Master Thesis

Contents
Abstract........................................................................................................................................................3
Introduction..................................................................................................................................................3
Statement of the Problem.............................................................................................................................5
Objectives.....................................................................................................................................................6
Research Methodology.................................................................................................................................7
Conclusion...................................................................................................................................................7
References....................................................................................................................................................9

Abstract
This papers aim is to provide useful information through a brief review as well as
analysis of the most recent trends concerning international financial integration with special focus
on the nature of financial globalization. The highlight is on the scale of cross-border positions
among the advanced economies which are growing more quickly comparing to emerging market
economies and countries in development. This paper will provide the factors that shape financial
globalization.

Introduction
Financial globalization by definition means integration of financial markets of all
countries of the world into one. It is possible only by following the global terms and conditions
across the globe for raising international loans. The differences in currencies prevent uniformity
in terms of conditions of the existing loans. That is why different currencies are seen as barrier
for such integration however it still benefits developed countries. The problem can be solved only
by setting a single worldwide currency and without that financial globalization is impossible.
From the late 90s until the late 00s emerging markets recorded growth of world GDP as
well as international trade which are most visible in the example of rapid growth in China and
India. Major role in financial globalization is also seen in increase of foreign exchange reserve
holdings as well as growth of sovereign wealth funds and the record of global imbalances which
show the most realistic picture of the current financial globalization. According to Philip R. Lane
and his research from January 2008 shows a figure where he presented fractions of global trade
and financial instruments which are accounted for by the advanced economies. The list of 23
countries has shown that their financial holdings increased while world trade shares declined.

Source: Philip R. Lane & Gian Maria Milesi-Ferretti, The Drivers of Financial Globalization, Page 2

The increase occurred despite the decrease on some of their shares of world financial
market capitalization. In the table bellow it is shown that the share that is increased is most
visible in cross-border non-reserve debt assets and debt liabilities which are debt securities, loans
and deposits, even if there is decline, as mentioned, in foreign exchange reserves.

Source: Philip R. Lane & Gian Maria Milesi-Ferretti, The Drivers of Financial Globalization, Page 2

Statement of the Problem

Advanced economies, gathered as a group represent the extensive cross-border asset
trade, and the major factor driving the trade is the pace of financial innovation regardless capital
account liberalization, financial deregulation and falling communication costs. Its growth,
however, has been driven by sectoral trends known as securitization, rise of hedge funds and
special purpose vehicles used by corporations either financial or non-financial, which was best
presented in 2007 when financial innovations in certain economy increase demand by investors,
mostly foreign from other economies, and these actions - set the strong connection between
financial innovation and financial globalization. Another factor that stimulates the growth in this
kind of asset trade is the creation of euro. The reason why this was an important step is because it
is the action of parallel actions by EU (all of its countries) to create a single currency, market in
financial services as well as having a great impact on monetary union in terms of integrating
money and credit markets across the countries that are members of the European Union. This
change has impacted financial trade in terms of increasing it with euro area boosting financial
trade with greater depth and liquidity. From the late 90s until 2006, several data showed that
intra-euro system increased share of world cross-border holdings from 13% to over 17%, as well
as external euro holdings from 21% to over 24%. Generally, single market economy or one of
developing country has a much smaller cross-border asset and liability position which is logical
since GDP of an advanced economy is much higher. Simply said, advanced countries have long
equity but short dept, while developing countries are seen as opposite. It means that the variations
in cross-border positions mean that international finance and its mechanisms is complex, where
different economies have different impact on other countries under same circumstances and
movements of financial returns.

Objectives
The focus of the paper is on some factors that are affecting international financial
integration such as: trade openness, domestic financial development, economic development,
country size, capital account restrictions, EU integration and financial centers with special focus
on advanced economies rather than developing countries. One of the drivers of financial
globalization is domestic financial development, which plays a crucial role in shaping the future
trade and position of the economy which affects the GDP as well as cross-border positions. Also,
domestic financial development can still get under the effect of foreign investment in domestic
financial system, meaning it creates domestic financial products which facilitate foreign demand
of domestic liabilities (Philippe Martin and Hlne Rey 2004). It is also important to stimulate
the engagement in cross-border asset trade to domestic residents, where they can impact
economic development meaning that larger economies allow more domestic diversity. As for the
capital restrictions it has a negative impact on foreign assets and liabilities. When considering
financial integration in the EU and the process of creating a single currency risk for intra-euro
area asset trade are closely connected to strong increase in cross-border holdings, meaning that it
allows for the possibilities that advanced economies of EU and neighbor countries that are
integrated have higher external assets and liabilities. The difference between external assets and
liabilities lies in two: firstly GDP per capita is stronger for external assets than for external
liabilities which are a positive correlation concerning economic development and net external
position. Secondly, financial development presents a stronger link for assets than for liabilities,
meaning shaping a strong relationship between domestic financial development and external
holdings.

Research Methodology
Method of research that has been used for this work is simple approach of reading of
various studies on the subject and taking basic data collected by the researchers findings. It is a
descriptive method using secondary data. None of the information presented in this paper
represent own opinions and conclusions, rather they are based on others research findings and
data that are accepted by the public. All of the literature reviews are based on academic
researches and accepted papers that present true information and similar conclusions. The paper
is a set of several other papers that present the idea of financial globalization which is a very
important topic for future researches since it is, with all the risks that may occur, beneficial to
world trade. However, there are many drivers of financial globalization and they were similarly
presented in most of the papers included in the references, and there are some that are presented
by individuals which may not be accepted by the public, rather they are taken as an option.

Conclusion
International financial integration as a future system for cross-border policies suggests
that it depends on deepening of domestic financial systems, as well as economic developments
worldwide and trading integration. What is expected to mostly affect foreign liabilities are
domestic financial sector including domestic banks, investors (institutional and individual) and
mutual funds which will also benefit private sector in terms of sustainable issuance of foreign
liabilities. With emerging of strong domestic banking sectors will enable governments to help in
capital account restrictions. However, financial integration carries some risks which are closely
connected to lower income countries which have limited trade openness and are more vulnerable
to pessimism among investors (as presented in the model of Martin and Rey 2006). Smaller

financial systems will hardly absorb shifts concerning global currency emergence as well as it
will shape the decline in home bias advanced economies all together with more advanced and
financially developed areas of the world. However, the positive link between financial
development and economic growth lies in reducing risks of crisis and the net impact long-term
growth may appear negative (Romain Ranciere, Aaron Tornell, and Frank Westermann 2008).

References

1. Chinn, Menzie and Hiro Ito. 2007. A New Measure of Financial Openness. Mimeo,
University of Wisconsin
2. International Monetary Fund, International Financial Statistics (Washington, DC:
International Monetary Fund)
3. Martin, Philippe and Helene Rey. 2006. Globalization and Emerging Markets: With or
without Crash? American Economic Review, 96(5), 1631-1651
4. The Drivers of the Financial Globalization (2008), Available at:
http://www.ecb.europa.eu/events/pdf/conferences/ecbcfs_cmfi2/Philip_Lane_paper.pdf
[29.05.2016]
5. World Bank. World Development Indicators (Washington, DC: The World Bank)