🏦Financial Institutions and Markets Unit 19 – Global Financial Markets and Institutions

Key Concepts and Definitions

• Global financial system encompasses worldwide network of financial markets, institutions, and instruments facilitating cross-border flow of capital
• Financial globalization refers to increasing integration and interconnectedness of global financial markets and economies
• International financial markets include foreign exchange markets, international bond markets, and global equity markets
• Multinational corporations (MNCs) operate in multiple countries and play significant role in global financial system
• Foreign direct investment (FDI) involves establishing controlling ownership in foreign business entities
  • Includes greenfield investments (building new facilities) and mergers and acquisitions (M&As)
• Portfolio investment refers to purchase of foreign financial assets (stocks, bonds) without controlling ownership
• Exchange rates represent value of one currency in terms of another and impact cross-border transactions

Global Financial System Overview

• Global financial system facilitates efficient allocation of capital across borders, promoting economic growth and development
• Consists of complex network of financial markets, institutions, and infrastructure enabling flow of funds worldwide
• Includes international banking system, foreign exchange markets, global capital markets, and payment and settlement systems
  • International banking system comprises commercial banks, investment banks, and other financial institutions operating globally
  • Foreign exchange markets facilitate currency trading and determine exchange rates
• Enables cross-border trade, investment, and risk management activities
• Influenced by economic, political, and technological factors, as well as regulatory frameworks and international agreements
• Plays crucial role in global economy by mobilizing savings, allocating capital, and facilitating risk sharing
• Interconnectedness of global financial system can amplify shocks and transmit financial crises across borders

Major International Financial Markets

• Foreign exchange markets are largest financial markets globally, with daily trading volume exceeding $6 trillion
  • Facilitate currency conversion and enable cross-border transactions
  • Exchange rates determined by market forces of supply and demand, as well as economic and political factors
• International bond markets allow governments and corporations to raise debt capital from foreign investors
  • Include sovereign bonds issued by governments and corporate bonds issued by companies
  • Eurobond market is significant segment of international bond markets, with bonds issued in currencies other than issuer's domestic currency
• Global equity markets enable companies to raise equity capital from investors worldwide through initial public offerings (IPOs) and secondary market trading
  • Major stock exchanges include New York Stock Exchange (NYSE), NASDAQ, London Stock Exchange (LSE), and Tokyo Stock Exchange (TSE)
• Derivatives markets, such as futures, options, and swaps, facilitate risk management and speculation on underlying assets (currencies, interest rates, commodities)
• Money markets involve short-term borrowing and lending of funds among financial institutions and corporations

Key Global Financial Institutions

• International Monetary Fund (IMF) promotes global monetary cooperation, financial stability, and sustainable economic growth
  • Provides financial assistance to member countries facing balance of payments difficulties
  • Conducts surveillance of member countries' economic policies and provides policy advice
• World Bank Group focuses on poverty reduction and shared prosperity in developing countries
  • Comprises International Bank for Reconstruction and Development (IBRD), International Development Association (IDA), and other entities
  • Provides loans, grants, and technical assistance for development projects and policy reforms
• Bank for International Settlements (BIS) serves as bank for central banks and promotes international monetary and financial cooperation
• Central banks, such as U.S. Federal Reserve, European Central Bank (ECB), and Bank of Japan (BoJ), implement monetary policy and oversee financial stability in their respective jurisdictions
• Commercial banks, investment banks, and other financial institutions facilitate cross-border financial transactions and provide services to global clients

Financial Instruments and Products

• Foreign exchange instruments include spot transactions, forwards, futures, options, and swaps
  • Spot transactions involve immediate exchange of currencies at current market rate
  • Forwards and futures are contracts to buy or sell currencies at predetermined future date and price
• International bonds are debt securities issued by governments, corporations, and supranational organizations to raise funds from foreign investors
  • Types include fixed-rate bonds, floating-rate notes (FRNs), and zero-coupon bonds
• Global equities represent ownership stakes in companies listed on international stock exchanges
  • American Depositary Receipts (ADRs) and Global Depositary Receipts (GDRs) enable trading of foreign stocks in U.S. and other markets
• Derivatives, such as interest rate swaps and credit default swaps (CDS), help manage risks associated with interest rates, credit events, and other financial variables
• Structured products, like collateralized debt obligations (CDOs), repackage and tranch cash flows from underlying assets to meet specific investor needs

Regulatory Framework and Governance

• Basel Committee on Banking Supervision sets global standards for bank capital adequacy, liquidity, and risk management (Basel Accords)
• International Organization of Securities Commissions (IOSCO) promotes cooperation among securities regulators and sets standards for securities markets
• Financial Stability Board (FSB) coordinates global financial regulatory policies and monitors financial stability risks
• National regulatory authorities, such as U.S. Securities and Exchange Commission (SEC) and U.K. Financial Conduct Authority (FCA), oversee financial markets and institutions in their jurisdictions
  • Implement and enforce regulations related to market conduct, investor protection, and financial stability
• Anti-money laundering (AML) and combating the financing of terrorism (CFT) regulations aim to prevent misuse of financial system for illicit activities
• International accounting standards, such as International Financial Reporting Standards (IFRS), promote transparency and comparability of financial statements across countries

Market Trends and Challenges

• Increasing digitalization and adoption of financial technology (fintech) are transforming global financial landscape
  • Blockchain and distributed ledger technologies have potential to revolutionize cross-border payments, settlement, and record-keeping
  • Robo-advisors and artificial intelligence (AI) are reshaping investment management and financial advice
• Sustainable finance and environmental, social, and governance (ESG) investing are gaining prominence as investors seek to align financial returns with positive societal impact
• Geopolitical risks, such as trade tensions, political instability, and policy uncertainties, can impact global financial markets and cross-border investment flows
• Cyber threats and data privacy concerns pose significant challenges to global financial system, requiring robust cybersecurity measures and data protection frameworks
• Demographic shifts, such as aging populations in developed economies, have implications for global savings, investment, and pension systems
• Climate change and transition to low-carbon economy present both risks and opportunities for global financial markets and institutions

Real-World Applications and Case Studies

• Global financial crisis of 2007-2008 highlighted interconnectedness of global financial system and importance of effective risk management and regulation
  • Subprime mortgage crisis in U.S. triggered global liquidity crunch and led to failures of major financial institutions (Lehman Brothers)
  • Resulted in significant reforms, such as Dodd-Frank Act in U.S. and Basel III framework for bank capital and liquidity standards
• European sovereign debt crisis (2010-2012) exposed vulnerabilities in Eurozone financial system and challenged European monetary union
  • High government debt levels and weak economic growth in countries like Greece, Ireland, and Portugal led to concerns about debt sustainability
  • European Central Bank (ECB) implemented unconventional monetary policies, such as quantitative easing (QE), to stabilize markets and support economic recovery
• Rise of China as global economic and financial power has significant implications for international financial system
  • Renminbi (RMB) internationalization and inclusion in IMF's Special Drawing Rights (SDR) basket reflect China's growing influence
  • Belt and Road Initiative (BRI) involves large-scale infrastructure investments across Asia, Europe, and Africa, reshaping global trade and investment flows
• Brexit (U.K.'s withdrawal from European Union) has created uncertainties for global financial markets and institutions
  • Impacts London's status as leading global financial center and requires renegotiation of financial services agreements between U.K. and EU
• COVID-19 pandemic has posed unprecedented challenges to global financial system, causing market volatility and economic disruptions worldwide
  • Central banks and governments have implemented extraordinary fiscal and monetary measures to support economies and maintain financial stability
  • Accelerated digital transformation and remote work have reshaped financial services industry and consumer behavior