Should Liberalization Of Financial Markets Be Practiced?

2216 words - 9 pages

There were many discussions regarding the benefits and detrimental consequences of financial liberalizations, however the issue is still subject to continuous debates and no ultimate solution have been reached at. The main issue of the debate is that there are significant positive effects of international capital surges into developing economies, but negative consequences can quickly overshadow these benefits if short-term inflows are allowed to reach unsustainable levels. The potential costs, and possible solutions to such problems, must be weighed against the benefits in order to determine whether short-term capital should be allowed to flow, without restriction, over international boundaries.Basically capital account transactions are classified into portfolio investment and direct investment. Portfolio investment encompasses trade in securities like stocks, bonds, bank loans, derivatives, and various forms of credit (commercial, financial, guarantees). Direct investment involves the purchase of real estate, production facilities, or substantial equity investment. To answer the question whether financial liberalization is good or bad we need to analyze arguments given by both opponents and proponents of financial liberalization. First we will consider arguments against financial liberalization followed by arguments supporting the view of financial liberalization.Arguments against financial liberalizationResearch finding proving the detrimental effect of liberalization on the financial systemThe Wyplosz research paper says that the evidence based on studies of the experience with liberalization in a sample of 27 developing and developed economies seems to be converging to the view that liberalization contributes to both banking and currency crisis.A study by Eichengreen, Andrew Rose and Wyplosz (1995) found that the presence of capital controls reduces the possibility of a currency crisis. This result has been confirmed in a 1999 study by Marco Rossi (IMF working paper WP/99/66) for a sample that includes developing countriesKaminsky and Reinhart's (1999) paper explored the links between banking crises, exchange rate crises and financial liberalization. The sample consisted of twenty countries, of which fourteen were developing ones and it covered the period 1970-1995. Results of the research revealed that the banking crises are often preceded by financial liberalization.In their influential study Demirguc-Kunt and Detragiache (1998) examined banking crises during the period 1980-1984 for a sample of 53 developed and developing countries. They found that the banking systems are not sufficiently developed, with capital account liberalization, banks become vulnerable to external economic shocks, financial liberalization leads to an intensification of competition among banks and hence to greater moral hazard and risk-taking than before.Wyplosz and Ajit Singh studies in this fieldAccording to Wyplosz study, liberalization of financial markets may be...

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