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FINANCIAL SERVICES LIBERALIZATION

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Outline

Introduction and OverviewThe Benefits of Financial ReformThe Pitfalls of ReformSetting the context : Toward the WTO

Financial Services Agreement Case Study : ThailandConclusion : Impacts of Foreign Entry on

the Domestic Banking Market

Introduction and Overview

The World Trade Organization (WTO) financial services agreement (FSA),completed on 13 December 1997,which will take effect early in 1999.

The FSA is less than meets the eyes,and our evalution suggests that is a significant agenda of market opening measures still to be taken.

Financial market development is a potentially factor in an economy’s long-term growth and development.

Financial-market development is fundamental in two ways:

Changes the speed at which capital accumulates.

Influences the efficiency of production in an economy.


How dose the FSA contribute to financial-market and to a country’s long-term growth and development? OECD-country Developing-country


The FSA promotes a country’s growth and welfare by providing a legal framework that reassures foreign institutions with long-term investments. It also provides external pressure for changes that promote sound financial institution, with domestic groups often resist to protect their own interests.


1. Internationalization ( or liberalization ) Opening domestic market to cross-border trade, allowing

entry by foreign firms, and opening the capital account.

2. Domestic financial reform Process of deregulation and strengthening domestic

financial institution

Financial Reform = 1+2


The focus of the WTO negotiations on freer cross-border trade and on foreign entry in financial services need to be understood in two contexts.

First, within the WTO, it reflects the fact that many standard policy interventions in the financial sector are untouched by GATS commitments.

Second, the FSA should be understood in terms of its contribution to financial-market development and growth.


The benefits of financial reform include faster growth.

The benefits of better financial services are illustrated in:cost savingquality improvements


The Benefits of Financial Reform

Can be relized by the households, businesses and governments that are the main users of these services.

Financial reform and internationalization in the industrialized countries have shown that:

Financial institutionSavers and investors



User also benefit from increased competition and access to foreign expertise in several intangible ways, such as improved quaility of services and wider choice.



Some countiries, however, are reluctant to deregulate fully, whereas others are reluctant to open. The reasons they cite are several.

First, the experience of countris that have deregulated their financial-market, opened those markets for foreigners, and liberalized their capital accounts has been mixed.


Objections to Deregulation and Market Opening

Second,these service, in this view, are best owned and controlled by domestic interests. More sophisticated foreign entrants, pursuingdifferent objectives, could come to dominate

Third,reform and internationalization are often politically difficult be cause, although users stand to benefit, other powerful interests stand to lose.



Agrument one by oneFirst

Reforming the domestic financial system and internationalizing it do ential risk.

Striking a balance between financial-market efficiency and economic stability is difficult.

Trade-off between economic stability and financial reform.



Two major factors influence the chances of successful adjustment to these changes.

Macroeconomic preconditions- stable and realistic price - prudent fiscal policy

Reform of the financial sector- free up interest rates - reduce subsidization of

credit- strengthen financial

institutions and their super vision



Second Foreign participation brings substantial

benefits and can be managed.Third The answer is not to halt the process of reform

and liberalization.Rather, it is to proceed while emphasizing the strengthening of the system’s ability to evaluate risk




Services that financial systems provide can be grouped into five categories:

mobilize an economy’s resources. facilitate the transactions necessary to carry on

economic exchange and trade. improve risk management by pooling and

diversifying the risks.collect and evaluate the information needed.monitor the behavior of corporate managers.

Financial institutions are considered to specialize in:

Collecting funds from saversEvaluating potentially risky borrowersAllocating the funds they collect to those uses

that promise the highest rates of return

All these services are crucial to financing growth and promoting entrepreneurship.


Idea : This chapter surveys the benefits that can be expected from financial reform and the promises of a successful WTO financial services agreement in that respect.

Increased competition will result in more efficient services and improvement in their quality and range.



The benefits to users take two forms: reduced costs of service to savers and borrowers with the introduction of more competition and improvements in from more efficient, customer-friendly financial institutions.

Benefits to Users

Benefits to savers

Receive higher rates of returnBroader choice of savings instrumentsEasier access to financial products


Benefits to Users

Benefits to borrowers

More accurate appraisal of risk Reduced waiting timesExpanded access to funds through more

sophisticated lending instruments available in a wider range of maturities

Benefits to Users


In exploring these two sources of benefits, we draw on available theoretical studies, empirical evidence, and anecdotes.

The deregulation of US intrastate bank branching in the 1980s.

The financial integration undertaken by the European Union.


Benefits to Users

Among the many users of financial services, small and medium-sized enterprises are likely to gain the most from more efficient and competitive financial services.

A study of 524 Indonesian manufacturing firms during 1981-88


Benefits to Users

Easing restrictions on financial markets and expanding competition

reduce corporate and household funding costs

Lower costs in turn reduce product prices and

Promote corporate competitiveness in international markets


Benefits to Users Cost savings

The survey by Berger, Hunter and Timme (1993) :

Technical inefficiencies account for 20 percent of bank’s cost.

Banks lose as much as 50 percent of their potential profits to inefficiency.

Two results emerge from surveying performance data :

Benefits to Users Cost savings


Users also benefit from financial services reform and internationalization in number of qualitative ways.

Increased competition brings a wider range of financial services, greater choice of institutions, new methods of services delivery, and price competition.


Benefits to Users Improved Service and Quality

Users obtain more accurate and comprehensible information

Innovative instrument to hedge risksBanks have supplemented their

traditional credit products with lower-riskFinancial services “mini-marts” offering a

range of products



Internationalization accelerates the pace at which such benefits are realized, as foreign financial institutions bring innovations in products and in service delivery.



As technological changes are introduced, users benefit from access to new distribution channels. In Taiwan, deregulation and

internationalization have brought substantial change:



The Pitfalls of Reform

Financial reform promises hefty benefits, but it also sets in motion a process of change that will impose some costs.

There are legitimate concerns about giving competitive forces free play.

But the analogy with trade in goods is useful here as well: protection against foreign competition is not the best way to address these concerns.

This chapter surveys: Three common arguments against financial

reform :That reform increases the chances of financial

crisisThat finance is a strategic sector and therefore

must remain in domestic hands and closely regulated.

That participants in the sector (and sometimes the government itself) will be hurt in bearing the burden of adjustment.


1. How Dose Financial Reform Increase the risk of crisis?

There is evidence that domestic deregulation and internationalization can expose or exacerbate problems in the presence of macroeconomic or regulatory weakness and may increase the risk that such weakness leads to a crisis.


Three Common Concerns

The answer is to address those weaknesses, within banking and in macroeconomy.

Foreign financial institutions and foreign entry are not, per se, associated with financial crises.

There is a popular impression that banking crises are associated with financial reform.


One study of banking crises noted that, in 18 of 25 cases, financial reform had occurre

d at some time in the previous 5 years.Other studies have identified a number of fa

ctors behind banking crises.Both studies agree on the association of

credit expansion with domestic reforms.


This discussion naturally leads to the interaction between opening to foreign competition and opening the capital account of the balance of payments.

In summary, a proper conceptual distinction among the issues at hand –opening to foreign competition, opening the capital account, addressing domestic banking-sector weaknesses, and stabilizing the macroeconomy –should help countries to realize that the challenge is not foreign competition per se.


2. Financial sector as strategic sector Another main reason why most countries

delay their liberalization of financial service is that financial sector is believed to as a strategic sector in economic development.

Financial sector is the medium through which most of economic transaction are conducted.


Banks also play important role in monetary transmission of monetary policy.

Developing-country governments with immature financial system often dominated by banks have tended to organize their financial systems to channel financial resources to development priorities.

Foreign financial institutions will have different priorities and will tend to ignore domestic objectives.


3. Political Economy of Financial Reform The third reason for governments' reluctance to

undertake reform relates to a set of political economy considerations about domestic costs of opening to foreign competition.

The key issue is how much benefits of foreign entry are in hands of the Thais who have less bargaining power.

The benefits are widely diffused and not well understood, making coalition building difficult.


Sequencing and Pacing Reform1. macroeconomic adjustment

2. trade liberalization

3. reform and restructure financial markets

The reasons for such a sequence are as follows

first, the capital inflow will cause a real currency appreciation

second, capital inflows may help to sustain otherwise unsustainable budget deficits


third, allowing capital inflows before liberalizing trade may cause those inflows to be channeled to the wrong industries

fourth, there is no reason to expect capital resources to be allocated to their most productive uses is the domestic financial system has not been liberalized.

In reality, there are a variety of possible reform sequences to choose from, depending on the country’s macroeconomic, financial, legal, political, and sociological conditions.


Setting the Context : Toward the WTO Financial Services Agreement

This chapter focuses on the history of the financial services negotiations in the WTO.

Beginning with the inclusion of services in the Uruguay Round.

The next section presents the General Agreement on Trade in Services (GATS).

The third section discuss the objectives of the financial services negotiations , basic stances and strategies of the negotiations.

Services in the Uruguay Round The introduction of services into the multilateral trad

e negotiations under the General Agreement on Tariffs and Trade (GATT) was one of the achievements of the Uruguay Round.

The US trade delegation officially raised trade and investment in services issues at the GATT ministerial meeting and kept the pressure on thereafter.

Eventually, the negotiating agenda was extended


Services in the Uruguay Round

The insertion of services into multilateral trade agreement recognized the growing importance of trade in services in the growth of the world economy

Most of the liberalization achieved for trade in goods should be extended to services

Services were eventually included on the Uruguay Round agenda and led to GATS

The final agreement of the Uruguay Round was completed in December 1993.


The three principles are embodied in the GATS TransparencyMost favored nation (MFN)National Treatment


Overview the GATS

The GATS includes two main elementsA core agreement with annexes and other

documents A list of commitments. ( schedule of commit

ments)


Overview the GATS

Article I of GATS identifies four modes of delivery of internationally traded servicesCross border Supply Consumption Aboard Commercial Presence Presence of nature person


Stances are divided by :

Developing- country stancesIndustrial – country stances


Objectives, stances, and Strategies

Developing-Country StancesDeveloping countries have recognized that

openness to the world economy is necessary for successful development, but there has been more hesitation about financial opening.

They are urged to caution by the financial crises that have taken place in countries that have liberalized.


Developing-Country StancesCountries have to devise an indigenous pha

sing process that takes into account initial conditions in their financial sectors.

Few of their financial firms have reached the size and efficient that could make them competitive in industrial countries’ financial markets.


Industrial – country stances The situation is different in industrial countries, whe

re financial firms have become large and powerful. Negotiations are undertaken sector by sector, a tra

de-off across sectors becomes impractical, and concessions to domestic sectoral interests in one area cannot be counterbalanced by those in another.

Finally, the success of some developing countries in catching up economically to the established industrial economies.


Case Study

THAILAND

Impacts of Foreign Entry on the Domestic Banking Market

Liberalization of financial services is a major trend recently due to necessities of financial services to support global activities such as international trade, investment and production.

Positive Aspects Liberalization of financial services lead to se

veral benefits as well as costs. Main benefits of foreign entry is higher competition in banking sector, leading to high quality, more variety of services at cheaper prices. This will benefit consumers of banking services.


(i) improve the quality and availability of financial services in the domestic financial market

(ii) serve to stimulate the development of the underlying banking supervisory and legal framework

(iii) enhance a country's access to international capital.


Negative Aspects Despite the potential benefits of financial ser

vice liberalization, there are three major concerns.

Risk of crisis

There is popular impression that banking crisis are associated with financial reform, and many government, especially in developing countries, considered an enhanced risk of crisis to be one to the costs.


Financial sector as strategic sector Another main reason why most countries delay t

heir liberalization of financial service is that financial sector is believed to as a strategic sector in economic development.

Political Economy of Financial Reform

The third reason for governments' reluctance to undertake reform relates to a set of political economy considerations about domestic costs of opening to foreign competition


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