Financial integration across borders and across sectors: implications for regulatory structures

Abstract

This paper considers the generic processes and linkages that comprise financial intermediation the basic ’financial hydraulics’ that ultimately drive efficiency and innovation in the financial system and its impact on real-sector resource allocation and economic growth. Maximum economic welfare demands a high-performance financial system. What does this actually mean? It documents some of the structural changes that have occurred in both national and global financial systems, and suggests how the microeconomics of financial intermediation work. These can have an enormous impact on the industrial structure of the financial services industry and on individual firms. Sequentially, financial channels that exhibit greater static and dynamic efficiency have supplanted less efficient ones. Competitive distortions can retard this process, but they usually extract significant economic costs and at the same time divert financial flows into other venues, either domestically or elsewhere. The paper also examines the consequences of this process in terms of financial sector reconfiguration, both within and between the four major segments of the industry (commercial banking, securities and investment banking, insurance, and asset management) as well as within and between national financial systems. Finally, the paper superimposes key regulatory overlays onto the basic economics and facts of reconfiguration in financial intermediation. This is a ’special’ industry, due both to the embedded systemic risks and its fiduciary nature. Balancing financial efficiency against stability and fairness is not easy. The economics of financial intermediation are highly regulation-sensitive, so small changes in regulation can create important changes in markets. Regulators inevitably make some mistakes, and regulatory mandates are unusually contentious and vulnerable to entrenched economic interests. This is also a discussion of the linkages between structural change in financial intermediation and supervisory and regulatory functions, including some comparisons between US and European legacies and prospects.