the bank entry in the Eastern and Central Europe resulted in a rapid growth of international ownership of the local banks (Goldberg, 2008). Another such example is the liberalization of financial sectors of Latin America during the 1990s. This first wave of liberalization was triggered by the expansion of FDI into the manufacturing sector, which led Latin American countries to face immense competition from Asian countries (Goldberg, 2008). With rising globalization, the banking industry has become exposed to several internal and external risks and through several ways these risks can be avoided. One such risk avoiding technique is capital strengthening. This criteria of capital adequacy has become mandatory since it got approved by the Basel Committee in 1988 (Bexley, Bond and Maniam, 2010).

The global payment mechanism is facilitated by a third-party, which is a bank or a deposit-taking institution or even a money transmitter. Major banks of each countries are linked to each other over an electronic communication network and one such linking role is played by SWIFT (Geva, 2013). Globalization and integration of financial markets have resulted in more efficient distribution of information within the banking industry. This had a positive impact on the growth of the commercial banks. However, large banks have benefited more from this globalization process, as they are more capable of accessing international technologies and innovations (Bexley, Bond and Maniam, 2010).

Foreign Exchange Market Globalization

Since the era of globalization, the foreign exchange market has an increasing influence on the stock, bond and commodity markets. Goods are now manufactured and traded across the world, which has made it increasingly important for the foreign exchange market to operate on a global basis (International Securities Exchange, 2008). The forex market plays an important role in pricing the currency of one country against another. This facilitates exports and imports of foreign goods against home currencies. The mechanism of the forex market is to set price equilibrium for buyers and sellers with their respective currency pairs (Sager and Taylor, 2006). Technological advancements have made it easy to deal with foreign currencies, giving a clear picture to the buyers and sellers about the currency values of every nation (International Securities Exchange, 2008).

Financial globalization has provided scope to the investors to understand the economies of different countries and their currencies. This also gives them a chance to hedge their domestic financial position in comparison to another nation and its currency. Financial globalization has resulted in the development of a new market called derivatives. With the use of derivatives, investors can hedge the risk involved in transactions with foreign exchange. The investors can also purchase and sell currencies in the derivate market and in the process can make profit (Lees, 2012a).

Technological advancements in foreign exchange markets have made it easier for the investors to get detailed information about a particular country’s currency rate and its fluctuations. Investors can buy and sell foreign exchange sitting at their home at just the click of a button (Finance Information, 2016). Some popular equity indexes are Nikkei 225 (Tokyo), DAX (Frankfurt), FTSE 100 (London), TSX (Toronto), SP-500 (New York) and S&P/ASX 200 (Sydney) (Finance Information, 2016). Through these indexes, every company can compare their currency rate with the currency rate of other companies across the world.

Since the early 1980s, there has been drastic change in the commodity market including a decline in prices, changing role of the government and the development of market liberalization programs. The government interference in marketing and pricing policies of export commodities has been reduced since the initiation of the liberalization program (Gilbert and Varangis, 2005). Commodity buyers and sellers are now actively participating in export and import deals on a global basis. Countries which are specialized in the production or extraction of a particular commodity are looking for buyers around the world and are making transactions in home currencies. On the other hand, countries which are incapable of producing certain commodities can do a comparative analysis between several producing countries and select the one that offers best price. This is mutually beneficial for both countries.

Hence, globalization had evidently impacted all the financial markets across the world. It has led to an increased amount of foreign transactions and the development of the global economy. Although the four financial markets operate with different financial instruments, some common features have been identified which are applicable for all the markets.

Common Features between different Financial Markets

First and most important is the role of information technology and the internet which has enhanced the financial globalization process. The use of advanced technology has facilitated stock market transactions across the globe. Investors can easily purchase stocks of foreign companies by sitting at their home online. Technological advancements also facilitate the banking industries in dealing with foreign transactions from their home country. Banks can also start operations in a foreign country with the effective use of technology (Lawlor, 2007).

In the commodity market, the buyers and sellers can get instant access to prices of various commodities from different countries which give them a wide choice before getting into a deal. With the use of technology the buyers can make payments for the goods to the seller sitting in a different country. In the foreign exchange market, institutional and individual investors can get a clear picture about the currency rate of each country through the use of technology. They can also purchase and sell foreign currencies from their home country. Thus, technology has played an important role in supporting the globalization of financial markets.

Secondly, the government of every country, specifically the government of the developing countries has supported the financial globalization process from the very beginning. The government of different nations has reduced its interference in foreign trade by lifting trade barriers and tariffs. They have implemented various liberalization programs which have enhanced the free flow of funds among various countries (Alfaro and Volosovych, 2007). Due to this liberalization, many companies have started to list themselves on the stock exchange for the purpose of raising capital. The government gives full freedom to individual investors to purchase stocks of a foreign company and even one company can purchase and sell stocks of another foreign company. By deregulating the money market, the government has helped the banks to become involved in foreign transactions and setting up operations in foreign countries.

The government gives full freedom in the transactions of commodities from one country to another with minimum or no tariff charges (Boundless, 2016). The prices of commodities are more often set by the sellers or in some cases are set by the government, considering the competitive rate prevailing in the market. The government of nearly all countries has also deregulated the foreign exchange market, promoting the free flow of foreign currencies from one country to another (Alfaro and Volosovych, 2007). Hence, it can be said that the government has played a very important supporting role in the financial globalization process. It is expected that this trend continues to strengthen in the future years.

Thirdly, the role of investors in the development of financial globalization is remarkable. Both individual investors and institutional investors have come out from their domestic boundaries and started to explore foreign markets (Singh, 2005). Previously, investors were more conservative in their investment techniques and preferred to invest in domestic capital and money markets. Since the start of globalization, investors have become much more radical and progressive in investing in foreign markets. Foreign direct investment (FDI) has played an important role in the process of financial globalization and economic growth of developing countries (Sharma, 2012). Individual investors have started to purchase stocks of foreign companies and have learned to manage the risk involved. Many companies now actively purchase shares of foreign companies with the motive of capital gain and control (Singh, 2005).

Common citizens who previously only trusted domestic banks for investing their money, have now started to invest their money in foreign banks. Commodity buyers and sellers actively participate in import and export deals with foreign countries. For example, countries like Saudi Arabia and Iran are the largest producers of oil, selling it to countries across the world. Africa is the largest producer of Cocoa, dominating the global Cocoa market, and companies from different countries purchases it for re-selling (Fold and Larsen, 2008). This resulted in the development of the foreign exchange market, where companies can purchase and sell goods in exchange of foreign currencies. There are many individual and institutional investors who buy and sell foreign currencies in the forex market with the intention of making a profit from the rate fluctuations (MoneySmart, 2016). Therefore, the investors have played an important role in integrating the various financial markets in the whole financial globalization process (Hale, 2011).

Contribution of Financial Globalization

The trend of financial globalization has actually emerged since the mid-1980s also because capital control was liberalized in most countries (Broner and Ventura, 2015). These mainly included the developing countries which were expecting that liberalization would instigate better economic growth and stabilize the consumption through cross-border capital flows. These developing countries which have actively participated in the financial globalization process have witnessed better economic growth than those countries who have not participated (Kose et al, 2007). However, the actual relationship between economic growth and financial globalization has not yet been discovered.

In spite of many studies, analysts have failed to identify how the liberalization and globalization of financial markets have actually resulted in cross-country growth. This is mainly due to the reason that measuring financial globalization remains challenging (Kose et al, 2009). Another reason is that the approach towards financial globalization varies from one country to another. Capital control techniques of developing countries are different from those of developed nations (Kose, 2007). Developing countries are more involved in accepting foreign direct investments than developed countries. Therefore, measuring the relationship between the globalization of different financial markets and global economic growth is testing, but it is evident that the process of financial globalization has a huge contribution towards the process of globalization as a whole (Kose, 2007).

Financial globalization has substantially increased the rate of foreign investments and capital flows across the globe; however, it has failed in contributing towards global productivity and employment growth. Moreover, the increasing rate of financial crises particularly in the developing countries has also placed the contribution of financial globalization under question (World of Work Report, 2008). These frequent financial crises have increased the rate of consumption in emerging economies and have made employment more volatile. The rate of banking crises have increased worldwide with the rise of financial globalization and it was particularly high in the 1990s in emerging economies. For example, the Asian crisis of 1997, in which GDP of five countries (Indonesia, Malaysia, Philippines, Korea and Thailand) contracted on average by 7.7 per cent (World of Work Report, 2008).

On the other hand, a positive aspect is that financial globalization had a beneficial effect on global macroeconomic policies. Certain countries like Northern Europe have learned how to maintain a strong welfare policy and a competitive economy simultaneously (World of Work Report, 2008). Financial globalization has contributed to the global economy by improving macroeconomic performance, the development of financial institutions and greater risk sharing (Lane, 2012).

The globalization of financial markets has directly affected certain determinants of economic growth in developing countries. They are an increase in domestic savings, technological advancements, a reduction in the cost of capital and a development of domestic financial markets and institutions. It has also indirectly affected certain segments like better risk management, the improvement in macroeconomic policies and an increase in cross-border competition (Prasad et al., 2007).

The concept of globalization which is often referred to as economic globalization indicates the integration of domestic economies into the international economy through several techniques like cross-border trade, foreign direct investment and free flow of capital (Svrtinov, 2013). The economic globalization is a dynamic process where resources of a country become available to the international market; whereas, economies of a country become more independent. This signifies the removal of national barriers to facilitate the free flow of commodities, capital and currencies (Svrtinov, 2013). This process of economic globalization had only been possible with the contribution and support of financial globalization. Hence, it can be said that financial globalization is an inevitable part of the whole process of economic globalization, which integrates a nation’s financial system with the global financial markets and institutions.

Conclusion

Financial globalization has benefitted many developing and developed countries by allowing companies to access global capital markets and trade in foreign currencies. Conversely, it has also resulted in several financial crises particularly in the developing countries. The globalization of financial markets has led to a severe competition among various domestic capital and commodity markets. It allows companies worldwide to reach out to a pool of investors, who are eager to invest in foreign markets. On the contrary, it has also given huge scope to individual and institutional investors to invest in a wide range of investment options.

The role of technology and governments has been significant in the globalization and integration of the financial markets. Removing trade barriers was an important step taken by the government of several countries to facilitate financial liberalization. At the same time, the use of advanced technology and the internet made it easier for investors to access the global capital market. In spite of the cases of financial crises, neither foreign capital raisings can be prevented nor foreign investment restricted, in order to promote the growth of globalized financial markets. The financial regulators across countries are estimated to become more harmonized which can prevent such crises in the future and continue the development of global financial markets. Therefore, it can be determined that globalization had a huge impact on the financial markets across the world and after the successful integration of the global financial markets it can be depicted that financial globalization has been a major contributing factor towards the whole process of globalization.

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