Financial systems and development

1960s. They speeded the international transfer of Effective competition in banking, especially for
financial technology. However, one result of their corporate business, has increased with the opengrowth
was an excessive emphasis on the expan- ing of domestic markets and the creation of spesion
of bank lending, which led in the end to the cialized nonbank financial intermediaries. But redeveloping
country debt crisis of the 1980s.
tail banking has also become more competitive,
In the 1960s the main innovations of the Euro- because commercial banks are turning toward the
currency markets were revolving medium-term household sector and offering new credit, deposit,
floating rate credit facilities and the syndication of and payment instruments.
large Eurocredits among several participating Deregulation has eliminated many of the manbanks.
Later innovations included changes in ma- made barriers to global finance, and technology
turity patterns (very short-term Euronotes and has lowered the barriers imposed by nature. Ad-
Eurocommercial paper, and perpetual debt instru- vances in computing, information processing, and
ments), in pricing (floating rate notes and zero- telecommunications have boosted the volume of
coupon bonds), and in funding options (complex business by reducing transaction costs, expanding
convertible bonds and bonds issued with war- the scope of trading, and creating information sysrants).
These innovations blurred the traditional tems that enable institutions to control their risk
distinctions between equity and debt, short-term more efficiently.
and long-term debt, and bank debt and marketable Deregulation, technology, and other common
securities. The development of swaps brought trends have caused a growing convergence of naabout
greater integration of markets through the tional financial systems. Universal banks and speinternational
diffusion of new instruments and the cialized institutions as well as institutional invesopening
up of national markets previously closed tors and securities markets all now play important
to Euromarket activity.
parts in the financial systems of most high-income
Most industrial countries have encouraged the countries. Nowhere is this convergence more evidevelopment
of government bond markets, so that dent than in Japan, which has successfully exthey
can finance their public sector deficits in a panded the nonbanking segments of its financial
noninflationary way, and have established or re- system to the point that it now has the largest sevived
their money markets, so that monetary and curities houses and stock market in the world, as
credit control can be achieved through open mar- well as the largest commercial banks, postal savket
operations. All this marks a considerable shift ings bank, and housing finance institution.
in the balance of power from governments to fi- The trend of convergence has been reinforced by
nancial markets. In addition, equity markets have the vast accumulation of financial assets by both
been reformed to allow commercial banks to play households and corporations in most high-income
an active part as market makers and securities countries (Figure 3.1). This underscores the growhouses,
and new markets with less demanding ing importance of the financial sector as a service
listing requirements have been created for smaller industry and its shift from the mobilization and
companies. Governments have used fiscal incen- allocation of new financial savings to the managetives
to stimulate venture capital and personal in- ment and reallocation of existing resources.
vestments in mutual funds and equities. Financial
futures and traded options markets have been es- Current policy concerns in industrial countries
tablished to allow hedging against the greater volatility
in exchange rates, interest rates, and equity Since the late 1970s the focus of financial regulaprices
that followed the move to floating exchange tion has also shifted. There is now less emphasis
rates and the use of indirect methods to control on product and price controls and more on prumoney
and credit.
dential regulation and supervision. Another goal
Recent years have also witnessed a major expan- has been to promote competition. Financial syssion
in international transactions fueled by the ac- tems are undoubtedly more efficient as a result.
cumulation of insurance and pension reserves and But some of the changes have caused concern in
the liberalization and modernization of stock ex- developed countries. Financial institutions are exchanges.
As in the nineteenth century, however, posed to greater risks, the potential for conflicts of
this expansion of capital flows has exerted a de- interest between institutions and their customers
stabilizing influence on markets, because foreign has increased, and the implications for the longinvestors
tend to repatriate their funds in troubled term performance of industrial and commercial
times.
corporations are unclear. The widespread distress
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