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Universal Banking Essay

1344 words - 6 pages

Universal banking is the norm in lower- and middle-income countries. Ever- expanding safety nets also seem to be the norm in the 20th century in these same countries. Is there a connection between the two? Should the structure of the financial system influence the depth or breadth of the financial safety net adopted by governments? Why or why not?

The role and the future of safety nets as an inherent feature of the majority of financial systems today have been debated widely following the recent financial and economic meltdown. In order to develop adequate reforms for the global financial system, it is important to understand the role of safety nets in both developed and developing ...view middle of the document...

Banking sector was not an exception and a small number of the most competitive and capital-endowed players gained large market shares and expanded their functions to become universal banks. Second, LMIC countries are almost always very centralized, with the institutions and businesses located in the capital serving the entire country, as opposed to a more diversified institutions of higher income countries where regional players have a stronger position. As a result, a handful of capital-based universal banks are serving the entire population in the LMIC countries. Third, national banks in these countries have to be larger in order to be able to compete with the more experienced and cost-effective foreign banks. Fourth, lack of information, incremental feature of the developing markets, makes investors allocate money in the leading banks, rather than in equity markets where transparency is crucial.

Expanding safety nets have been the main trend of LMIC financial systems’ development in the 20th century for a number of reasons. First, the main purpose of the safety nets’ creation was to provide stability to the volatile financial systems and therefore allow for economic growth. In order for the financial system to be stable, both banks and depositors should be insured against disruptive shocks. Under a safety net, depositors are guaranteed that their deposits are secure in the banks while the financial institutions are protected against such shocks as bank runs. Safety nets in the LMICs are also designed to mitigate one of the major institutional voids of the developing markets – lack of information. Consumers are often unable to protect themselves the way they would do it in more developed markets – through obtaining and analyzing reliable public information about banks, and influencing them with the help of consumer protection institutions.

Second, safety nets in the LMICs are often a part of the arrangement between governments and powerful business groups, capable of influencing government policies. They use their financial support as a leverage to promote regulations that protect their businesses and allow them to take on a higher risk, leading to the main shortcoming of a safety net – moral hazard. Third, it is common for LMICs to have a significant share of government-owned banks, which makes regulators in these countries develop safety nets in order to protect government interests. Fourth, governments in the LMICs are generally prone to the private sector intervention and imposing safety nets as one of the ways to control banks. Finally, despite the fact that safety nets were significantly restricted under the Basle I standards in the late 80’s, they were signed only by higher-income countries, making LMICs’ regulators the largest users of safety nets.

While the universal banks and safety nets in LMICs emerged because of the reasons described above, there are few factors that made them interconnect and reinforce each other....

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