The Restructuring of the Financial System in the 21st century

The Restructuring of the Financial System in the 21st century

Elisabeth T. Pereira (University of Aveiro, Portugal)
Copyright: © 2019 |Pages: 22
DOI: 10.4018/978-1-5225-8906-8.ch002


The financial system on the first decades of the 21st century followed the trend of the last decades of the 20th century with corporate restructuring and international financial markets integration and delocalization being oriented by profits and mergers and acquisitions. The global economy and financial structure changes, in the current century, derived from financial innovations, market deregulation, globalization, technology, market structure changes, regulatory reforms, and (re)formulation of central banks' monetary policy. Currently, the financial system is interconnected, interactive, interdependent, and became over-leveraged. The present chapter focuses on the analysis of the evolution of the financial system and the main determinants of global financial markets restructuring on last decades to explain the relevant changes verified in the financial system in the 21st century. After a literature review, an evaluative and descriptive macro analysis of the financial system is presented to study the process of restructuring of the financial system in the main developed economies.
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The first decades of the 21st century reflected the changes occurred in the financial systems in the last decades of the 20th century, with corporate restructuring and international financial markets integration and delocalization; being oriented, essentially, by profits and mergers and acquisitions. These facts had repercussions on the economic and financial crisis verified in the first decade of the 21st century and in the way households and companies demand and supply the financial assets. The global economy and financial structure changes occurred both in the decade of 1990s and in the following first two decades of the current century, resulting from financial innovations, market deregulation, globalization, advances in technology, regulatory reforms of national (governments and national central banks) and international institutions (e.g., the World Bank, the International Monetary Fund (IMF), and the European Central Bank (ECB)), market structures and (re)formulation of central banks’ monetary policy.

Currently, global finance is interconnected, interactive and interdependent; and the financial system became over-leveraged. The finance and banking corporate restructuring and business processes have been influenced by the quick growth of financial markets, where companies can rapidly change owners inside the country and across country borders, and also by the emergence of financial markets of increasingly internationally open countries, as for example the countries of former Soviet Union, China, India and other emergent markets, with effects on global finances. The financial market development is positively correlated with the per capita real gross domestic product (GDP) (Beck, Demirgüç-Kunt & Levine, 2010; Mishkin, 2017).

The subject under study, in this chapter, is of great relevance to understanding the changes occurred in the financial system restructuring, which have started in the 1990s in the international financial markets and that is of paramount importance for the proper functioning of the financial, banking and insurance systems. This issue is also at the heart of understanding the functioning of the financial system as a pillar of economic growth and development (Demirgüç-Kunt & Levine, 2010; Bofinger, 2001; Cecchetti, 2006) and as an explanation for the occurrence and contagion of crises that have occurred in recent decades (Lane, 2012). Like was the example’s cases of what happened in the United States in the Great Depression of the 1930s, the economic collapse in Thailand and Indonesia with the Asian crisis of 1997 (Lindgren et al, 1999), the Russia bond default in 1998, the Korean banks default in 1998 and in United States and European countries with the Subprime crisis after 2007 (Cecchetti, 2006; Abreu et al. 2007). So, for the desirable countries’ economic growth and development in required a healthy and sustainable financial system (Mishkin, 2017; Pereira, 2019).

Key Terms in this Chapter

Securitization: Is the process of transforming illiquid financial assets (e.g., residential mortgages, auto loans, and credit card receivables) into marketable capital market securities. This is one of the most important financial innovations in the past decades.

Value Reserve: The money retains purchasing power over time, allows to separate the moment of the formation of income from the moment of its use. This function is related to the property of Liquidity that is the measure of the facility with which an asset is converted into a medium of exchange. This function results in different money settings (M0, M1, M2, M3, ...). This aggregates depending on the central bank definition.

Money: Is an asset generally accepted for payment of goods and services or for payment of debts. Money distinguishes from currency, once money is a general concept that includes currency; and currency represents the fiduciary money of notes and coins.

Conglomeration: Is the process leading to the creation of groups of financial companies operating in the different sectors of the financial system.

Asymmetric Information on the Financial Market: Consists in the fact that primary savers and primary borrowers have incomplete information about each other, the level of information being uneven between the contracting parties. If the problem resulting from asymmetric information occurs before the financial transaction we have an adverse selection problem – it occurs when insufficient information about potential borrowers leads to a poor selection of projects for which funding is requested. If the problem resulting from asymmetric information occurs after financial transformation we have a problem of moral hazard – it consists of the risk propensity of the agent contracting a loan to change the initial destination of the funds after the loan is granted. There is also another type of problem associated with asymmetric information, the problem of the principal agent or agency theory.

Financial System: The financial system represents the set of markets and intermediary institutions that coordinate the supply and demand for funds, savings and investment. The financial system allows 1) the creation of liquidity, 2) minimize transaction costs between savers and investors, 3) minimize the costs of supervising the funds, and 4) spread and dilute risks.

Money Functions: Exchange instrument or payment method that is used to pay for goods and services, allowing greater efficiency in the process of exchange by reducing transaction costs and eliminates the requirement of double coincidence of needs, leads to specialization and division of labor promoting economic efficiency.

Scriptural or Fiat Money: Instructions to the bank to withdraw funds from the depositor's account and transfer those funds to the person or company whose name is written on the order line. Examples include checks, credit notes.

Unit of Account: Is used to measure value in the economy. It eliminates the need to know all relative prices, and all prices are expressed in monetary units.

Regulation of the Financial System: Consists in the control the essential role played by the accumulation of capital and the allocation of financial resources in the process of economic development and the particularities of the financial intermediation activity and the operators involved. So, the regulation intents to prevent and avoid systematic risks, protect consumers and investors, and encourage the stability and efficiency of the financial system in the economy.

Prudential Regulation: Is related to solvency concerns and financial soundness of the intervening institutions.

Behavioral Regulation: It is associated with the way the business is conducted by financial institutions to its clients. It covers the dissemination of information.

Commercial Paper Market: Is the market where is transacted the commercial papers.

Commercial Paper: Is a short-term debt security issued by large banks and corporations.

Merchandise Money: Goods that have intrinsic value recognized by the parties involved in the exchange, for example, shells, coffee, cattle, salt, precious metals.

Fiduciary Money: The value comes from the trust decreed by the State. Represents the currency in circulation.

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