Introduction to International Financial Markets Free

International Financial Markets and Financial Flows to Developing Countries

This course is made possible through the generous financial support of the Arab Gulf Program for Development (AGFUND). _For more information visit the Global Platform on Financial Inclusion _

The first part is an overview of the history of international finance in the post Second World War period.

Part 1: A Brief History of International Finance and Description of the Post 1971 Order

The Post Second World War system was based on the agreements reached at the Bretton Woods Conference in 1944 at which the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD) were established.

This system required each participating state to establish a "par value" for its currency. The par value was to be determined in reference to the U.S. Dollar, whose value was set at $35 to an ounce of gold.

This meant, for example, that governments regulated the interest rates that banks could charge their borrowers and pay their depositors.

Under this new system, each country was free to choose whatever exchange rate system it wished, with the one exception that they could not set the value of their currency in terms of gold. The result was that most countries moved to more flexible exchange rate systems.

They also began to remove restrictions on access to their financial markets.

Five Critical Developments that Help Explain the Evolution in International Financial Markets

The dramatic developments in information and communication technologies that have occurred over the past two decades have facilitated the globalization of finance.

These countries were reacting to pressures from financial institutions who wanted to respond more effectively to the needs of their clients whose activities were becoming increasingly multinational and to the changes that were taking place in financial markets.

One consequence of deregulation has been a substantial increase in international capital movements.

Over the past twenty years there has been a trend towards structuring financial transactions so that the creditors can trade the financial instruments representing the debt transaction rather than having to hold the debt to maturity. This trend has been accentuated by two related phenomena.

The second phenomenon is disintermediation, which refers to the fact that both savers and borrowers are making less use of financial intermediaries such as banks in making their financial transactions.

Similarly, borrowers are discovering that they can raise funds from these asset management vehicles and such other financial institutions as insurance companies, in addition to commercial and investment banks.

For example, in addition to standard loan agreements, borrowers can now obtain funds utilizing a range of securities.

These securities, in addition to coming in different currencies and with different maturities, may also have features that allow the holders or the issuers to structure the transaction to more closely meet their particular needs.

One consequence of the increased use of derivatives has been to strengthen the links between different financial markets and different financial actors.

It makes it possible for each of the original parties to a transaction to convert their bilateral transaction into a complex inter-linked network of transactions with entities active in different markets.

The Impact of These Developments on Developing Countries

As a result, national regulators cannot assume that all the holders of their debt instruments are citizens or residents of their jurisdiction. Some of them may be foreigners who are largely outside the scope of their jurisdiction.

This has obvious implications for monetary policy, debt and financial management and for the regulation of financial institutions and financial markets.

A second consequence is that financial markets have become stratified so that different categories of potential borrowers have very different levels of access to the markets.

The Challenges for International Finance and Financial Flows to Developing Countries

How to deal with increased uncertainty and the volatility of international financial flows? This challenge places a premium on risk management and effective regulation.

How to ensure that poor countries that are dependent on official sources of funds are able to obtain access to sufficient funds? This also implicates the issue of global economic governance because it raises the issue of how should these official sources use and can be held accountable for the use of their increased power over those member states that have become more dependent on their funds?

How to deal with the income and wealth inequalities that seem to be a feature of modern life both within countries and between countries and that seems to be related to the changes in access to and allocation of credit that have occurred over time?

Part 2: An Overview of Financial Flows to Developing Countries

Global flows of FDI will be under severe pressure this year as a result of the COVID-19 pandemic.

Flows to developing countries will be hit especially hard, as export-oriented investments and manufacturing-linked investments are among the most seriously affected.

Official v. Private Sources of Funds: Official sources are funds that are provided by the public sector. It includes governments and their agencies and instrumentalities, and international organizations.

Summary and Glossary

During this period, most countries imposed restrictions on international financial flows especially capital movements.

Major international institutional agreements after World War II, such as the Bretton Woods agreement, liberalized international trade but did not do much to free the movement of international capital flow.

That situation changed dramatically in the 1970s, and the pace of change accelerated during 1980s.

There were five developments that have influenced the evolution of financial markets as illustrated in this module.

These developments have led to massive international capital flows across boundaries. At the same time, the structure and operation of international financial markets have been transformed.

Nowadays, international financial markets are highly integrated, and transactions have become increasingly complex.

Introduction to International Financial Markets: Quiz