Globalization of Finance and Financial Risks

Abstract

he structural changes that have occurred in national and international finance during the past two decades can be seen as part of a complex process best described as the globalization of finance and financial risk. The key elements of this ongoing transformation have been (1) an increase in the technical capabilities for engaging in precision finance, that is, for unbundling, repackaging, pricing, and redistributing financial risks; (2) the integration of national financial markets, investor bases, and borrowers into a global financial market place; (3) the blurring of distinctions between financial institutions and the activities and markets they engage in; and (4) the emergence of the global bank and the international financial conglomerate, each providing a mix of financial products and services in a broad range of markets and countries. These changes have altered investor and borrower perceptions of financial risks and rewards around the world, and their behavior across national and international financial markets. This annex documents the broad areas of structural change that have occurred in the past decade or more. The first subsection examines the consolidation and restructuring that has occurred in the international financial services industry comprised of banks, investment banks, institutional investors, and insurance companies. The second subsection describes the increased integration of capital markets, including the greater linkages between trading exchanges and national markets. The final subsection describes the impact of information technology and mathematical models on finance, and their ability to unbundle, repackage, price, and trade precisely defined elements of financial risk, and some of its implications for risk management. The global financial services industry has been transformed during the past two decades, and aspects of this transformation appear to have accelerated in the 1990s. Two basic characteristics have defined this transformation. First, traditional banking institutions have been transformed into new financial services firms taking on new business lines and new risks—in-cluding those of institutional securities firms, insurance companies, and asset managers. Second, non-bank financial institutions—such as mutual funds, investment banks, pension funds, and insurance com-panies—now actively compete with banks both on the asset and liability sides of banks' balance sheets. In effect , the financial services industry has become deseg-mented, which is increasingly blurring the distinction between banks and nonbanks. The motives for expanding beyond traditional banking have been twofold and have operated both domestically and internationally. First, the lowering and removal of regulatory barriers has meant that banks could enter businesses that …