According to Mishkin (2007), globalization is the opening of domestic markets to foreign goods and direct investment, as well as to foreign capital and foreign financial institutions. Relating to the nowadays context of the global financial crisis we will focus on the investigation of financial globalization, which is the concept referring to rising global linkages through cross-border financial flows (Prasad et al, 2003). A closely related concept that of financial integration which remarks an individual country’s linkages to international capital markets (Prasad et al, 2003). It is natural to expect that increasing financial globalization is at the same time rising financial integration. Consequently, these two concepts will be used interchangeably in this paper.
It is soundly proved that developed financial systems have a positive effect on economic growth (e.g. King and Levine, 1993; Levine, Loayza, and Beck, 2000; Honohan, 2004). It is also argued that globalization stimulates the development of financial sector and, in turn, spurs the advancement of economies. Yet, the topic of globalization and especially financial globalization has always been and still is highly controversial. This controversy could be explained by the benefits and problems it brings.
On the one hand, financial globalization creates more competitive environment due to foreign institutions/capital; allows to diversify capital allocations; domestic firms become more efficient because of spillovers from foreign firms: they bring knowledge, managerial experience, and promote technology transfer; the increased availability of funds assures higher liquidity, lower cost of capital which, in turn, leads to more investment and economic growth. On the other hand, opening up financial markets and economy to foreign capital flows can lead to financial crisis. This occurs due to mismanagement of financial liberalization/globalization processes and severe fiscal imbalances, which further leads to losses of banks and capital crash because of problems created by the presence of asymmetric information: adverse selection and moral hazard. Further, contagion effects deepen problems in financial system and result in economic contractions.
After the history and current situation of financial globalization is explained, and the controversy of the topic is explicitly revealed, we do not intend to evaluate the aggregate positive and negative effects of financial globalization and provide the judgment whether globalization is beneficial or highly flawed. Rather, we strive to show that there are ways to make globalization work so as harmful side effects could be avoided. It is necessary to understand that the causality usually runs from poor prudential regulation and supervision systems to financial crisis on the global scale, but not strictly from the globalization to financial crisis. Thus, the inferences for the future path of financial globalization with respect to the fields to be improved/changed are provided. The globalization of financial markets should be further advanced only in line with increasing regulations for safety, e.g. the introduction of the assessment of risk management, sufficient capital restrictions to banks, no regulatory forbearance. Basel II accord should be shaped in a way that it is effective not only theoretically, but also works in practice. Nowadays financial crisis shows that the regulatory framework is suboptimal and there is a need for more optimal solutions.
The paper is composed as follows. First of all, a short insight into the development of financial globalization is provided to make a reader familiar with the history of globalization, which serves as a background for interpreting the current situation. Section three presents salient advantages and disadvantages of globalization, which is the essence of economists’ disagreement about the overall impact of financial interdependence on real economy. Section four depicts the current financial crisis. Further, the role of supervisors and regulators given turbulence in financial world is considered. Further, inferences into the future with respect to financial developments are pointed out in section six. Finally, section seven concludes the report.
Contents
List of Abbreviations
Abstract
1. Introduction
2. An Insight into the History of Financial Globalization
- 2.1. The Age of Great Discoveries
2.2. Colonialism and Metropolitan States
2.3. XX Century
2.4. Steps towards Better World: Current Situation
3. The Controversy of Financial Globalization: Advantages versus Disadvantages
- 3.1. The Advantages of Globalization
- 3.1.1. Development of Domestic Financial Sector
3.1.2. Diversification
3.1.3. Reduced Cost of Capital
3.1.4. Widening Liquidity Constraints
3.2. The Disadvantages of Globalization
- 3.2.1. Financial Laissez-faire
3.2.2. Fiscal Imbalances
3.2.3. The Case study of Argentina
3.2.4. Financial Crisis
3.2.5. Currency Crisis
3.2.6. Contagion Effects
4. The Current Financial Crisis
5. Regulation and Supervision
- 5.1. The Role of the Governments
5.2. The Role of the Regulators
6. Insight into the Future of Financial Systems: Lessons to be Learnt
- 6.1. Deposit Insurance
6.2. Risk Management
6.3. Connected Lending
6.4. Activities of International Organizations
6.5. Rating Agencies
6.6. Capital Restrictions
6.7. Too Big To Fail Policy
6.8. No Regulatory Forbearance
6.9. Basel II Accord
6.10 Currency Mismatch
7. Conclusions
References
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