Private Enterprise and Financial Markets > Infrastructure and Financial Markets > Financial Markets
Liberalization and Integration of Financial Markets in the Western Hemisphere
By Paul R. Knapp, Andres Velasco (11/97, IFM97-103, En)
Executive Summary
Financial system development makes important contributions to economic performance. A well-functioning financial system channels resources and capital from those who hold them to those who can put them to productive use. By strengthening incentives to save and invest, a modern financial system spurs economic growth. By liberalizing their financial systems--making them more accessible and efficient--Western Hemisphere countries are improving their economic performance. Investment and finance have become a global matter, and, for developing and developed economies alike, liberalization is not enough. To reap all of the economic benefits that can come with contemporary financial systems, countries must integrate their domestic financial systems into the emerging global system. Integration is a key to tapping global financial resources. Much of the potential that liberalization offers in a globalized financial system is not realized without the mechanisms for smooth business and regulatory interaction that are established through integration.
Although global integration is the ultimate goal, regional and subregional integration are progressive steps along the road to global integration. In fact, regional cooperation can speed the integration process by giving the countries of the region a framework and guidelines for action; it can support progress by creating a regional network of people focused on financial system liberalization and integration; and it can bring interim benefits to the countries of the region as investment and financial transactions among them expand. Formal efforts to support regional and/or subregional integration of financial systems should be initiated. That effort should focus on adopting and implementing internationally preferred standards and practices.
Liberalization and integration efforts should be focused on creating an environment for liberalization, domestic depository/credit institutions, cross-border capital flows, foreign direct investment and foreign portfolio investment, and trade in financial services. The best environment for liberalization and integration is characterized by well-developed and stable systems of government, macroeconomic management, laws, regulation, and taxation. Also important is a high level of transparency that ensures accurate and liberal public disclosure of laws, regulatory systems and procedures, government and private sector economic information, and investment-related information. Once inflation and public finances are stabilized, domestic depository/credit institutions should be liberalized. Deposit insurance should be rationalized; lender of last resort practices should be clarified and enforced; the roles of various types of financial institutions should be clarified; regulation of banks should be strengthened; and customers should be given the incentives and opportunity to evaluate and choose between depository institutions. Constraints on cross-border capital flows should be reduced after prudent fiscal, monetary, and macroeconomic management mechanisms and practices are in place and functioning, and inflation has been stabilized. Liberalization of cross-border capital flows should be preceded or accompanied by the establishment of a framework for promoting domestic investment and by the deregulation of domestic financial systems.
Foreign investment is a powerful source of domestic economic stimulus and, at the appropriate stage of the liberalization process, the controls on foreign direct investment and foreign portfolio investment should be eliminated or at least minimized. Foreign investors should face rational and consistent policies regarding confiscation and corresponding compensation, arbitration in case of disputes, and taxation. Banking, insurance, and securities services are becoming increasingly tradable internationally and Western Hemispheric countries should liberalize their treatment. Financial services firms should have the right of free establishment and national treatment; artificial quotas and constraints on types of business that foreign firms can undertake should be eliminated; disclosure of investment information should be improved; and supervision of financial institutions should be in conformity with international standards. Financial services should be included in future negotiations of regional trade agreements.
Many Western Hemispheric countries are taking steps to reform, or liberalize, their financial systems. Included in these steps are reductions in government controls. Such reforms, which are ongoing, have generally been successful in increasing financial intermediation and in improving economic performance. The Western Hemisphere is not alone as financial system liberalization and integration are moving at a rapid pace in many forums around the world. The countries of the Western Hemisphere should continue to be an active part of both liberalization and integration--at the domestic, subregional, regional, and global levels.
The research presented in this paper was sponsored by the Inter-American Development Bank at the request of the Committee on Hemispheric Financial Issues. It was prepared by Paul R. Knapp, of the Catalyst Institute, and Andres Velasco, of New York University. The views and opinions expressed in this paper are those of the author(s) and do not necessarily reflect the official position of the Inter-American Development Bank, or any institution affiliated with the author(s). This paper may not be quoted or referred to by citation without written permission of the Inter-American Development Bank.
Last updated: 06/01/07
