The following article will highlight the five main changes in international capital market. The changes are: 1. Liquidity 2. Securitisation 3. Separation of Risk 4. Reduced Transparency 5. Changing Roles of Intermediaries.
Change # 1. Liquidity:
Changes in communication, computerisation and the increasing sophistication of modern finance allow large amounts of capital to be mobilised very rapidly. The ease with which financiers have been able to raise the capital to take over large corporations is just one of many way in which modern markets are able to generate capital funds.
Change # 2. Securitisation:
Secondly, lenders can place their money with banks and let the banks do the lending for them, or they can lend directly to the borrower through purchasing securities. One of the current tends is for more and more corporations and government borrowers, which used to borrow through banks, to borrow through securities; the process is known as securitisation. A company with a good reputation, working with an investment banker or brokerage house, can arrange an issue of securities and pay smaller fees than it would through a bank.
Change # 3. Separation of Risk:
It used to be that a lender took all the risk involved in a loan:
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(a) credit (or default) risk, which is the risk that the borrower would not repay,
(b) interest (or market) risk, the risk that interest rates would rise before the loan was due, reducing the present value of the loan,
(c) scheduling risk, the risk that tire payments would be delayed and (d) foreign exchange (or currency) risk, the risk that the currency of payment would fall in value.
The lender may not have wanted to take all these risks, and may have been in a better position to judges, and take, some of the risks rather than others. Today, the capital market can often sell the different risks separately.
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One set of techniques involves a financial institution making the judgment on the credit risk, but selling the interest rate risk. An example is a bank selling securities on mortgages or other loans, where it agrees to pay the purchasers’ interest, whether or not the underlying loan defaults.
Change # 4. Reduced Transparency:
A number of the changes that are occurring in financial markets today have the effect of making it harder to assess underlying risk. Financial institutions are probably carrying more contingent liabilities, agreeing, for instance, to buy up unsold securities, to support a secondary market, or to guarantee securitised transactions.
The health of the intermediary is much more difficult to judge when liabilities are only contingent upon a failure somewhere else. Moreover, various risk pooling and other innovative financial devices often make it quite difficult to measure the underlying risk.
Moreover, many of economists fear that in the process of reducing the role and influence of the banks, the information gathering and risk assessment in the market have declined. The riposte to that suggestion is that the separation of credit, interest and exchange rate risk places risk with specialised holders, each better able to assess the risk than a more generalised institution.
Change # 5. Changing Roles of Intermediaries:
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As the markets have changed, so have the institutions in the market. The distinction between commercial bank — which accepts deposits, holds reserves and makes loans — and an investment house or merchant bank — which underwrites and places securities issues has virtually disappeared. It is a necessary adjustment to the changes in market liquidity.
Conclusion:
Changes in the global financial markets have been great. We now even speak of “financial revolution” which has occurred in some countries and is likely to occur in other countries in near future. On a microeconomic level, the changes have served to increase competition, lower the costs of loans and apportion and divide up risk to those most willing to bear it.
Such changes are not always a good thing because the development of so many new instruments and the rapid change in the market have reduced transparency of some activities, making it harder for authorities and individual investors and borrowers to access risk.
While the increased internationalisation of the market has created a great deal more activity, much of that activity is thriving — many trades for small profits or small reductions of risk — or superior allocations of existing capital flows among lenders and borrowers. However, the capital market has not increased net flows of capital much if we ignore the five major changes that have occurred in the capital market in recent years.
In short, the internationalisation, securitisation and increases in liquidity have made monetary policy far less effective in influencing investment, particularly in developing countries. In other words, fiscal policy has become the major macro-economic tool in countries like India.