SUERF Colloquia and Colloquia Publications 1969-2003 in Figures and Locations
Colloquium 12: Shifting Frontiers in Financial Markets
Cambridge, March 1985
President of SUERF and Chairman of the Colloquium: Mario Monti Colloquium book
Editor:Donald E. Fair
Authors:Marie-Christine Adam, Akbar Akthar, Richard Aspinwall, Andrew Bain, Morten Balling, Didier Bruneel, Carlo Cottarelli, Franco Cotula, Michel Develle, André Farber, Charles Freedman, Wolfgang Gebauer, David Gilchrist, Charles Goodhart, Christopher Johnson, Jan Koning, Patrick Lawler, Robin Leigh-Pemberton, Mario Monti, Giovanni Battista Pittaluga, Jack Revell, Tadeusz Rybczynski, Hartmut Schmidt, Niels Thygesen, Pehr Wissén.
Publishers: Martinus Nijhoff Publishers, Dordrecht/Boston/ Lancaster, 1986, xii, 361 pp.
– Shifting which frontiers?
“The shift in financial frontiers has two different dimensions. The first, which can be described as an external dimension relates to the extension of the external frontiers within which the finance industry has been operating. The extension of external frontiers in turn has two elements, that resulting in an increase of clients for the existing and new services offered by the industry but situated in a given area; and secondly, that leading to the extension of the geographical area which the services are made available. The second dimension of the shift in financial frontiers can be described as the tendency for the removal and disappearance of internal frontiers between the activities undertaken by and confined to the institutions which have tended to specialise in providing them ...” (Tadeusz M. Rybczynski, Economic Adviser, Lazard Brothers & Co, London, p. 257-258)
– Factors and motivations:
“... One reason why (the recent acceleration in structural change) may have been greater in the US and the UK is that the thrust of policy there has moved particularly towards a greater reliance on markets, which in turn has pointed towards deregulation. A second, more economic, factor distinguishing them from Germany, is the greater volatility and level of both interest rates and
inflation in the last 25 years. Some of the changes in instruments, markets, and financial behaviour, have been primarily defensive, to allow financial intermediaries to protect themselves, and in some cases their clients, against the worsening uncertainties and risks caused by such volatility ... Important though this essentially defensive response to worsening risk may have been, I do not regard it as the main factor underlying the recent structural changes;
for many of the new initiatives have been undertaken by firms striving for a larger share of the market ... Competitive pressures in domestic markets are leading to the development of new technologies to extend more efficient, lower cost methods from large customers in wholesale markets to smaller customers in retail markets ... How confident can we be that the direction of causality runs only from volatile financial markets to sophisticated innovations and not at least in part, the other way?” (Robin Leigh-Pemberton, Governor of the Bank of England, pp. 12-15)
“What were the factors responsible for the weakening and disappearance of the internal barriers between the various financial activities in the UK and those leading to the strong tendency towards conglomeration and changes in the size and character of the financial industry? Broadly speaking the factors behind this development fall into two groups. The fundamental economic factors (group) include an increase in per capita and total income and technological advance within the industry. The regulatory framework (group) cover the legal and institutional framework within which the industry operates ...” (T.M. Rybscynski, op. cit., p. 264)
“... While structural factors may often be the underlying cause of changes in the financial system, legislative factors – particularly tax legislation – have a crucial influence on their manifestation. Tax factors have a bearing on the choice between debt and equity issue, on the merits of leasing versus borrowing, and on the advantages and disadvantages of index-linked securities to both borrowers and lenders ...” (Andrew. D. Bain, Group Economic Adviser, Midland Bank, London, p. 106)
“A continued thread in these (US) stories is the importance of large budget deficits, just as the main thread in explanation of financial market change a few years ago would have been inflation. Inflation has receded substantially, but variable rate securities remain, even thrive, because real interest rates remain unstable ...” (Patrick Lawler, at the time Economist, Division of Research and Statistics, Board of Governors of the Federal Reserve System, Washington, p. 122)
“The French financial scene used traditionally to be distinguished by its profusion of regulations and its segmented markets and circuits. This situation is now in the throes of rapid and far-reaching change. Over the coming years, the developments that are now getting underway can be expected to gather added momentum, gradually bringing the financial structure of the French economy still more closely into line with that of the other leading industrial countries” (Didier Bruneel, Director, Etudes Statistiques et Monétaires, Banque de France, p. 63)
– An (apparent) digression on the persistently high real interest rates:
“... The absolute level of (real) interest rates on financial assets is of no particular consequence by itself. In particular, it is irrelevant for investment decisions into real capital unless it is related to any useful (operational) rate of return on capital investment.” (Wolfgang Gebauer, Assistant Professor, European University Institute, Florence, p. 135)
“Real interest rates are not yielding to disinflation due to the high levels of debt and insufficient savings, as the central monetary authorities have adopted a necessarily cautious attitude in an effort to prevent any resurgence of inflation ... A reasonable solution would be to reform taxation and trim the American deficit, while at the same time targeting a smaller growth rate, more in line with its domestic savings capacity. The resulting rise in household savings rate could reduce the drain on international savings. The cutback in public deficits and the continued improvement in the corporate profit ploughback rate, obtained by scaling down household consumption in other countries, would greatly contribute to rebalance world financial flows. At the end of the process could lie a lower real interest rate premium ...” (Michel Develle, Chief Economist, Banque Paribas, Paris, p. 162-164)
“Changes in the observed volatility of interest rates and inflation did not follow similar patterns across countries. Except for the general variability following the breakdown of the international monetary system, differences appear in national experiences ... We tested Fisher’s relation under the joint assumption that financial markets are efficient and that ex ante real interest rates follow a random walk. Our results show an obvious dichotomy within the sample of countries: while the model provides a reasonable approximation of the UK and the US experience, the results for the Netherlands, Belgium and Germany lead to a rejection of the joint assumption and tend to support the view that there are asymmetries in interest rate adjustments ...”
(Marie-Christine Adamand André Farber, Professors, Université Libre de Bruxelles, p. 178)
– Some major shifts:
“Because of greater competition, the emergence of liability management has produced a new financial environment in which the prevalent liabilities of the banks pay market-determined interest rates. As a consequence of the process of financial innovation, fostered by liability management, a myriad of new financial instruments has appeared in the last ten years ... The ‘marketisation’
of banking and finance – a term that refers to financial intermediation on conditions that are mainly determined by market forces – has not been restricted to the liability side of the balance sheet ... Within a more homogeneous financial system both the liabilities and the assets of financial institutions pay and earn, respectively, market-determined rates. In this financial environment interest rate adjustment has become faster and more important.” (Jan Koning, Head of Department of Financial Statistics, Netherlands’ Central Bureau of Statistics, p. 330-332)
“The main trends which seemed to emerge from our discussions were:
(abbreviated text)1.The tendency for corporate borrowers to borrow more at the short end than at the long end of the market; 2. Governments have increasingly, in contrast to corporations, been borrowing at the longer end of the market; 3. Preference for variable rather than fixed interest rates by corporations; 4. Substitution of bond for bank loan finance much more on the part of the public sector than the corporate sector; 5. Innovation in the type of instrument used; 6. New equity instruments in the small to medium sized sector; 7. International instruments ... used in preference to those available in domestic markets ...” (Christopher Johnson, Group Economic Adviser, Lloyds Bank, London, as general rapporteur, p. 349-351)
– Implications for monetary policy: are shifting frontiers destabilizing monetary control?
“... The problem that the structural changes do bring are not that they diminish the Central Bank’s power to control, but rather that the blurring of instruments and institutions make it more difficult to assess and to interpret financial developments, and thence to judge how to apply monetary controls ... In such circumstances, if these are indeed a proper reflection of today’s reality, it would hardly be possible, for the authorities to commit themselves rigidlyto achieving a specified numerical growth rate for any particular definition of money over any period much longer than a year, or two .Nevertheless in a fiat system world, there is an understandable fear that the growth of the money stock, and thence inflation, is driven by the short-term expedients of the authorities, which may not only have a bias to inflation, but also gives no basis for confidence about longer term price stability, nor even what rate of
inflation, might be reasonably expected. Against that background, there is an understandable and justifiable demand for the authorities to adopt a degree of pre-commitment, to submit themselves to certain clearly-defined rules, sufficient to allay fears about future uncertain inflation, and to provide the necessary basis of financial stability for the economic system to work effectively. It is the counter-balance between the shifting structure of the financial system on the one hand, and the need for rules and pre-commitment on the part of the authorities on the other, that makes it so hard to select an optimal form of monetary targets ...” (Charles Goodhart, Chief Adviser Monetary Policy, Bank of England, p. 324-325)
“...The demand function for money has become sufficiently unstable to offer less guidance for policy-makers than was hoped when targets for the monetary aggregates were introduced in the mid-1970s ... A purely domestic orientation of monetary policy is not stabilizing, if international factors cause the money demand function to shift. To contain the impact of such shifts there has to be some explicit external orientation of policy which brings the exchange rate into focus ...” (Niels Thygesen, Professor of Economics, Institute of Economics, University of Copenhagen, p. 24, 26)
“Shocks generated by financial innovations may seriously complicate the use of monetary targets ... In our opinion these targets still can play a vital role in monetary policy, provided that the extent and frequency of financial shocks remain with reasonable bounds. In addition to monetary target aggregates, the central bank should also pay attention to other monetary indicators, especially interest rates ...” (Jan Koning, op. cit., p. 340)
– Implications for supervision: again the supervisor’s dilemma ...
“Gilbert claimed that a policeman’s lot was not a happy one, but he could just as well have been referring to a supervisor. The supervisor must try to balance an acceptance, even an encouragement of competition, and with that innovation which leads business into new and unfamiliar territory, against the various risks of financial difficulties, whose eventually may bring down obloquy upon his head ... As the form which change takes will depend on policy and supervisory practices, the process becomes one of interactive give and take between the supervisors and the supervised. Change will be allowed to proceed more freely the greater the degree of self imposed prudential restraint exercised by the participants both in structuring their balance sheets and in their conduct of competition.” (Robin Leigh-Pemberton, op. cit., p. 16, 18)
“The need to adjust supervisory systems may arise because of weaknesses of old supervisory instruments, introduction of new financial instruments, formation of new multipurpose institutions or groups of institutions, financial innovations outside the supervised area, new information and communication technology, new control systems and reporting and auditing procedures, new tax systems, and because of changes in international financial markets ...
A continued internationalization of the financial services industry seems to imply a continued internationalization of the supervisory systems ...”
(Morten Balling, Professor, Graduate School of Business Administration, Aarhus, p. 300)
Colloquium 13: International Monetary and Financial