1. World Bank and University of Amsterdam
Financial Stability
Stijn Claessens
World Bank and University of Amsterdam
October 25, 2006
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2. Slide 1: Outline Anatomy Dynamics Actions Consequences
Global financial integration is a long-run trend
But more two-way diversification in the 21st century
Dynamics
Globalization, deregulation and technology
Actions
International financial architecture: approach & players
Consequences
In a narrow sense and broader sense
The challenge: balance of influences
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3. Slide 2: Anatomy: Long-run trends in financial integration (according to Obstfeld)
Stylized facts (ca ):

4. Slide 3: Anatomy: price and quantity metrics
Deviations from covered interest parity

5. Slide 4: World total foreign assets and liabilities 1970-2003

6. Slide 5: Two-way diversification accelerated in the 21st century
Massive 2-way diversification differentiates the current from the earlier period of globalized capital markets
In the 19th century, most flows were “development” rather than “diversification” flows
This phenomenon finds one expression in the fact that today, most capital flows from rich to other rich countries
In the 19th century, there was a relatively greater flow from rich to poorer
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7. Slide 6: Anatomy: Foreign assets, then and now
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8. Slide 7: Dynamics: Three Major Forces
Globalization
All product markets and financial markets
Technology
Telecommunications, Internet
Deregulation
Capital account & financial services liberalization
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9. Slide 8: Globalization and Technology
Increased economic integration in all aspects
Greater specialization and economies of scale
Resulting in greater trade, also in financial services, through both capital flows and cross-border entry
Technology
Facilitating remote delivery, better telecommunications
Providing new distribution and access channels
Revamping industrial structures for financial services, by allowing entry of non-bank entities (telecoms/utilities)
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10. Slide 9: Deregulation Product, market and geography
Integrated banks offering a broad array of services
Entry of new providers. Increased (foreign) presence in many markets, more cross border FDI, M&A, etc. activity

11. Slide 10: Actions: Overview
General changes in development policies: Washington consensus being revisited, also in international finance
Financial crises in 1990s (Mexico, East Asia, Brazil, Russia) start debate on international financial architecture
Approach keeps market orientation, but adds:
Focus on enhancing attractiveness and stability of emerging markets for developed countries’ investors
Reduced risk of spillovers to the global economy
Has been called new international financial architecture
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12. Slide 11: IFA has focused on standards and enhanced surveillance
Introduced many (new) standards
Basle Core 25 Principles of Banking Supervision; OECD Corporate Governance; Fiscal/Monetary Transparency; National bankruptcy procedures, etc. Newly added: Anti-Money Laundering and Counter Terrorist Financing
Altogether more than 60 standards, of which 12 core
Strengthened national financial systems especially
Overseen by World Bank/IMF
Conducted through FSAP/ROSC process and regular surveillance
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13. Slide 12: The proposals were largely shaped by developed countries
G-7 and G-10 institutions, private and public, dominate discussions and control agenda setting
Strong financial sector lobbying and liberalization bias maintained
Emerging markets’ influence in IMF, World Bank, BIS etc. already limited and remained so
G-20 newly created, but role/input unclear
Few emerging markets represented in Financial Stability Forum
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14. Slide 13: The onus has consequently been on poor countries to adapt
Policy reflects investors’ preferences, not national development objectives
Openness to foreign financial institutions encouraged, constraints of capital mobility discouraged
Standards constrain national autonomy, but not developed countries’ and investors’ choices
One-size-fits-all solutions do not always work
Extensive legal and institutional adaptation faces political constraints
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15. Slide 14: Consequences in a narrow way…
New institutional changes, such as Sovereign Debt Reduction Mechanisms (SDRM) failed in part due to lack of support from emerging markets
Financial crises have not been avoided, e.g., Argentina, Turkey. Other near misses
Solutions continue to be ad-hoc, e.g., Argentina
Risks remain still considerable
Countries continue to adopt own solutions, e.g., foreign exchange reserves very large in Asia
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16. Slide 15: Foreign Exchange Reserves: Asia
(U.S. $ billion)
End-97
End-01
Latest
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17. Slide 16: Consequences in a broader way…
Policies not developed with development needs in mind, leading to inappropriate policies
Insufficient attention to longer run difficulties of adjustment and institutional/legal adaptation
G-7/G-10 private sectors better represented than developing countries in international organizations/fora
Legitimacy of the system affected, bad as well as good elements questioned. E.g., external monitoring, standards, review and sanctions can help countries adopt first best, but requires legitimacy to be acceptable
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