Emerging Trends in International Capital Markets

Three interrelated developments in global capital markets are:

  1. The sustained rise in gross capital flows relative to net flows;
  2. The increasing importance of securitized forms of capital flows; and
  3. The growing concentration of financial institutions and financial markets.

Taken together these trends may signal what some others have  referred to as a ‘quiet opening’ of the capital account of the balance of  payments, which is resulting in the development, strengthening and growing  integration of domestic financial systems within the international financial  system. Finance is being rationalized across national borders, resulting in a  breakdown in many countries in the distinction between onshore and offshore  finance. It is particularly evident and most advanced in the wholesale side of  the financial industry, and is becoming increasingly apparent in the retail side  as well.

Key Trends in International Capital Markets

Taken together these three effects have contributed to a sharp rise in  volatility — in both capital flows and asset prices — which may be  characterized as periods of turbulence interspersed with periods of relative  tranquility. Investor behavior (the supply of international capital) is a critical  reason behind the rise in volatility. These broad trends have some important  implications for the ongoing development of capital markets and institutions,  including those in developing countries.

1. The Sharp Rise in Gross Capital Flows

The evidence points to an acceleration of capital account opening in  most regions of the world since the late 1980s. The effects of opening in the  formal sense of liberalizing transaction taxes and regulatory and legal  restrictions on capital movements have been augmented by the liberalization  of domestic financial sectors and by technologically induced reductions in  transaction costs. This opening has resulted in a sharp rise in gross capital  movements relative to net capital movements.

2. The Rise in Securitized Forms of Capital

International capital flows have increasingly been in a securitized  form. At a global level, direct intermediation through bonds and equities has  begun to dominate more traditional forms of capital, such as syndicated bank  lending and foreign direct investment.

The current trend to securitization of capital flows to emerging  markets possibly had its origins in the global debt crisis of the 1980s. At that  time private capital movements primarily involved syndicated bank credit.  Following the extensive losses that many of the large international banks  sustained during this period, there was a marked reluctance on their part to  extend sovereign credit in the form of syndicated loans. Their espoused  strategy has been to focus on so-called bankable business, in the form of trade  credit or loans for specific commercial purposes with clearly identifiable cash  flows and/or suitable collateral. The debt and debt-service reduction  agreements at the end of the decade that resulted in the issuance of tradable,  collateral-backed Brady bonds in exchange for outstanding loans provided the  basis on which emerging market bonds have been erected. Impetus also came  from the accelerating trend in mature markets toward nonbank forms of  financial intermediation.

In the United States and Europe, the larger internationally active  banks have sought to diversify into higher margin, fee-generating activities in  an attempt to raise their return on equity. It is worth noting that this trend has  been further stimulated recently by the rapid expansion of Euro-area securities  markets, which has accelerated the shift by European banks into wholesale  finance. As noted below, the expansion of Euro-securities markets has  provided new opportunities for emerging market finance. While bank lending  is still the dominant form of corporate finance in Europe, the direction of the  trend seems clear enough. Similarly, in Japan, it is a reasonable conjecture that  restructuring of the banking system will lead in time to a marked increase in  directly intermediated finance.

3. The Consolidation of Financial Institutions

The past few years have witnessed an acceleration of consolidation  among financial institutions in mature markets and a similar trend is now  gathering momentum in emerging market countries. The main forces driving  consolidation include: attempts to reap economies of scale and scope (a search  for cost reductions driven by competitive pressures on margins and  shareholder pressure for performance); improvements in information  technology, as well as the onset of e-commerce and the spread of e-banking;  and deregulation, particularly that which is encouraging the spread of  universal banking. Most merger and acquisition activity during the past  decade has involved the banking sector, and has resulted in the creation of  large and complex financial institutions (LCFIs).

Consolidation is also affecting securities exchanges. In addition to the  effect of technology on trading, the main causal factors are the liberalization  of commissions, reduction in barriers to foreign entry, removal of antiquated  trading rules and changes to governance structures. In many countries, the  rapid growth and consolidation of private pension funds has been a major  factor driving financial sector consolidation.

Credit: International Finance-CU

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