World Bank Document

had a preference for U.S. government securities financial system, which may have implications for
and paper issued in the international bond and the future pattern of external financing for develnote
markets.
oping countries:
These pressures for change operate within a reg- * A gradual increase in world wealth has led to a
ulatory framework for domestic and international greater demand for financial assets and a diversififinancing.
Exchange controls, for example, were cation of asset holding across markets and currenused
extensively before the 1970s. Their abolition cies worldwide. One measure of this trend is the
in many industrial countries during the 1970s sig- share of external claims of banks in their total
nificantly increased the ability of banks to lend claims, which has increased from 8.5 percent in
abroad. Moreover, monetary controls, though 1973 to 18.4 percent in 1983. Deregulation in
aimed primarily at containing money supply domestic banking markets and the changing portgrowth
or influencing interest rates, can have folio objectives of the banks may slow this process
major international side effects: such controls in or reverse it in the future. It is possible, however,
the United States and some other industrial coun- that other forms of wealth holding may be internatries
were one reason for the growth of the off- tionalized; increased institutional purchase of forshore
Eurocurrency markets (see Box 8.3 in Chap- eign stocks and bonds might eventually lead to
ter 8). Similarly, access to the foreign bond mar:kets enhanced flows to developing countries.
has been subject to controls: the markets operate * There has been movement toward lending at
formal or informal entry requirements and queuing floating rates both in the banking markets and in
systems. The role of taxation in influencing the bond markets. In the latter the floating rate note
pattern of capital flows can also be illustrated with (35 percent of total bond issues in 1984) has
reference to the bond markets. Some govern- recently found favor, especially with banks seeking
ments, for instance, have imposed interest equali- greater marketability in their portfolios. In the
zation taxes, blunting demand for foreign issues of banking markets floating rates seem here to stay
bonds, or have removed withholding taxes in even if inflation and interest rate volatility subside.
order to encourage capital inflows for the purchase In the bond markets the issuance of fixed rate
of bonds. In general, however, the 1970s were an bonds will remain subject to periodic fluctuations
era of financial liberalization, and this had a deci- depending on inflation and interest rate expectasive
impact on the pace at which financial institu- tions. About 43 percent of developing countries'
tions internationalized their business.
long-term external debt was in floating rate form in
Prudential controls on commercial banks have 1983, compared with 16 percent in 1974.
probably had some effect on international lending * A trend has emerged toward greater use of
(see Box 8.4 in Chapter 8), although the effect is bonds and other types of securities in international
difficult to measure. Most industrial countries have lending; a so-called process of securitization may
recently urged banks to be more prudent in deal- be under way. Given the debt service difficulties of
ing with the added risks faced in international many developing countries and the high crelending.
Banking supervisors have encouraged ditworthiness required in these markets, there is a
banks to raise their capital ratios and strengthen question as to the extent to which these countries
their balance sheets. They have also sought to can benefit from the trend.
ensure that the banks have adequate means of * Major advances in information technology
assessing country risk. The increasingly global nat- and the widening of the range of business transure
of banking has led the supervisors to cooperate acted by individual financial institutions have led
to strengthen the international banking system. to an integration of financial markets. The various
Finally, political factors have combined with eco- national banking markets have been drawn
nomic pressures to limit certain types of capital together by the workings of the international interflows.
The limited constituency for aid, combined bank market (see Box 6.3) because banks are able
with budget stringencies in several industrial to switch funds quickly between markets. Close
countries, has reduced the amount or slowed the links also exist between conditions in the banking
growth of their aid in recent years. And some markets and those in the bond markets. The
developing countries have restricted inflows of advent of currency and interest rate swaps (see
equity investment to prevent their domestic Box 5.5 in Chapter 5) has helped integrate financial
resources from passing into foreign control or markets, as has the growth of hybrid instruments
ownership.
that blend features of the banking and bond mar-
Several broad trends can be discerned in the kets. The trend toward integration is important for
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