Living Globalization: Implications for International Banking and Financial Institutions

1. Living Globalization:Implications for International Banking and Financial Institutions Joseph E. Stiglitz Frankfurt September 28,2007

2. Globalization • Has created global banking institutions and other global financial institutions • Facilitating movements of capital from areas of capital abundance to areas of capital scarcity • Facilitating adoption of best practices globally

3. But banking (and other financial institutions) are information industries • Gathering, processing, and disseminating information • Deciding on what projects should be undertaken (who is creditworthy) • Monitoring (ensuring that funds are used appropriately) • Enforcing (collecting money due, terminating credit) Banks are like the Brains of the Economy

4. But much information is local • Especially concerning small and medium sized enterprises • Ascertaining creditworthiness • Monitoring • Knowing needs of customers • With internet banking, relationship between banks and customers weakened • Securitization has also weakened links • Knowing circumstances of customers • Is firm facing a temporary problem, a short term cash flow problem • Or is there a more fundamental problem?

5. Localization of information provides a limit on globalization • Problems highlighted by sub-prime mortgage crisis • Many international firms bought these mortgages, without evidently understanding details of American market • They were among those most adversely affected

6. America’s mortgage problem • Should have realized the deep problems facing American economy • Growth for past 5 years has been highly dependent on real estate • Large numbers of individuals had taken out mortgages in excess of 80% of value of property, with “teaser” rates involving negative amortization for first 2-3 years • In expectation of continuation of low interest rates and rising house prices • So they could refinance • Not sustainable

7. That which is not sustainable will not be sustained • Only issue was when bubble when break • And when it broke, he deep would be the resulting real estate crisis • And the form of government intervention

8. The double edged sword of securitization • Risks spread around the world • France, Australia, others affected directly • Many more affected indirectly as a result of change in risk premium (Indonesia) • More people affected, but impact on US reduced • Renegotiation (debt restructuring) more difficult • Parallel to problem in sovereign debt markets • Banks do a better job at ascertaining creditworthiness, monitoring, enforcement • Security markets often free ride on information provided by banks

9. Key to Success • Mixing global and local • Global technology—best available IT technologies for gathering, processing, and disseminating information • Global practices—best techniques for marketing • Global trends • With globalization all countries are eventually affected • But dissemination of ideas and impacts of trends are not instantaneous

10. But the most important information is still local • Countries where international banks have taken over vast majority of local banks have faced problems • Drying up of credit for small and medium sized enterprises • Lower growth • But the problems are not inevitable

11. Supply Chain Economics • Globalization of manufacturing has entailed breaking up production process into many stages • Taking advantage of local comparative advantages for each stage of the production process • But using best globally available “appropriate” technology at each stage

12. But successful supply chain economics is information intensive • Requires knowledge of global technologies • Requires knowledge of local supply side conditions • Requires knowledge of demand side

13. Most importantly • Requires coordination • linking each stage to final product • Which is based on customer’s needs and preferences • Many forms of “industrial organization” • Vertically integrated • But given importance of local information, relatively rare • Various forms of contracting

14. So too in finance • Financial markets intermediate between savers and investors • With globalization, savers and investors can be scattered all over the world • But savers and investors in different parts of the world have different needs and opportunities • Which is why local information is so important

15. Combining global and local • At the same time, competition occurs at global level • Success requires best of global technologies and global practices • Including those required to ascertain creditworthiness, monitoring, enforcement • And those required to meet needs of savers • New and appropriate financial instruments

16. Challenge is to combine global and local information • Rich ecology of institutional arrangements • Some international banks serving Multinational corporations, large domestic clients • A few international banks developing international expertise in some specialized markets • Some international banks acquiring local information by buying local banks • Most firms engaged in only part of supply chain—with contracting relationships with other parts of the supply chain

17. Living with Globalization • Challenge for each firm (financial institution) is to ascertain its dynamic comparative advantage, to locate itself within this ever evolving ecology • Some will become international banks or international financial institutions

18. But most will have a particular niche • Part of the global financial “supply chain” • Linking themselves with other firms/financial institutions and global securities markets • Success, as always, entails information about these other financial institutions • And knowledge of global securities markets and their limitations • Using local knowledge/information • But taking advantage of global best practices/global technologies

19. Challenge for each firm • Not only to figure out their dynamic comparative advantage • What their particular “niche” should be

20. But to develop the supply chain relationships required for success • Information intensive • best “fits” • Identifying those who have best information about local supply and demand side conditions and are using that information best

21. Combining Global Knowledge and Local Knowledge • And simultaneously to draw upon best of global knowledge and practices • Including knowledge and practices for managing local information • New instruments • New technologies • This talk has tried to provide a framework for thinking about these issues