As the global financial system evolves, so does the financial sector. This chapter highlights the changing face of finance, both in terms of the types of financial assets and financial intermediaries that have proliferated and the regulatory changes that have accompanied these changes. Here are ways in which fiscal policy has affected the financial sector.
1. Revolution in the form of the rise of credit intermediaries
Fiscal policy has greatly increased the role played by credit intermediaries in the economy. Credit intermediation and secularization have been key agents of financial deepening throughout most of history. In many developing countries, including China and India, the central bank is generally the only credit intermediary. However, with the development of modern financial markets, there have been important shifts in this traditional pattern away from government-backed institutions and towards private banks and specialized clearinghouses. In developed economies such as Canada, Japan, and Switzerland, where regulation is more developed, new forms of retail banking and deposit insurance have emerged. These developments have been driven partly by a desire among private providers to capture market share for themselves and partly by an accompanying drive toward greater efficiency.
2. Increased role of risk management
Increased use of derivative contracts has led to growth in the number of people employed at financial firms across all world regions. These derivatives include swaps, forward currency agreements (commonly known as futures), interest rate options, credit default swap (CDS) transactions, and similar instruments. Most importantly, risk management products allow market participants to hedge positions without taking physical possession of the underlying asset. Firms can thus benefit from hedging opportunities while lowering their exposure risks on long positions or even using short selling techniques. By allowing them to take advantage of volatility premiums associated with certain positions, derivatives also enable investors to reduce their overall portfolio volatility.
3. Increased role of insurance
Insurance companies have become increasingly important players in the financial services industry. They provide a wide range of services, including property and casualty coverage, life insurance, annuities, pensions, and general liability. Insurance companies also provide liquidity to financial markets through investment operations, and they often act as re-insurers, protecting against catastrophic losses. Insurance companies generate income by charging fees for their services, but some insurers also offer returns to shareholders as dividends. Because the cost of insuring against risk varies widely depending on the type and timing of events. The business is highly profitable when low insurance costs and losses occur infrequently.
4. Changed the structure of the financial sector
As a result of globalization, financial markets have grown beyond national borders. More than 50% of global assets under custody are now located outside North America. Global financial markets consist not just of stock exchanges and securities dealers but also bond markets, commodity trading facilities, and money centers that perform functions analogous to currencies. These activities are organized into specialized areas within the financial sector, such as foreign exchange dealing, commodities and energy trading, and treasury and debt management. Major international finance centers have also arisen, including London and New York City for stocks, Tokyo for industrial shares, Hong Kong for bonds, Seoul for emerging markets, and Singapore for convertible bonds.
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