Rym Ayadi

Financial Sector Development Scenarios

This chapter presents future scenarios of the financial system development in SEMC. If the analyzed countries adopt the best European practices, bank credit to the private sector, banks’ meta-efficiency and stock market turnover could reach much higher levels, although they would be still lower than the best performers in Europe. More specifically, we find that improving the quality of institutions, increasing per capita GDP, further opening capital accounts, and lowering inflation are necessary before financial systems in the SEMC are able to converge with those of Europe.

Convergence of Banking Regulation

Despite some convergence in regulation, the banking sectors of the SEMC suffer from weak deposit insurance, entry obstacles, political interference, and lack of legal rights. Deposit insurance systems in many of the SEMC are not explicit, leading to uncertainties in the provision of support to banks in case of default. Most of these banking systems do not align the banks’ incentives in risk-taking with those of taxpayers by implementing risk-based premiums. Barriers to entry into the sector and government ownership of banks are issues. Some of the SEMC have not caught up with the increase in supervisory independence in the EU-MED in the 2000s. While creditor protection remains weak, improvements in credit information have occurred since 2003 through the establishment of private credit bureaus with universal coverage.

Compelling International Initiatives

The previous chapter outlined some of the key areas of growth while highlighting the reputational risks faced by financial centres. The discussion started with the late 1990s, with first the G-7 and then the G-20 countries partly driving a change in the operating environment of financial centres. In addition to the regional roles of specific jurisdictions or supranational bodies (such as the EU), the sector-specific initiatives have been divided up between different international organizations.

Risks and Opportunities

The following discussion will cover the most important challenges and opportunities awaiting the small financial centres during the rest of the 2010s. The objective is not to provide an exhaustive list of potential issues but simply a general overview of the main factors and forces that may drive change within the period foreseen. The main issues considered will be: the short- to mid-term impact of the financial crisis; the renewed drive to regulate the financial market, especially in the EU; the growing attention paid to global cooperation on tax competition; fiscal concerns in most developed countries; and the shifting poles of global economic activity and wealth.

Conclusions and the Way Forward

The external environment awaiting European small financial centres is likely to change in the upcoming years. The fiscal challenges in most advanced Western economies, due both to the crisis responses and to the aging population, is likely to lead to higher taxes and fiscal problems. The financial crisis has also led to a new regulatory drive, widening both the scope and depth of financial market regulations. As the increased importance of the G-20 clearly attests, there is also an agreement to achieve greater global coordination and governance. Reputation is becoming capital, with small financial centres that have weak records facing increasing scrutiny and substantial drawbacks in the international political arena. Meanwhile, global wealth is increasingly shifting to the East and towards the emerging economies, posing concentration risks to the small European financial centres.

Appendix I: Survey of Selected Financial Centres

Before summarizing the highlights for each financial centre individually, it may help to consider how the jurisdictions included in our study compare with one another.

Evolving Nature and Scope of Activities

Almost all of the financial centres considered in this book have developed since the 1960s in response to the globalization of capital markets and wealth generation. They have also benefited from restrictions imposed to limit international capital flows and to improve balance of payments in the host countries. Particularly prevalent in the US, the relevant policy actions included greater reserve requirements for banks, binding interest rate ceilings, and restrictions on the range of products and services that banks could offer.1 More generally, several developed countries, most notably the UK, implemented tax hikes in 1960s and early 1970s, especially on corporate income and investment earnings. These developments led financial institutions and businesses to look for alternative venues, to conduct their transactions elsewhere.

On the Required Regulatory Support for Credit Derivative Markets

This valuable book discusses in detail, through a blend of theory and empirical research, the processes of innovation and the diffusion of new financial instruments.