The Role Of Global Financial Development

By M. Isi Eromosele

The worldwide financial crisis has starkly highlighted the importance of financial systems and their role in supporting economic development, ensuring stability and reducing poverty.

Global Finance matters, both when it functions well and when it functions poorly. Supported by robust policies and systems, global finance works quietly in the background, contributing to economic growth and poverty reduction.  

However, impaired by poor sector policies, unsound markets and imprudent institutions, global finance can lay the foundation for financial crises, destabilizing economies, hindering economic growth and jeopardizing hard-won development gains among the most vulnerable.

Fostering sustainable financial development and improving the performance of financial systems depends on numerous institutional factors and stakeholders. The policy makers, the regulators, the bankers and the financial consumers must all play their part.

All the above participants has to be actively engaged in financial sector work, aiming to help various parts of the institutional mosaic, including regulation and supervision, corporate governance and financial infrastructure, which would ensure that the global financial sector contributes meaningfully to strong and inclusive world growth.

Sharpening the focus on the central role of global finance in socioeconomic development and understanding how financial systems can be strengthened are crucial if we are to realize the goal of boosting prosperity and eradicating poverty.

In seeking to achieve the above goal, the diversity of the modern financial systems must be recognized and used as a solid foundation. While global states have a role to play in global finance, they should avoid simplistic, ideological views. Instead, they should aim to develop a more nuanced approach to global financial sector policies based on a synthesis of new data, research, and operational experiences. 

As global states have a crucial role to play in the global financial sector, they need to provide strong prudential supervision, ensure healthy competition and enhance financial infrastructure in their respective countries.

Over longer periods, direct state involvement can have important negative effects on the global financial sector and the world economy. Therefore, as crisis conditions recede, the evidence suggests that it is advisable for governments to shift from direct to indirect interventions.

Because the global financial system is dynamic and conditions are constantly changing, regular updates are essential. Hence, there should be ongoing projects aimed at supporting systematic evaluation, improving data and fostering broader partnerships.

Future actions might address global financial inclusion, the development of local currency capital markets, the financial sector’s role in long-term financing and the global states’ role in financing health care and pensions.

These new series of analytical actions will prove useful to all stakeholders in promoting evidence-based decision making and sound financial systems for robust global economic performance.

On September 15, 2008, the failure of the U.S. investment banking giant Lehman Brothers marked the onset of the largest global economic meltdown since the Great Depression. The crisis triggered policy steps and reforms designed to contain the crisis and to prevent repetition of those events.

The crisis has prompted a major reassessment of various official interventions in global financial systems, from regulation and supervision of financial institutions and markets, to competition policy, to state guarantees and state ownership of banks and to enhancements in financial infrastructure.

It is important to use the crisis experience to examine what went wrong and how to fix it. Which lessons about the connections between finance and economic development should shape policies in coming decades?

The bigger point is that the quality of a state’s policy for the financial sector matters more than the economy’s level of development. The role of the state in global finance needs to be reassessed.

Two building blocks underlie the role of the state in global finance. First, there are sound economic reasons for the state to play an active role in financial systems. Second, there are practical reasons to be wary of the state playing too active a role in financial systems.

The tensions inherent in these two building blocks emphasize the complexity of financial policies. Though economics identifies the social welfare advantages of certain government interventions, practical experience suggests that the state often does not intervene successfully.

Furthermore, since economies and the state’s capacity to regulate differ across countries and over time, the appropriate involvement of the state in the financial system also varies case by case.

An important complicating factor is that the same government policies that ameliorate one market imperfection can create other, sometimes even more problematic distortions. For example, when the government insures the liabilities of banks to reduce the possibility of bank runs, the insured creditors of the bank may not diligently monitor the bank and scrutinize its management. This can facilitate excessive risk taking by the bank.

An even deeper issue is whether the state always has sufficient incentives to correct for market imperfections. Governments do not always use their powers to address market imperfections and promote the public interest.

Sometimes, government officials use the power of the state to achieve different objectives, including less altruistic ones, such as helping friends, family, cronies and political constituents. When this happens, the government can do serious harm in the financial system.

Determining the proper role of the state in global finance is thus as complex as it is important: one size does not fit all when it comes to policy intervention.

In less developed economies, there may seem to be more scope for the government’s involvement in spearheading financial development. However, less development is often accompanied by a less effective institutional framework, which in turn increases

the risk of inappropriate interventions.

And the role of the state naturally changes as the financial system creates new products, some of which obviate the need for particular policies while others motivate new government interventions. Reflecting this complexity, country officials and other financial sector experts often hold opposing views and opinions on the pros and cons of various state interventions.

M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance

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