understanding monetary policy series no. 32 globalization … monetar… · globalization of...

CENTRAL BANK OF NIGERIA

UNDERSTANDING MONETARY POLICY SERIES

NO. 32

c 2013 Central Bank of Nigeria

GLOBALIZATION OF FINANCIAL SERVICES

Chidi C. IhediwaChidi C. IhediwaChidi C. Ihediwa

10TH

ICYL DO EP PY AR RA TT ME EN NO TM

AnniversaryCommemorative

Edition

Central Bank of Nigeria33 Tafawa Balewa WayCentral Business DistrictsP.M.B. 0187Garki, AbujaPhone: +234(0)946236011Fax: +234(0)946236012Website: E-mail:

www.cbn.gov.ng [email protected]

ISBN:

© Central Bank of Nigeria

978-978-52861-5-1

iii

Central Bank of NigeriaUnderstanding Monetary PolicySeries 32, August 2013

EDITORIAL TEAM

EDITOR-IN-CHIEF

MANAGING EDITOR

EDITOR

ASSOCIATE EDITORS

Aims and Scope

Subscription and Copyright

Correspondence

Email:[email protected]

Moses K. Tule

Ademola Bamidele

Charles C. Ezema

Victor U. ObohDavid E. Omoregie

Umar B. Ndako Agwu S. Okoro

Adegoke I. Adeleke

Sunday Oladunni

Understanding Monetary Policy Series are designed to improve monetary policy communication as well as economic literacy. The series attempt to bring the technical aspects of monetary policy closer to the critical stakeholders who may not have had formal training in Monetary Management. The contents of the publication are therefore, intended for general information only. While necessary care was taken to ensure the inclusion of information in the publication to aid proper understanding of the monetary policy process and concepts, the Bank would not be liable for the interpretation or application of any piece of information contained herein.

Subscription to Understanding Monetary Policy Series is available to the general public free of charge. The copyright of this publication is vested in the Central Bank of Nigeria. However, contents may be cited, reproduced, stored or transmitted without permission. Nonetheless, due credit must be given to the Central Bank of Nigeria.

Enquiries concerning this publication should be forwarded to: Director, Monetary Policy Department, Central Bank of Nigeria, P.M.B. 0187, Garki, Abuja, Nigeria,

Oluwafemi I. Ajayi

iv

Central Bank of Nigeria

Mandate

Vision

Mission Statement

Core Values

§Ensure monetary and price stability

§Issue legal tender currency in Nigeria

§Maintain external reserves to safeguard the international

value of the legal tender currency

§Promote a sound financial system in Nigeria

§Act as banker and provide economic and financial

advice to the Federal Government

“By 2015, be the model Central Bank delivering

Price and Financial System Stability and promoting

Sustainable Economic Development”

“To be proactive in providing a stable framework for the

economic development of Nigeria through the

effective, efficient and transparent implementation

of monetary and exchange rate policy and

management of the financial sector”

§Meritocracy

§Leadership

§Learning

§Customer-Focus

v

MONETARY POLICY DEPARTMENT

Mandate

To Facilitate the Conceptualization and Design of

Monetary Policy of the Central Bank of Nigeria

Vision

To be Efficient and Effective in Promoting the

Attainment and Sustenance of Monetary and

Price Stability Objective of the

Central Bank of Nigeria

Mission

To Provide a Dynamic Evidence-based

Analytical Framework for the Formulation and

Implementation of Monetary Policy for

Optimal Economic Growth

The understanding monetary policy series is designed to support the communication of monetary policy by the Central Bank of Nigeria (CBN). The series therefore, provides a platform for explaining the basic concepts/operations, required to effectively understand the monetary policy of the Bank.

Monetary policy remains a very vague subject area to the vast majority of people; in spite of the abundance of literature available on the subject matter, most of which tend to adopt a formal and rigorous professional approach, typical of macroeconomic analysis. However, most public analysts tend to pontificate on what direction monetary policy should be, and are quick to identify when in their opinion, the Central Bank has taken a wrong turn in its monetary policy, often however, wrongly because they do not have the data for such back of the envelope analysis.

In this series, public policy makers, policy analysts, businessmen, politicians, public sector administrators and other professionals, who are keen to learn the basic concepts of monetary policy and some technical aspects of central banking and their applications, would be treated to a menu of key monetary policy subject areas and may also have an opportunity to enrich their knowledge base of the key issues. In order to achieve the primary objective of the series therefore, our target audience include people with little or no knowledge of macroeconomics and the science of central banking and yet are keen to follow the debate on monetary policy issues, and have a vision to extract beneficial information from the process, and the audience for whom decisions of the central bank makes them crucial stakeholders. The series will therefore, be useful not only to policy makers, businessmen, academicians and investors, but to a wide range of people from all walks of life.

As a central bank, we hope that this series will help improve the level of literacy in monetary policy as well as demystify the general idea surrounding monetary policy formulation. We welcome insights from the public as we look forward to delivering content that directly address the requirements of our readers and to ensure that the series are constantly updated as well as being widely and readily available to the stakeholders.

Moses K. TuleDirector, Monetary Policy DepartmentCentral Bank of Nigeria

FOREWORD

CONTENTS

vii

Section One:

Section Two: Cost and Benefits of Globalization of Financial Services

Section Three: Necessary Conditions for a Successful Financial Services Liberalization

Section Four: Globalization of Financial Services: Challenges to Monetary Policy

Section Five: Conclusion

Bibliography

Introduction .. .. .. .. .. .. 11.1 Types of Global Financial Integration .. .. .. .. 21.2 Evolution of Global Financial Services .. .. .. .. 31.3 The Early Age of Discoveries .. .. .. .. .. 31.4 The Era of Territorial Controls of Metropolitan States .. .. 41.5 The World War Experience in Financial Globalization .. .. 41.6 Development of the Present Day Financial Globalization .. 5

7

.. .. .. .. .. .. .. ..

2.1 Direct Benefits of Financial Globalization .. .. .. 7 2.1.1 Development of Domestic Financial Sector .. .. 7 2.1.2 Diversification .. .. .. .. .. .. 8

2.1.3 Reduced Cost of Capital .. .. .. .. 92.1.4 Narrowing Liquidity Constraints .. .. .. 92.1.5 Indirect Benefits of Financial Globalization .. .. 9

2.2 Adverse Effects of Financial Globalization .. .. .. 102.2.1 Fiscal Imbalances .. .. .. .. .. 102.2.2 Rapid Capital Flows Reversals .. .. .. .. 112.2.3 Rapid Spread of Shocks for Global Financial System .. 11

.. .. .. .. .. .. 133.1 Financial Sector Development .. .. .. .. 133.2 Institutional Quality .. .. .. .. .. .. 133.3 Quality of Domestic Macroeconomic Policies .. .. 133.4 Trade Integration .. .. .. .. .. .. 13

.. .. .. .. .. 154.1 Monetary Policy Transmission Mechanism in a Financially

Globalized Economy .. .. .. .. .. .. 154.2 Challenges of Financial Integration for Monetary Policy .. 16

.. .. .. .. .. .. 17

19


1

G L O B A L I Z A T I O N O F F I N A N C I A L S E R V I C E S 1

Chidi C. Ihediwa2

SECTION ONE

Introduction

Globalization of financial services refers to the process by which the economic

services provided by the finance industry are being interconnected across

boundaries around the globe. This includes the operation of broad range of

financial institutions that manage money, such as banks, insurance companies,

finance companies and some government sponsored enterprise. The

globalization of financial services can also be seen as the act or state of

application of financial services that is becoming global in coverage.

Globalization of financial services implies the synchronization of rules and

elimination or reduction of barriers to facilitate the free transfer of capital and

allow all financial services firms to compete in all markets around the world.

Financial globalization is therefore defined as the degree of openness of the

financial market to foreign investors. The overall index of financial liberalization is

comprises three sub-indexes: domestic financial liberalization, international

liberalization and stock market liberalization (Stallings 2004). Each of these sub-

indexes, in turn, is made up of several indicators.

While financial globalization could be seen as the openness of financial market to

foreign investors, globalization on its own is the growth of worldwide networks of

interdependence, including the large scale operations in finance and business,

on a world scale, irrespective of national border. Since its re-emergence in the

early 1960s, the term globalization has been used to describe a system, a force,

an age, a condition and, in some cases, an ideology. These interactions

permeate all facets of human endeavor. Thus, globalization is multi-dimensional,

spanning economic, political, cultural and social activities.

1This publication is not a product of vigorous empirical research. It is designed specifically

as an educational material for enlightenment on the monetary policy of the Bank.

Consequently, the Central Bank of Nigeria (CBN) does not take responsibility for the

accuracy of the contents of this publication as it does not represent the official views or

position of the Bank on the subject matter.

2Chidi C. Ihediwa is an Assistant Economist in the Monetary Policy Department, Central

Bank of Nigeria.


2

In the past twenty years, global financial services have witnessed an upsurge with

continued general expansion of global financial integration. This phenomenal

resurgence is now known as the Second Age of Globalization. The first age of

globalization, however, is the discovery of new territories and expansion of trade

relations to other countries. There has been tremendous growth in the portion of

financial services with significant foreign component in most countries. Moreover,

the forms of global financial services have been evolving from a type with main

cross-border capital transfers, to that which incorporates both internationally

diversified ownership of financial services and cross-border transactions. This

financial interaction includes services obtained by branches and subsidiaries of

parents firms that are situated in the host country market.

Globalization is described as a process of liberalizing national economies and

markets, expanding the spread and type of cross border transactions, based on

the productive atmosphere internationally. Mostly, globalization is driven largely

by deregulation of capital market and liberalization of trade, supported by

technological changes, which reduces the cost of communication and

transportation and improves international collaboration of services.

Financial institutions seeking to expand geographically have benefited

immensely due to recent innovations in communication and technology, leading

to a significant reduction in diseconomies of scale that is related to cost of

financial institutions business. Financial infrastructure such as ATM networks,

internet banking, online shopping, internet based payment systems and the

connectivity of various financial services has enhanced the efficiency of long-

distance interaction between financial institutions and their customers. Moreover,

customers have becomes very much dependent on the new-found ability to

transact businesses without the limitations of boundaries, such that businesses lose

competitiveness if they are connected technologically.

An additional driving force for the geographic diversification of firms, involved in

financial services, has been the proliferation of corporate consolidation strategies

aimed at improving efficiency such as mergers, acquisitions, strategic alliances

and outsourcing.

1.1 Types of Global Financial Integration

Kenen (2007) noted four types of financial integration namely:

The integration of public/government finance by way of external

borrowing, classified into two different forms: issuance of foreign currency

and local currency debts, which would be guided by foreign and local

laws. These debt instruments will can be subscribed to, by both foreigners

and locals in the home market.


3

Globalization of domestic private corporations by way of foreign direct

investment (FDIs) and equity issuance, as well as cross-border borrowing in

their countries’ market.

Globalization of financial services in the form of buying and selling of bonds

and stocks of other countries’ corporations in those countries’ asset

markets.

Integration in the form of temporary borrowing and lending of worldwide

interbank transactions of the banking sector. This option was exercised by

some countries’ commercial banks prior to the global financial crisis, but it

resulted to a very dire consequence.

1.2 Evolution of Global Financial Services

The evolution of civilization thousands of years ago, paved way for the need to

facilitate the exchange of goods and services that will enable man proffer

solution to the problem of satisfying human wants, with very limited or scarce

resources. In pre-civilization years, trade by barter was the only prevalent or legal

means of payment for goods and services. However, the barter system lacked

some major features of current means of payment. At the beginning of

civilization, the olden day Babylonian temple provided the first banking services.

Deposits in such banking entities were commodities such as wheat, live stocks,

crops, gold and other precious stones and metals. The first loan services, which

were performed in the early days, were documented in the early Babylon cities. It

could therefore, adduce that the beginning of monetary and financial systems

could be traced to Babylon. The history of financial interaction is, therefore, as old

as human existence. To appropriately understand the evolution of globalization

of financial services, there is need to discuss the various stages of development in

financial services.

1.3 The Early Age of Discoveries

Barriers in terms of geography and skills among countries, coupled with the need

to obtain resources and services, which are not obtainable in the home countries,

introduced differentiations among various countries. In addition, trading between

countries became a very important source of economic welfare as countries

moved beyond their boundaries to transact a wider range of commodities with

other countries. . Following the discovery of other territories to enable economic

advantage, the continued increase in the price of commodities impacted on the

financial system. In addition, commodities such as gold, which functioned as the

basis for money, declined sharply and the theory of neutrality of money became


4

continuous (Izmir 2009). On the whole, these issues facilitated financial

globalization.

1.4 The Era of Territorial Controls of Metropolitan States

According to Izmir (2009), the search to improve the welfare of domestic

populace in the western world led to the formation of stronger navies, which in

turn developed the trend in imperialism and foreign affair policy. As a result, the

ruling world power divided the world into colonies and protectorates for political,

religious and most especially, economic advantages. This period was a very

crucial moment in the development of financial globalization, because countries

began to interact with each other in exchange of goods and services, hence,

introducing financial activities. For this reason, most of the stronger countries

required their colonies to adopt their monetary and financial systems.

However, the development in financial activities did not improve the financial

integration of the colonies. The system practiced by the dominant countries was

not in line with natural economic conditions, because the colonies were not

integrated into their own financial system, rather the colonies were used only to

obtain resources such as labour and land, thus, neglecting developments in

such territories. Financial services within the colonies were controlled and

directed by the foreigners on behalf of their countries. Financial globalization

took off from this point as the negative side effects on the colonies gradually

phased out, leading to a much more developed financial integration of the

weaker colonies.

1.5 The World War Experience in Financial Globalization

There was a disruption in the development of financial globalization due to the

World War I and II. The world economy stagnated during the period, especially

during the great depression, which emanated immediately after the World War I.

Personal disposable income and international earnings declined drastically. The

stock market was also affected by the global economic downturn starting with

the Black Tuesday of October 29, 1929, when the stock market all over the world

crashed. The economic downturn of the 1930s was aggravated, because the

central banks could not use monetary policy instruments to correct the crisis. All

major currencies of the world (U.S. dollar (USD), Russian rubble (RUB), Japanese

yen (JPY) and British pounds (GBP)) were fixed to the gold standard. This means

that money was supported by Gold reserves. However, the short supply of gold

led to the abandonment of the standard (with the Great Britain making the first

move). This was to ensure that the supply of money was controlled. The world

wars and global economic downturn delayed financial integration by

suspending capital flow and international trade (Izmir 2009).


5

1.6 Development of the Present Day Financial Globalization

The devastation and economic slowdown emanating from the World War II, led

to many steps that were taken to create a more stable, efficient and more

integrated financial system. In order to develop a sound and robust financial

system with appropriate regulatory framework and the encouragement of global

monetary corporation, the International Monetary Fund (IMF) was established in

1944. Also, the Bretton-Woods system was established to fix most of the world

currencies to the gold standard again.

However, after a few decades of Bretton-Wood adoption, it collapsed in 1971

and instead of the gold standard; US Dollar was adopted as the reserve currency

for countries in the system.

The period after the World War II could be ascribed as the era of prosperity of

financial globalization. The period led to the transfer of capital between countries

in form of FDIs and financial assets. Also, various economic unions reinforced their

international trading policies, while there has been continued suggestion for the

establishment of a common monetary system. The world has become a global

village with accessible market for goods and services traded within and across

countries with limited barriers. Transactions across countries now include real and

tangible assets, which have been facilitated through technological

advancement in banking and banking systems. Financial globalization has been

enabled by array of complex securities, which obviates the differences in

regulatory framework and financial systems that are specific to countries. The

evolution of financial globalization has led to the profitability of firms, while it and

also imposes great responsibility on governments and international corporations

to market very safe product and become as transparent as possible.


6


7

SECTION TWO

Cost and Benefits of Globalization of Financial Services

The extent and acceptance of financial globalization during the last two

decades has been very huge. The development has attracted a lot of interest

from academics, economists and policy makers. On the one hand, is a group

that blames the rapid increase and acceptance of financial globalization as the

main cause of the recent global financial crisis, while on the other hand, are

those that believe that financial globalization is beneficial, and has contributed

positively towards reducing the impact of the financial crisis. Accordingly, this

section deliberates on the arguments behind financial globalization by

elaborating the main costs and benefits.

2.1 Direct Benefits of Financial Globalization

There is a general agreement that the openness of the world, in terms of financial

services and trade activities, makes the global economy better off. With the

presence of division of labour, diversification and free trade amongst countries,

the issue of scarcity becomes less problematic. Due to the globalization of

financial services, investors can now choose from different options of investment

opportunities both locally and internationally, this endears an efficient allocation

of funds. The available choices of investors in narrowing the risk premium

associated with a particular investment decision are always an issue of concern

for investors; hence, investors benefit more in a diversified economy. If there is

capital flows in a form of foreign direct investment (FDI), additional competitive

atmosphere emerges in the domestic economy. This forces firms to perform more

productively.

Finally, additional capital would not only mean competitiveness and

diversification, rather, it will present employment opportunities and economic

diversification. Globalization of financial services makes it easier for financial

institutions such as banks as well as consumers to meet their financial needs

through border lending channels and interest rate flexibility. These benefits are

elaborated below.

2.1.1 Development of Domestic Financial Sector

Financial openness would improve the development capacity of the local

financial sector due to the presence of foreign financial institutions and the

acquisition of technological skills and improved techniques of domestic financial

institutions. First, the participation of foreign banks means more access to foreign

financial markets and increased availability of funds. Secondly, due to the

globalization of financial services, countries or foreign investors would introduce


8

an improved regulatory and supervisory framework practiced in their countries.

Also, financial instruments and improved techniques in financial market will

develop the local market (Prasad et al, 2003). Finally, it is expected that the

competitiveness amongst the financial institutions will intensify. The presence of

foreign financial institutions will force the domestic financial institutions to become

much more effective and efficient in order to survive. This will enhance the

efficacy of domestic financial services. An advanced financial sector in an

economy will serve as a cushion for moderating any financial and economic

shocks or crisis.

Also, macroeconomic policies and regulating institutions will improve as a result of

the competitive pressure that will emanate from the “discipline effect” of

globalizing financial services (Prasad et al, 2003). This is with the assumption that it

would attract more foreign investors who will adhere and pay more attention to

the supervisory and regulatory framework in the country, in order to ensure good

investment returns. Furthermore, when an economy lifts or relaxes its restriction on

movement of funds both inwardly and outwardly, it indirectly signals to the

investors, of the likelihood of such policy been pursued in future. However, such

relaxation of capital flows restriction will immediately attract more capital to the

country in the short-term.

2.1.2 Diversification

Usually, countries may attract more capital flows from investors who are in search

of higher returns with a certain level of risk premium. Multinational institutions

canvass for higher marginal capital productivity; thus, instigating investments in

emerging markets. In addition, international corporations quest for investment in

emerging market are driven by their desire to ensure bigger marginal capital

productivity. This search also allows for diversification. As pointed by Krugman,

when trade barriers are eliminated, firms benefit in tougher competition,

economies of scale and products opened to wider market (The Economist, 2008).

The free flow of capital enables countries to benefit from spillover effect,

therefore, investment in financial services also bring other forms development in

various sectors of the economy. The capital flows attracts managerial

experience, promote information and technology development and create

employment opportunities. FDI flows also serves as an inducement for economic

growth and boosting of aggregate productivity in the country. The benefits of

capital diversification for both investors and the economies where their funds are

invested is that: for the former, it offers opportunity for higher returns and

additional risk mitigation, while for the later, it offers an opportunity for the inflow

of knowledge, technology and improvement of the overall economy (Izmir 2009).


9

2.1.3 Reduced Cost of Capital

When financial services are integrated amongst countries, the risk associated with

a particular financial service could be borne amongst countries. This would

reduce some of the systemic risk that may emanate from financial services. Since

the integration of financial services will increase capital flows across countries, in

turn, it will lead to a more liquid domestic stock market. Also, equity risk premium

will be reduced, leading to a reduction in the cost of capital as a result of

increased domestic liquidity level. Globalization will induce firms to invest more as

a result of risk diversification and lowered cost of capital for investment, thereby

promoting domestic output.

2.1.4 Narrowing Liquidity Constraints

The transfer of capital across countries does not only impact on the GDP of the

receiving country, but also improves domestic savings, giving room for

consumption or investment above normal budget constraints. The gain that

accrues from higher accessibility to loans is important for the entire business

community in every economy. If an individual or corporate organization can fund

the purchase of an asset using mortgage loan, it is probable that he/she will do

so. When foreign financial companies introduce a different kind of competition

into the local companies by lowering the cost of funds and attracting many

customers, these customers in turn channel their funds to productive ventures,

which will boost the overall output in the economy. For instance, in Nigeria, there

is high influx of foreign financial companies that render variety of products such

as insurance, banking, mortgage financing etc. The services of these companies

provide more liquidity in the system that will drive economic development.

2.1.5 Indirect Benefits of Financial Globalization

The possible indirect benefits of financial globalization are categorized into three

key important areas: namely;

Financial Sector Development

Macroeconomic Policies

Institutional Quality

Financial Sector Development

Financial openness directs funds to the banking sector and equity market, and

improve the regulatory and supervisory framework of home country. Some

country case studies have shown that the larger the presence of foreign financial

institutions, the better the quality of financial services and the more efficient, the

level of financial intermediation. For the equity market, the presumption is that

most portfolio investment inflows in stock market increases efficiency.

Globalization of financial services has also led to a lot of countries to adjust their


10

corporate structure in response to foreign competition and demand from

international investors.

Macroeconomic Policies

Globalization of financial services has led to the liberalization of capital account

of many countries. It has also increased the potential costs associated with weak

government policies and improved the benefits associated with good ones.

Countries with higher financial openness will mostly have more robust monetary

policy outcomes in terms of inflation, exchange and interest rates. Such countries

have witnessed tremendous benefits such as reserve accretion, growth in

manufacturing and favourable balance of payment.

Institutional Quality

In an open economic environment, commercial banks are the first to take huge

risks by pushing lending capacities to its limits. This occurs because the banks see

this as a very good opportunity to make extraordinary profit, due to market

expansion arising from influx of investment activities through capital transfers.

However, the existence of government safety nets during crisis, or the presence of

global monetary institutions such as the IMF, that is seen as countries’ lender of

last resort, operates as an inducement to undertake risk, referred to as moral

hazard problem. In a study by Kaminsky and Reinhart (1999), they explained that

20 years ago, 18 out of 26 financial crisis occurred five year after liberalization of

financial system. This indicates the existence of incompetence by the

management of financial firmsin the preparation for free flow of capital across

borders. In a study conducted by Mishkin (1999), it was discovered that banks

improve on lending ability by 15 – 30 per cent in a year after an economy is

liberalized. The study also indicates that lending is more than doubled, when

compared to a closed financial market regime.

2.2 Adverse Effects of Financial Globalization

2.2.1 Fiscal Imbalances

Globalization of financial services enables the government to access more

borrowing options, thereby increasing its debt liabilities. When a Government

faces budget finance difficulties,in order to fill the deficit gap, it borrows from the

banks, residents and abroad. This is usually done by issuing bonds such as the

treasury bills. But if the budget deficit persists, and it represents a significant

portion of the country’s GDP, borrowers will become suspicious of the country’s

ability to repay its debt liabilities. This will lead to the borrowers’ to demand for

increase in interest rate. On the other hand, patronage of government bonds will

decrease and the balance sheet of the financial institutions that hold

government instruments will deteriorate, meaning that the net worth of those


11

institutions will decline. The impact of these on the entire economy is that

commercial banks may slow down its lending functions due to liquidity shortage.

Additionally, there will be massive withdrawal from the banks due to public panic.

2.2.2 Rapid Capital Flows Reversals

Rapid capital flow in terms of inflows or outflows can cause serious difficulties in

macroeconomic management. An external sector with unfavourable balances

can only be financed temporarily, as hidden current account deficit can easily

emerge if foreign capitals begin to flow outward due the bleak economic

environment in the country. Thus, if the level of investment grows excessively, due

to foreign capital inflows when domestics saving is low, this will result to

macroeconomic difficulties, especially as current account deficit is directly

related to macroeconomic stability. Movement of capital across national

boundaries will become difficult to control effectively as a result of rapid

integration of financial markets. More importantly, the distinction between

destabilizing and stabilizing short-term capital flows becomes unclear. Apart from

making monetary policy transmission difficult, globalization of financial services

increases unemployment in those countries with relative low skilled labour. This is

because labour mobility is higher under globalization.

2.2.3 Rapid Spread of Shocks for Global Financial System

Another important adverse effect of financial globalization is the rapid spread of

disturbance form one financial market to another. Although such shocks can be

absorbed by large financial markets, they, however, contribute largely to the

obstacles militating against the achievement of macroeconomic stability. The

pursuit of macroeconomic stability may be undermined by rapid inflow of

capital, if such inflows are not driven by enhanced domestic economic

fundamentals. To maintain the inflow, a high interest rate regime may be

sustained with an attendant inflationary pressure, especially when the inflow

cannot be sterilized. For external sector competitiveness, real exchange rate will

continue to increase, and become counter-productive when invest commence

to move funds outwards on the realization that the economy will no longer be

productive in the long term.


12


13

SECTION THREE

Necessary Conditions for a Successful Financial Services

Liberalization

kose et al (2007) considered four major factors or conditions that could

necessitate a successful and efficient financially globalized economy, taking

cognizance of growth in an economy while lowering risks of crisis. These factors

includes; financial sector development, institutional quality, quality of domestic

macroeconomic policies and trade integration. These factors are discussed

below;

3.1 Financial Sector Development

The financial sector development of an economy determines largely the extent

to which the globalization of financial services can benefit and stabilize that

economy. The more the developed of the financial sector is, the greater the

growth benefit of capital inflows and the lower the country’s vulnerability to

financial crisis, either through direct or indirect channels.

In a developing economy such as Nigeria, with relatively shallow financial sector,

an instant shift or change in the direction of capital flows aggravate the boom-

bust cycle. Also, a mismanaged or improper domestic financial sector

liberalization may have contributed to financial.

3.2 Institutional Quality

The quality of institutions appears to play an important role in determining the

level and outcome of financial integration. It also influences the nature or the

composition of inflows into an economy, and affects macroeconomic outcomes.

Better institutional quality also helps to attract capital to a country in the form of

FDI and portfolio equity flows.

3.3 Quality of Domestic Macroeconomic Policies

The level and composition of inflows is determined by the quality of domestic

macroeconomic policies, as well as the vulnerability level of the economy to crisis

and external shocks. An effective monetary and fiscal policy enhance the growth

and benefits of financial liberalization and enables the mitigation of crisis in

economies with capital account liberalization.

3.4 Trade Integration

Trade integration associated with financial system openness improves the cost-

benefit trade-off associated with financial integration. Even though some schools


14

of thought have argued in favour of placing trade liberalization ahead of capital

account liberalization. To achieve this cost-benefit trade-off, some basic

supporting condition or threshold would be designed to determine where the

continuum of potential cost and benefits, a country ends up.


15

SECTION FOUR

Globalization of Financial Services: Challenges to Monetary Policy

The monetary policy transmission mechanism would generally improve the

efficiency of the domestic financial market. The efficacy of monetary policy

highly depends on the kind of monetary policy instrument or strategy applied. For

instance, interest rate as a monetary policy tool may not achieve its objectives

because domestic capital market is underdeveloped and commercial banks

dominate the intermediation of short-term domestic credit and foreign currency

dominated funds. In this instance, monetary policy will mainly impact on the

economy through domestic money supply and more importantly, exchange rate

management (Gudmundsson 2008).

As the domestic financial market develops, the importance of monetary policy

instruments becomes much more pronounced in the economy. This is because

firms and household finance their expenditure and investment in domestic

currency and at longer tenured maturities, either through bank credit or in the

bond markets.

4.1 Monetary Policy Transmission Mechanism in a Financially

Globalized Economy

Monetary policy transmits into a developed economic system through two major

channels. These two main channels are the interest rate and the exchange rate

channels.

The Interest Rate channel of monetary policy transmission mechanism is driven by

current and expected short-term rates, which in turn, closely corresponds to the

policy rates at normal periods. The impact of the longer-term rates is very crucial,

as consumption and investment demand is more responsive to medium and

long-term rates, than the short-term. The second is the Exchange Rate Channel:

changes in the policy rates in the home country alters the interest rate

differential, when compared to what is obtainable abroad, and immediately

affects the exchange rate. For a small open economy that may not be able to

influence the global interest rates, economic theory predicts that globalizing the

country’s financial services will gradually impact adversely on the interest rate

channel. i.e making it ineffective. However, the exchange channel will still be

useful in tackling any inflation target in the medium to long run, and

consequently, maintain some countercyclical force in the short-run. This will take

place provided that the monetary authority will allow the exchange rate to be

flexible.


16

4.2 Challenges of Financial Integration for Monetary Policy

The challenges faced by monetary policy as a result of financial globalization

can be summarized as follows:

It is becoming very difficult and almost impossible for a particular

economy to detached itself from the rest of the world;

Due to free flow of fund beyond boundaries, interest rate channel of

monetary policy is gradually becoming weaker and less predictable;

There is huge impact of speculative capital flows: causing high level of

exchange rate volatilities and sometimes significant disconnect from

fundamentals; and

Such disconnect of the exchange rate channel directly affect balance of

payment and the price of general goods and services.


17

SECTION FIVE

Conclusion

The paper has shown that globalization of financial services may present a source

of strength for an economy, but could also pose a very strong risk to such

economy. Therefore, there is need for economies intending to increase financial

openness to be mindful of all the risks that such an openness might cause. This

calls for close cooperation among world economies, so that a crisis will not

emanate from financial globalization. In that regard, the IMF has taken a big step

to foster close cooperation among countries, with its new emphasis on

multilateral surveillance, which is meant to remind the major countries that they

are jointly responsible for the stability of the international financial system.

Prior to the global financial crisis, the world financial system was relatively calm

and stable, but the latest global financial crisis provided a severe test to the

appropriate level of a country’s exposure to international financial market

activities. Economic shocks in one country may adversely affect other countries.

There is need therefore for proactive macroeconomic policies that would help to

guard against the effect of international shocks.


18


19

Bibliography

Bong-Chan K, Stulz R. M., and Warnock F. E. ((2008). Financial Globalization,

Governance, and the Evolution of the Home Bias. (Journal of Accounting

Review)

CentralBankofNigeria:http://www.cenbank.org/devfin/fininc.asp,http://www.cen

bank .org/Paymentsystem/Modes.asp

Devereux M. B. (2012). Inflation and Financial Globalization. NBER, CEPR and

University of British Columbia

Devereux M. B. and Sutherland A. (2007). Financial Globalization and Monetary

Policy. 2007 International Monetary Fund Working Paper /07/279

Kramer C. F., Poirson H. K. and Prasad A. (2008). Challenges to Monetary Policy

from Financial Globalization: The Case of India. IMF Working Paper

WP/08/131

Prasad E., Rogoff K, S. Wei and Kose M. A. (2003). Effects of Financial Globalization

on Developing Countries: Some Empirical Evidence

Gudmundsson M. (2008). Financial Globalization: key Trends and Implications for

the Transmission Mechanism of Monetary Policy (Forthcoming BIS Paper

No 38)

Izmir, Banyt J. and Raišyt V. (2009). Global Financial Crisis: Reasons, Effects and

Solutions (Stockholm School of Economics in Riga)

Kamin S. B. (2010). Financial Globalization and Monetary Policy (Board of

Governors of the Federal Reserve System, International Finance Discussion

Papers Number 1002)

Kose A. M., Prasad E., Rogoff K. and S. Wei (2006). Financial Globalization: A

Reappraisal. Working Paper 12484 http://www.nber.org/papers/w12484.

National Bureau of Economic Research.

Kose A. M., Prasad E., Rogoff K. and S. Wei (2007). Financial Globalization Beyond

the Blame Game (Finance and Development: A quarterly Publication of

The International Monetary Fund March 2007, Volume 44, Number 1.

Kenen P. B. (2007). The Benefits and Risks of Financial Globalization. Cato Journal,

Vol. 27, No. 2 (Spring/Summer 2007). Copyright © Cato Institute. All rights

reserved.

Lane P. R. (2012). Financial Globalization and the Crisis, Trinity College Dublin and

CEPR

Obaseki P. J. (2002). Globalization and the Nigerian Economy. CBN Economic &

Financial Review, Vol. 38 No. 2

Ofanson E. J., Aigbokhaevbolo O. M., and Enabulu G. O. (2010) The Financial

System in Nigeria: An Overview of Banking Sector Reforms

Ogiji P. (2007). Financial Liberalisation and Economic Growth: Lessons for Nigeria,

Ogiji P(ed) The Nigerian Economy: Challenges and Direction for Growth in

the Next 25 years. Aboki Publishers Makurdi-Ibadan-Abuja.

http://www.cenbank.org/devfin/fininc.asp

http://www.nber.org/papers/w12484


20

Omotor D. G., Ezi C. T., and Tarurhor (2007). Globalization: Opportunities and

Threat to the Nigerian Economy, Ogiji P.(ed) The Nigerian Economy:

Challenges and Direction for Growth in the Next 25 years. Aboki Publishers

Makurdi-Ibadan-Abuja.

Pavel C. and McElravey J. N. Globalization in the Financial Services Industry

(Federal Reserve Bank OF Chicago)

Regoff K. S. (2007). The Impact of Globalization on Monetary Policy, lecture notes

prepared for Yale University Okun Lectures, January.

Soludo C. C. (2008). Financial Globalisation and Domestic Monetary Policy:

Whither the Economics for the 21st Century? 40th Inaugural Lecture of the

University of Nigeria, Delivered on October 30, 2008

Taghipour A. and Mousavi (2011). The Effect of Financial Globalization on

Monetary Policy Discipline: The Evidence from 22 Developing Countries

(Money and Economy, Vol. 6, No. 1, Fall 2011)

Quadrini V. (2012). Monetary policy with Asset Price Shocks and Financial

globalization. University of Southern California and CEPR

CBN Deposit Money Banks Monthly Activities Report for March 2012

Charles F. Kramer, Hélène K. Poirson, and A. Prasad (2008). Challenges to

Monetary Policy from Financial globalization: The Case of India. IMF

Working Paper, Asia and Pacific Department


21


22

understanding monetary policy series no. 32 globalization … monetar… · globalization of...

Documents