International Financial Institutions' Role in Global Market Governance - Coursework Example

Several international financial s (IFIs) such as the International Monetary Fund (IMF), the World Bank, and the Asian Development Bank (ADB) have claimed leading roles in promoting global market governance. A general consensus has been hammered out regarding the global strategy to increase transparency of domestic financial sectors across the globe. Transparency is the linchpin of the global financial architecture which seeks to survive the inherent volatility of global financial markets. The prevailing distortions of information within financial markets are the key to explaining the large influx of foreign capital into emerging markets as well as its rapid departure during times of crisis. Transparency in global financial markets prevents foreign investor overreactions due to unclear market signals, quicker and smaller adjustments by investors in responding to new information, advance planning by local firms in supervising investment flows, and greater market efficiency. Global investors also demand greater market transparency, hoping that the greater flow of information regarding the actions of governments and firms in emerging market economies will allow them to better manage their investments. While few governments, banks, or private firms disagree the imporant need for an increased level of transparency, transparency still proves to be an elusive goal. These international financial institutions rely on their multilateral mandates for surveillance, financial data collection, and data diffusion. In addition, these institutions also have to contend with a whole panorama of transnational, multinational, domestic, and international persons regarding the preparation of financial information and the dissemination of the financial information. Transparency in busines is an excellent global governance strategy. Transparency needs to standardize all of the regulatory processes through which financial information is prepared for the global investor. The regulators also need to examine the specific procedures that govern the diffusion of this data. The financial information that helps investor decision encompass credit ratings, bond ratings, and measures of interest rate and exchange rate risk. The data is useful when the processes through which this information is produced are standardized across markets. The data must also highly accessible to the global markets. (Shuster, 2000) Banking can be a hugely profitable endeavor. In addition, the synergies between commercial banking and investment banks merge: a banks loan customer is doing very well and decides to take the company public. Because it already has a relationship with the company and knows its credit worthiness, a bank should be able to manage the process more easily than an outside firm. Banks became financial holding companies but not in reality, deriving most of their earnings from standard bank offerings such as deposits and loans. The market for investment banking is highly competitive and reputation is important. There are the firms that are at the top of the industry: Goldman Sachs and Morgan Stanleys. Companies which plan to go public want to be associated with a respected investment bank in order to maximize their offering price. However, the second-tier investment banks are also very profitable. The banks need to combine disparate businesses together in a way that brings greater value to customers so as to provide exceptional value to shareholders. For instance, Bank of America is successful in capital markets because it is ambitious and capable of generating profits and revenues. Competition is stiff and one needs a solid earnings base and franchise to be competitive against the strongest in this industry. The different cultures of investment and commercial banking can be challenging to blend. The corporate clients need banks to raise capital or Wall Street financing from a single advisor who understands their company and industry dynamics. The importance of a smart and competent management pool is essential when integrating investment banking with commercial banking. Investment bankers have very strong personalities with highly independent personalities and a completely different pay scale. Lehman Brothers valued its reputation very much. Reputation is a crucial issue among investment bankers. Trust among investment bankers is closely related to confidence and credibility. Trust is a relationship that develops when a group of people share a common level of understanding that the rules for behavior covering their system and society functions well. This smooth functioning leads to a better situation for everyone. With trust, less effort is expended in watching over others; hence, systems are managed more efficiently. With trust, the bank management can develop confidence that others will do what they say they will do. Therefore, trust is built over a certain period of time. Trust is related to transparency in investment banking. A move towards increasing transparency is also a move towards increasing trust. The banking industry is subject to a rigid hierarchy that ties an investment banks reputation to its relative influence in the industry. (Greider, 200). The investment banks in the upper bracket of this hierarchy such as Goldman, Sachs & Co. and Salomon Brothers wielded a more influential position than their competitors in the lower bracket. These banks have defended their position by getting out of profitable deals. The compounded events of the junk bond fiasco, the market rigging activities of Salomon Brothers, and the lawsuits pertaining to the losses suffered by corporations in trading financial derivatives have blemished the reputation of the investment banking industry among individual and institutional investors alike. (Verdier, 2002). Companies now find it more expensive to raise funds because once trust is broken; very few investors are willing to part with their funds. Then they also demand a premium for the increased risk they are willing to take. With dwindling trust, financial markets find it difficult to function well. To prevent the loss of trust in financial markets, the regulators need to repair the defects that can undermine investor confidence. There is a need for clear and transparent rules and procedures so that company auditors can reveal the financial position of all companies. The investors should be able to benefit from the veracity of company disclosure available in the rating agencies and independent financial analysts. The insiders buy or sell before positive or negative excess returns are observed which means that the insiders of the investment banks are not likely to trade based on inside information alone. (Valentine, 2007). This serious concern for reputation has a binding effect on the investment banks. Lehman Brothers has collapsed because the other investment banks refused to do business with it. Without the ability to trade, and without investors prepared to bet on its long-term viability, Lehman was pushed out of business. Lehman had engaged in a complex business trading in a web of assets. Lehman had supported 100% mortgage loans offered by specialist lenders to people with questionable means of support. When the interest rates skyrocketed at the start of the subprime crisis, borrowers failed to remit their monthly payments. Due to the prevailing economic crises, the US treasury has reached the limit of taxpayer funds it is willing to gamble on by rescuing investment banks. (Evening Standard, 2008). Lehman Brothers Asset Management (Europe branch) and other special purpose vehicles remain viable. The drop in share prices and the capital flight of foreign investors has made the sitaution of Lehman brothers worse since the company depends on their shareholders for capital. The capital provided by shareholders is the bedrock for their lending and without it they cannot continue trading. (Ramirez, Yung and Tin, 2000) Lehman Brothers was among the leading banks and financial houses which have been added as defendants of the lawsuit called the "Enron Ponzi scheme." The nine investment banks had devised the manipulative deals which concealed the true state of the company. The banks were the principal beneficiaries of the massive scam. The lawsuit documented the rampant use of freewheeling stock options. As Enron Company officials worked with the investment bankers, Enron insiders unloaded their stock options worth over $1.2 billion dollars. Enron started changing its accounting entries and inflating profits from different long-term energy contracts by booking future-year returns upfront. Instead of admitting its accounting errors, Enron put up the "special purpose entities" (SPEs) to improve its balance sheet. The basic ingredient of a Ponzi scheme is the promise of fast and generous returns paid to the first investors which are then financed with the additional money taken from new and other subsequent investors. Lehman Brothers already had serious problems regarding its liquidity levels: undisclosed credit exposure to bad mortgages and a host of poor investment decisions had led to its downfall. However, some key officers in the top management echelon were not able to deal with the problems quickly and appropriately. Fuld managed Lehman from the Sheraton Hotel in Midtown. Several investment bankers had consulted him and followed his tips. As shares dipped and recession developed, Lehman Brothers had led the market. By 2003, the company had become the fourth biggest dealmaker on Wall Street. Fuld relied on his diversification strategy which enabled the company to support its clients during volatile markets. Lehman became the most influential trader on the London Stock Exchange, and the fourth largest on the New York Stock Exchange. At the time of its permanent closure, Lehman Brothers held approximately 12% of the total US bond sector market share. After the downfall of Lehman Brothers, many investment banking analysts were deeply worried that most of the investors would withdraw their money. The problems the industry faces currently are multiple and persistent. Mortgage assets that both commercial and investment banks hold on their balance sheets continue to decline in value as buyers wait for prices to fall even further while sellers refuse to buy at the current prices being offered. At the same time, stable revenues from related transactions like debt and equity underwriting and proprietary trading were decreasing. (Upton and Weintraub, 2000) In a post-Lehman Brothers scenario, there is a need for investment banking reform. First, the financial statements which provide the linchpin on which financial markets operate must reflect the true status of a company. Clear and accurate corporate reporting is crucial. Corporate information must be presented in a candid manner. The company earnings reported annually should be used to disclose accurate information and not to hide it from shareholders and investors. Secondly, gaining confidence must be a constant effort of several corporate managers and directors, independent auditors, bank analysts, investment advisors, rating agencies and district regulators. The reputations of many investment banks have been threatened by the Lehman Brothers debacle, and by the suspicion that a few insiders have been profited from the company’s downfall at the expense of the shareholders and the general public. The government regulators need to check regularly on the private auditors to determine if they are truly independent of companies which they currently audit. Third, risk assessment needs more attention from companies outside the financial sector. Companies need to inform investors how they manage the external risks that they face and the internal risks they have chosen to take on as part of their business strategy. Normal investor transactions require that investors sign a form that informs their broker about their risk tolerance before they buy a stock. Hence, banking companies which issue stocks to the public should be able to give those investors a good disclosure of the total assessment of the risks involved their investment. To conclude, strict reprobation will be the main strategy to restore and maintain confidence that the rules are being enforced in the global financial markets. The US and foreign regulatory and supervisory bodies have to deal with the high-profile bankruptcies and the possible bankruptcies of vulnerable financial institutions in the future. As an added service, the United States Financial Accounting Standards Board is assessing proposals to determine when so-called "special-purpose entities" should be consolidated on company balance sheets. Moreover, the US Securities and Exchange Commission has also proposed an additional set of rules which demands a more detailed and timely corporate disclosure from the investment banks. References Greider, William, May 13, 2002, “The Enron Nine: Wall Street’s Most Prestigious Firms May Have Been Involved in a Ponzi Scheme,” The Nation. vol 274. Issue no 18, Page 18. “If Things Were Going Wrong at Lehman, Its Digital Mind Would Know; Tough-Guy Image: Richard Fuld Has Spent Four Decades Building a Reputation for Solidity at Lehman Brothers.” The Evening Standard. March 19, 2008. Page 38. Ramirez, Gabriel, Kenneth Yung and Jan Tin, 2000, “Firm Reputation and Insider Trading: The Investment Banking Industry,” Quarterly Journal of Business and Economics, vol 39, Issue no 3, page 49. Schuster, Leo, 2000, Shareholder Value Management in Banks, St. Martins Press, New York. Upton, Barbara and Sidney Weintraub, 2000, The Multilateral Development Banks: Improving U.S. Leadership, Praeger, Westport CT. Valentine, Lisa, 2007, “Tough Sell: Only a Small Handful of Banks Has Been Willing to Do What It Takes to Crack Investment Bankings Ranks. Clevelands Two Regionals like the Challenge.”ABA Banking Journal, vol 99, issue no 4, page 37. Verdier, Daniel, 2002, Moving Money: Banking and Finance in the Industrialized World, Cambridge University Press, London. Read More