Definition of Globalisation, Global Financial Transactions - Coursework Example

INTRODUCTION Definition of Globalisation or financial Globalisation Globalisation as a word is very broad and can be defined in a variety of ways as most scholars seem to view it from their own unique perspectives and respective backgrounds. But for the purpose of this brief, we will take three approaches which are, social, political and economic. On social terms, Jain and Srinivasan (2008, pp 180) define globalisation as the process of linking nations together to form a worldwide community or redefining roles, possibilities and risks of different nations, resulting in a redefinition of international relations and foreign policy. From the political perspective, Boutros-Ghali (1996) sees globalisation as the interconnectedness of different nations into a single unit, making national boundaries obsolete but creating new problems and possibilities. Economically, Harris (1993, pp758) defines it as the expansion of production, distribution and marketing of goods and services across national boundaries. The following project is aimed at examining the role of government in fostering or hindering financial globalisation. It starts with looking at the evolution of financial globalisation, and looks at how and why governments may play a role in it. It then goes further to examine the pros and cons of government intervention in financial globalisation and takes a look at our case study, Northern Rock and how the effects of globalisation pushed the company to the brink of bankruptcy before proceeding to conclude. The evolution of Global Financial Transactions The extent to which government plays a role in financial globalisation can be determined by the degree of centralisation of the financial system and the existence of a financial hegemon or leading power (Germain, 2004, pp 71). This has developed from the 19th century with the world’s financial system overwhelmingly centralised in London which was organised around the activities of a small number of internationally active financial institutions (Germain, 2004, pp 71). During this period, financial governance was provided through the customs and mores and norms of the code or conduct which were supplemented by central bank cooperation operated by the government (Germain, 2004, pp 72). This practice was succeeded during the middle decades of the 20th century (The Bretton Woods era) by the American administration which established the legal and normative frameworks that governed cross border financial transactions, hence, financial governance during this period became “associated with what the American government did” (Germain, 2004, pp 72). The above two giant governing bodies no longer determine cross border transactions today, yet they are growing daily and have taken other forms of operation. How and why Governments intervenes in Financial Globalisation. Governments will generally play a role in the globalisation of financial markets for two basic reasons. These include the “increasing demand for government expenditure to smooth out fluctuations in the economy associated with external shocks and the diminishing taxation capacity by national governments due to enhanced capital mobility” as financial boarders are flung open (Kimakova, 2009, pp 395). Every sovereign government’s tax structure and expenditures are affected by globalisation is two basic ways. As there is increasing international financial integration, national governments lose part of their monopoly power over fiscal policy as they increasingly find themselves in a situation of strategic interaction with external counterparts (Bretschger and Hettich, 2002, pp 698). Also, globalisation increases uncertainty in fiscal policy, demanding structural adjustment in the economy, a process called ‘the efficiency hypothesis’ or the ‘compensation hypothesis’ (Bretschger and Hettich, 2002, pp 698). Naturally, as there is disparity in developmental level of world economies, there is also bound to be volatility in international capital flows which necessitates government action or intervention. These volatilities are largely characterised by periods of high flow which are suddenly replaced by a liquidity crunch when financing particularly to the developing or emerging markets is not readily available (Kimakova, 2009, pp 395). In the wake of the 2008 global financial crisis, it was seen that even the more developed economies were not immune to the risks of financial contagion, and thus, some political or government influence is relevant to check financial globalisation (Kimakova, 2009, pp 395). Governments also play an advisory or regulatory role through financial governance in the financial global market. By financial governance, we mean “the processes and mechanisms of decision making that generate rules which enables financial transactions to occur” (Germain, 2004, pp70). Should financial institutions be left alone to interact in the global financial markets, then there will be a lot of coercion in their behaviour particularly in cross boarder financial transactions. Thus, as a regulator in the sector, governments play the role of smoothing out this coercion. (Germain, 2004, pp 71). The most important role of governments in the global financial system has been the stabilisation of the entire system and prevention of its collapse. The judicious activity of public authorities has in recent years prevented catastrophic financial meltdowns of the entire system (Germain, 2004, pp 77). This is exemplified by the major financial powers together with the chief international financial institutions coming together to rescue key emerging market economies in the early 1994s and other individual authorities leading the way to lower interest rates during the tumultuous events of autumn of 1998 (Germain, 2004, pp 77). Secondly, the government in the global financial system plays the role of setting monetary and exchange rate policies, which paves the way for a healthy and soundly organised financial system. This is realised through the connections between capital account liberalisation, prudential regulations and systemic stability (Germain, 2004, pp 77). Thus, the government acts as regulator to ensure that financial flows are not for speculative activity but are geared or allocated to industry and trade (Arestis and Basu, 2004, pp 130). Taking part in financial globalisation, governments ensure that productive sectors are neither constrained by the price of finance no by inadequate financial flows (Arestis and Basu, 2004, pp 130). This often happens due to the fact that lender may have inadequate knowledge about a particular sector or borrowers may not be able meet lenders’ credit standards (Arestis and Basu, 2004, pp 130). Merits and demerits of Government intervention in financial Globalisation The foremost merit of government of globalization have been the opening of financial markets which has increased competition and productivity, stimulated circulation of savings worldwide, reduced unemployment and considerably increased aggregate wealth (Cavelaars, 2009, pp 397; Zolo, 2007, 23). In this respect, the common market and single currency in Europe has created vast economic zones, favouring transnational companies into countries like Greece, Czech, Portugal, Poland, Romania, Bulgaria etc which were formerly considered as the fringes of continental development in Europe (Cavelaars, 2009, pp 397; Zolo, 2007, pp 23). With the adoption of international commodity prices by sovereign states, globalization can be said to affect the equilibrium inflation rate through its impact on competitiveness which brings the global economy closer to potential, so that less is to be gained by unanticipated inflation (Cavelaars, 2009, pp 399). Governments, particularly those of the industrial nations play an indirect role in financial globalisation through their affiliation with international organisations like the World Bank and the International Monetary Fund. This has been in the form of policies imposed by influenced on, and imposed by these institutions in the name of globalisation which have greatly disfavoured the poor nations. In addition to performing functions traditionally attributed to them at the Bretton Woods in 1944, these rich nations like the USA have, for the past decade, taken enormous quantities of financial resources from poor countries and consigned them to the coffers of the wealthy nations (Zolo, 2007, pp19). The free movement of capital entails weaker power by governments to control corporations as a move to increase taxation on a multinational can be met by blackmail or threats to simply move the corporate headquarters to tax havens (Zolo, 2007, pp 10). This is the case that has seen the recent influx of corporate headquarters into the UK from France and Sweden (Zolo, 2007, pp 11). This definitely will require some level of intervention or control by sovereign governments as they lose grip over their domestic fiscal policies if globalization were to be left unchecked. The free movement of financial resources also will lead to tax evasion by unscrupulous corporations by moving their financial resources and transactions to tax havens, and thus, rendering government fiscal policies unattainable or unachievable. Generally speaking, financial globalization gives rise to perfectly integrated financial markets, which in turn, obey the ‘law of one price’. Within Europe, such gains have led to higher industrial output at lower prices due the integration as identical assets are selling at one single price. Also, globalization has led to economies of scale and scope and an increase in competitive pressure. As internal economies of scale are important in the financial sector, restricting operations within national boundaries by respective governments implies foregone cost and price reductions (Kleimeier and Sander, 2000, pp 1008). The Northern Rock Society Northern Rock a building society that was formed on 1 July 1965 from the merger of Northern Counties Permanent Building Society (established in 1850) and Rock Building Society (established in 1865), with a number of small local building societies making an amalgamation of 53 societies became a public limited company in October 1997. The bank was listed on the London Stock Exchange and authorised to operate under the Banking Act 1987. At the same time, the Northern Rock Foundation, an independent charitable body was also established with objectives to tackle disadvantage and to improve quality of life in the North East and Cumbria. In 2007, as a result of the subprime loans from the USA that caused credit markets to shrink, Northern Rock became unable to meet repayment of the loans she had taken. In order to keep the bank afloat and protect private money saved in the bank, the bank of England in February 2008, temporarily took over ownership of Northern Rock by using £13 billion of tax payers money to guarantee that The Northern Rock Foundation continues to exist. Before facing the crises, Northern Rock had established itself as the top securitisation bank making £6,1 billion in January 2007 and £10,7 billion in the first half of May 2007. In 2006, the bank was the fifth biggest British bank and made a pre-tax profit of £627 million. Northern Rock strategies from 1997 Northern Rock main strategy was borrowing cheap funds when available on the whole sale market and lending to her customers worldwide at more attractive rates than her competitors. Cheap market funds are the most risky loans since they are not secured and lack any legal backing such as government backing. When credit markets get frozen, this means there will no more funds available on the market and the bank will be unable to generate the required money for repayments. Therefore, Northern rock should now concentrate on funding her loans from retail deposits since they are secured and most often based on savings and deposits from clients. In such a way, the bank knows that they are sufficient funds before making any loans. Securitisation by all means is a good idea since it presents a better way of risk management since the risk of funding is diversified. But pooling the loans from people to put everything on give to lenders, the process works well if there is enough money circulating on the market. But when the credit dries off, it becomes difficult to raise the get back the money given out to investors especially as they too may have invested the money in other market assets. In this case therefore, it will be of great importance if not all loans are sold in form of securitised loans. Northern rock had failed to strictly implement stress tests and create avenues for lending from the Central Bank in case of illiquidity. The bank since it was mostly based in England failed to exploit her Irish outlet to get funds from the Central Bank due to negligence from management since it thought that the wholesale market was to exist for ever. Stress tests that would have been used to test the faith of the bank in case where the credit market dries up were not strictly implemented. Therefore, it will be prudent for management now to exploit all relevant avenues to tap in cash into the bank should there be a credit crisis and at same time keep a close look at the functioning of her branches. Leadership at Northern Rock up to February 2008 Leadership at Northern Rock was very ambitious, but lacked the foresight. The decision to unnecessarily take high risk without putting in place adequate measures to counter any problems is a case in hand. Management under Applegrath had involved the bank into excessive risk taking that pushed the bank to the brink of bankruptcy. Leadership blunders never ended within the bank. The decision to reduce interest rates on customer’s deposit accounts without a prior notification was a blunder on management and Applegarth as identified by the Daily Telegraph. Such decisions may cause a stampede on the bank and seriously weaken customers trust on the bank. Management under Applegarth had concentrated on borrowing huge sums of money to fund mortgages to an extent that it had loaned out six times more money than it had in their coffers. In such situations, when the credit markets from which management based as source of funding dried up and when interbank lending stopped, they had no deposits to cover the loans, therefore exposing the bank to credit risks. This was really a management flaw and lack of foresight. With increasing interest rates, Appelgrath due to lack of foresight who should have stopped borrowing money from the cheap wholesale market, went further to borrow more. A major instrument that should protect the bank in case of rising interest rates such as the insurance policy was sold as a means to raise further cash to meet their targeted growth rate of 20% per year. This act alone further exposed the bank to problems as when this was done, interest rates effectively increased. Applegrath had concentrated power in his hands so much that, the department that was in charge to monitor risks had no functions to perform. Rather than reporting to Finance Director who was in charge of managing risks, the Treasury department was now made to report directly to Applegrath. New strategies that can be followed New management has to know here that they are taking on an institution that has given a poor image to her shareholders, the government, and the customers. Mr. Sandler so far has two options; either turn the bank to a profit making institution and get the taxpayers money paid back, or fail completely and the assets of the bank be sold to reclaim any money pumped in the bank to save it from collapse. The question now is, will Mr. Sandler be able to use their competitive advantage on the mortgage market and outplay the other British banks? The advantage here is that Mr. Sandler is dealing with a bank in which he can use the fact that depositor’s accounts are backed by the government and attract more deposits from where they can give out loans at more attractive rates than other mortgage institutions on the mortgage market. But at the same time, he should be prepared for strong competition from other banks. New management should avoid in the very first place what caused the failure of their predecessors. The idea of backing loans with cheap money from the wholesale market was a risky investment. Therefore, new management should base on using retail market funds such as deposits and savings from their customers to fund any loans. Loan securitisation should be an absolute area where the bank should not fully engage all available funds. Securitisation is considered to be part of hedging the loans which are given out. But when all loans are bundled and given out to an investor, the bank should know that in times of lack of liquidity and when the investor fails to pay the loans, then the bank will be in serious problems. The bank has to use more hedging techniques such as buying insurance policies on loans. The fact that the old management team sold the insurance policy that could cover the bank in times of crisis should be avoided. The best thing to often do is to make sure that loans are often covered with an insurance policy or at least a collateral security so that if the client fails to repay the loan, the insurance policy or collateral can cover the loan. New management should be able to increase their bank outlets and make use of them in times of crisis to borrow from the European Central bank. As was the case with the former management, who failed to use their Irish outlet to seek help from the European Central Bank when other banks in Europe did, was a failure that exposed the bank when the credit markets dried up. Stress tests should be strictly applied and at all times to all factors, while keeping a keen eye on the credit market. All market signals such as increase or cuts in interest rates be watched carefully and at every stage, the management should analyse the impact of any small change on the market on the bank. Stress tests are obviously of great importance since they show the bank management what may be going wrong and the effect on the bank assets. Market indicators such as falling company share price, fall in company profits should not be ignored at any one moment. It is just a matter of keeping a good loan book, but trying to see how the bank is fairing on the stock market. A fall in stock price is an indication that bank activities may not be moving well and needs change. But when this factor is ignored and instead the bank pushes further to increase the number of loans, then it is just a bad signal to the market and the share price will obviously continue to fall thereby fall in customer confidence on the bank. Lending should be based on a certain benchmark such as the London Inter Bank Offered Rate (LIBOR). LIBOR is a common of benchmark interest rate indexes used by banks, securities houses and investors to fix the cost of borrowing in the money, derivatives and capital markets around the world and also to make adjustments to adjustable mortgage rates. An increase in LIBOR rates should reflect to management that there is increasingly liquidity pressure in funding markets internationally. Therefore, the new management should take LIBOR rates important and not ignore them as did the Applegrath team. Functions should be decentralised, giving each person that ability to function where it is necessary and only report to the Director (in this case Mr. Sandler) if absolutely needed. When powers are usurped from relevant departments and crowded on the Director, then it leaves room for mistakes especially as the Director shall now have much to do at the same time. Conclusion As Kiely (2005, pp 73) puts it, globalisation is said to refer to an increasingly interdependence world, where information flows transcend nation states and knowledge is said to be the main source of the post industrial world. Hence, the role of state becomes that of facilitating these phenomena, such as providing education and training for the labour markets (Kiely, 2005, pp 88). But events of the post cold-war and post colonial world, led to the abandonment of these narrow interests to be replaced by global governance. Such has been the recent cases in the USA and UK where serious governmental considerations are being given to the viability and desirability of the current wave of financial and market failures (Perrons and Posocco, 2009, pp 133). As advanced in the essay, the main objective of government intervention in the global financial system is to bring financial stability and to promote government’s economic and social objectives. From the above, we can say here that government intervention in the global financial market place has not really been fair, as policy has been drawn to favour the very rich, which have majority stakes in the international financial organisations. Bibliography Arestis, P., Basu, S. (2004). Financial globalisation and regulation. Research in International Business and Finance. Vol 18, pp 129-140. Boutros-Ghali (1996). Global Leadership after the Cold War. Vital Speeches of the Day. Vol 75, No 2, pp86-98. Bretschger, L., Hettich, F. (2002). 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KYKLOS, Vol. 62, No. 3, pp 394–406. Kleimeier, S., Sander, H. (2000). Regionalisation versus Globalisation in European Financial Markets: Evidence from Co-integrating analyses. Journal of Banking & Finance. Vol 24, pp 1005-1043. Pieterse, J. N. (2000). Global Futures: Shaping Globalization. Zed Books. London. Perrons, D., Posocco, S. (2009). Globalising failures. Geoforum. Vol. 40, pp 131-135. Zolo, D. (2007). Globalisation: An Overview. ECPR press monographs. Web site consulted http://companyinfo.northernrock.co.uk/investorRelations/corporateProfile/, retrieved on 05-12-2010 at 20,05pm Read More