World Bank Document

Part III Mechanisms for International Financial Flows
6 The international financial system
and the developing countries
The international financial system has evolved in tant impact on economic activity in developing
response to the changing requirements of borrow- countries.
ers and lenders, most of them in the industrial The term international financial system normally
countries. It has also responded to changes in the covers the institutional arrangements for ensuring
objectives, constraints, and behavior of the finan- that the world's surplus funds flow to countries or
cial institutions operating in the system. It is there- entities in deficit, the rules governing the internafore
a dynamic system constantly adapting to the tional exchange rate regime, and the mechanisms
global economic and financial environment. The for creating and distributing liquidity. In Part III of
speed of adaptation has been faster in some parts the Report, the focus is on the institutional
of the system-particularly among banks in recent arrangements-the institutions, instruments, and
years-than it has in others. markets-for channeling finance specifically to
This chapter, which serves as an introduction to developing countries. These arrangements involve
Part III, examines the international financial sys- a wide range of participating entities-internatem
from the perspective of developing countries. tional financial institutions, governments, com-
It describes how the system has evolved and the mercial banks, and industrial companies-that
factors that have driven its evolution. Against this provide or channel funds to developing countries.
background, it suggests some criteria for assessing Sometimes the funds flow directly to developing
whether the arrangements have provided suffi- countries, but other times they flow through varicient
opportunities for developing countries to ous intermediaries and markets. Roughly 40 permanage
their external borrowing and debt success- cent of net flows to developing countries went
fully.
through intermediaries and markets in 1970, but
this figure had risen to more than 60 percent by
Functions and use of the system 1983.
The institutional arrangements relevant for
In many ways the international financial system developing countries can be divided into two
performs on a global basis what a national financial parts. The official sector contains direct channels
system does domestically. It provides a payments for capital flow-for example, bilateral aid-and a
mechanism and offers facilities for borrowing and number of intermediaries, such as the World Bank
disposing of surplus funds. It creates different and the other multilateral development banks. The
types of financial assets and liabilities, which aim private sector, too, has direct mechanisms-direct
to satisfy the portfolio preferences of lenders, foreign investment, for instance-as well as interinvestors,
and borrowers. To the extent that it is mediaries, such as commercial banks and markets
not hindered by national policies, such as controls for international bonds and other securities.
on capital movements, it helps to allocate funds to Because intermediaries of all kinds have become
their most efficient use around the world. It also increasingly important in channeling finance to
determines the ease with which capital can be developing countries, the range of maturities, curmoved
between countries, which has a significant rencies, and financial instruments offered to develinfluence
on the choices open to governments in oping countries has grown. The economies of scale
adjusting to shocks. The efficiency with which the achieved by financial intermediaries-in terms of
international financial system performs its various information, transaction costs, research, credit
functions can influence the volume of savings and assessment, and portfolio diversification-yield
investment generated in the world economy. The efficiencies that reduce costs and risks for savers
functioning of the system therefore has an impor- and borrowers. Ultimately, improvements in
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