MODULE 1

INTRODUCTION TO INTERNATIONAL FINANCIAL MANAGEMENT

 An Overview of International Finance Management (IFM)
International financial management is also known as ‘international finance’.
International finance is the set of relations for the creation and using of funds (assets), needed for
foreign economic activity of international companies and countries. Assets in the financial aspect
are considered not just as money, but money as the capital, i.e. the value that brings added value
(profit). Capital is the movement, the constant change of forms in the cycle that passes through
three stages: the monetary, the productive, and the commodity. So, finance is the monetary
capital, money flow, serving the circulation of capital. If money is the universal equivalent,
whereby primarily labor costs are measured, finance is the economic tool.
The definition of international finance is the combination of monetary relations that develop in
process of economic agreements - trade, foreign exchange, investment - between residents of the
country and residents of foreign countries.
 International Financial Management is the art of managing money on a global scale.
 IFM is a popular concept which means management of finance in an international
business environment, it implies, doing of trade and making money through the exchange
of foreign currency.
 International financial management is also known as ‘international finance’.
 International finance, sometimes known as international macroeconomics, is the study of
monetary interactions between two or more countries, focusing on areas such as foreign
direct investment and currency exchange rates.
 Increased globalization has magnified the importance of international finance.
 An initiative known as the Bretton Woods system emerged from a 1944 conference
attended by 40 nations and aims to standardize international monetary exchanges and
policies in a broader effort to nurture post World War II economic stability.
 Six aspects provide importance to IFM
1) Specialization of some goods and services
2) Opening of new economies
3) Globalization of firms
4) Emergence of new form of business
5) Growth of world trade
6) Development process of Nations
 When a firm operates in the domestic market, both for procuring inputs as well as selling
its output, it needs to deal only in the domestic currency. When companies try to increase
their international trade and establish operations in foreign countries, they start dealing
with people and firms in various nations. On this regards, as different nations have
different currencies, dealing with the currencies becomes a problem-variability in
exchange rates have a profound effect on the cost, sales and profits of the firm.
Globalization of the financial markets results in increased opportunities and risks on
account of overseas borrowing and investments by the firm.

 How are currency exchange rates determined in India?

 No single authority or institution sets the exchange rates in India.
 India has a floating exchange rate system where the exchange rate of the rupee with
another currency can be determined by market factors such as demand and supply.

 6 factors being the driving force determining the exchange rate of a currency
 Inflation in the country
 Interest rate or Repo rate
 Level of current account deficit
 Import and export of gold
 Amount of public debt
 Stability and economic growth

 REASONS FOR GROWTH IN INTERNATIONAL BUSINESS

Saturation of Domestic Markets- In most of the countries due to continuous production

of similar products over the years has led to the saturation of domestic markets. For
example in Japan, 95% of people have all types of electronic appliances and there is no
growth of organization there, as a result they have to look out for new markets overseas.
Opportunities in Foreign Markets- As domestic markets in some countries have
saturated, there are many developing countries where these markets are blooming.
Organizations have great opportunities to boost their sales and profits by selling their
products in these markets. Also countries that are attaining economic growth are
demanding new goods and services at unprecedented levels.
Availability of Low Cost Labor- When we compare labor cost in developed countries
with respect to developing countries they are very high. As a result, organizations find it
cheaper to shift production in these countries. This leads to lower production cost for the
organization and increased profits.
Competitive Reasons- Either to stem the increased presence of foreign companies in
their own domestic markets or to counter the expansion of their domestic markets, more
and more organizations are expanding their operations abroad. International companies
are using overseas market entry as a counter measure to increase competition.
 Increased Demands- Consumers in counties that did not have the purchasing power to
acquire high-quality products are now purchasing them due to improved economic
conditions.
Diversification- To counter cyclical patterns of business in different parts of the world,
most of the companies expand and diversify their business, to attain profitability and
uncover new markets. This is one of the reasons why international business is developing
at a rapid pace.
Reduction of Trade Barriers- Most of the developing economics are now relaxing their
trade barriers and opening doors to foreign multinationals and allowing their companies
to set-up their organizations abroad. This has stimulated cross border trade between
countries and opened markets that were previously unavailable for international
companies.
Development of communications and Technology- Over last few years there has been a
tremendous development in communication and technology, which has enabled everyone
to know about demands, products and services offered in other part of the world. Adding
to this is the reducing cost of transport and improved efficiency has also led to expansion
of business.
Consumer Pressure- Innovations in transport and communication has led to
development of more aware consumer. This has led to consumers demanding new and
better goods and services. The pressure has led to companies researching, merging or
entering into new zones.

 NATURE OF IFM
 IFM is concerned with financial decisions taken in international business.
 IFM is an extension of corporate finance at international level.
 IFM set the standard for international tax planning and international accounting
 IFM includes management of exchange rate risk

 SCOPE OF IFM
 Foreign exchange markets, international accounting, exchange rate risk management etc.
 It also includes management of finance functions of international business.
 IFM sorts out the issues relating to FDI and foreign portfolio investment.
 It manages various risks such as inflation risk, interest rate risks, credit risk and exchange
rate risk.
 It manages the changes in the foreign exchange market.
 It deals with balance of payments in global transactions of nations.
 Investment and financing across the nations widen the scope of IFM to international
accounting standards.
 It widens the scope of tax laws and taxation strategy of both parent country and host
country.
 It helps in taking decisions related to international business.
  FEATURES OF IFM
1. Foreign exchange risk - When different national currencies are exchanged for each
other, there is a definite risk of volatility in foreign exchange rates. Variability of
exchange rates is widely regarded as the most serious international financial problem
facing corporate managers and policy makers. Exchange rate variation affect the
profitability of firms and all firms must understand foreign exchange risks in order to
anticipate increased competition from imports or to value increased opportunities for
exports. Thus, changes in the exchange rates of foreign currencies results in foreign
exchange risks.
2. Political risk - Another risk that firms may encounter in international finance is political
risk. Political risk ranges from the risk of loss (or gain) from unforeseen government
actions or other events of a political character such as acts of terrorism to outright
expropriation of assets held by foreigners. The other country may seize assets of the
company without any reimbursements by utilizing their sovereign right, and some
countries may restrict currency remittances to the parent company. MNCs must assess the
political risk not only in countries where it is currently doing business but also where it
expects to establish subsidiaries.
3. Market imperfections - The final feature of international finance that distinguishes it
from domestic finance is that world markets today are highly imperfect. There are
profound differences among nations’ laws, tax systems, business practices and general
cultural environments. Imperfections in the world financial markets tend to restrict the
extent to which investors can diversify their portfolio. Though there are risks and costs in
dealing with these market imperfections, they also offer managers of international firms
abundant opportunities.
4. Inflation- Inflation measures how much more expensive a set of goods and services has
become over a certain period, usually a year. Inflation rate differs from country to
country. Higher inflation rates in few countries denote inflation risks.
5. Tax and Legal system - Tax and legal system varies from one country to another
country and this leads to complexity in their financial implications and hence give rise to
tax and legal risks
6. Expanded opportunity sets - When firms go global, they also tend to benefit from
expanded opportunities which are available now. They can raise funds in capital markets
where cost of capital is the lowest. In addition, firms can also gain from greater
economies of scale when they operate on a global basis.

 GOALS OF IFM
The main goals of IFM includes ensuring an uninterrupted supply of funds for the
business activities of the organization & its optimum utilization so as to generate the
highest possible returns for the business.
Basic Goals
  Wealth Maximization of Shareholders - It is a long-term goal that a company cannot
achieve just in a few days or even months. A company can achieve this objective by an
excellent overall performance consistently year on year. The managers should manage
the funds such that it is always adequate as per the requirement of the company. Separate
budgets for separate functions within the organization need to be made and
implemented. Working capital management should be effective, production and other
allied activities should go on uninterrupted and employee welfare should also be a
priority. Effective and efficient management of the firm’s resources along with good
investment decisions will result in achieving high standards in the organization. This will
lead to an increase in revenue with higher profits. This will in turn maximize the wealth
of the shareholders by higher value generation, increasing the stock price as well as
higher dividends payout.

 Profit Maximization - International financial management aims to maximize the profits

of the organization by making correct investment decisions. It promotes investments that
are safe and will generate good returns. Also, the utilization of funds should be such that
the activities of the company go on without interruption. This will result in an increase in
turnover and thus, profits.

Secondary Objectives

 Optimum Rate of Interest- International financial management aims to achieve an

optimum rate of interest on the funds that a company borrows. The managers should
check and compare all the possible options of finance that a company has. They should
choose the source that is reliable, safe, and with the least possible rate of interest. Lower
interest or lower financing costs will boost the profits in turn.
 Foreign Exchange Risk Management - Exchange rates are volatile and unpredictable.
They can result in gains as well as heavy losses in case they are not favorable for the
company. Hence, the managers should adequately consider, cover, and hedge against
foreign exchange risk while doing international trade.
 Political Risk Management - Effective political risk management is one of the important
goals of international financial management. The management should take into account
cases of political unrest or instability in countries before they invest there. Political risk
can arise in the domestic market too, and hence they should be cautious about it.Changes
in laws and policies of the government, or a change in the government itself can create
trouble for any company. They may face cancellations of projects or hindrances, red-
tapism, and delays that may cause significant monetary losses to the company. Hence, the
managers should always take political risk into consideration while investing in any
project, especially if it is for the long term.
 Effectively Use Expanded Sets of Opportunities - International financial management
aims to make the best possible use of opportunities that arise from investing in different
countries. Interest rates and the cost of capital can be very low in some countries. Or
labor can be inexpensive in some other country. Some foreign markets may have the
extra potential for a particular line of product. The managers should be dynamic and
 flexible in this fast-changing business environment. They should immediately make use
of any of such opportunities that may arise and result in monetary benefits for the
company.
 Effective Inflation Risk Management - Another goal of international financial
management is to effectively manage the inflation risk that may arise in different
countries at different times. Inflation or the continuous rise in prices of inputs can cause a
major financial strain on any company. The output price or the selling price may not
increase immediately due to market constraints, resulting in lower profits or even
losses.Managers need to properly plan and budget for inflation risk by properly studying
the economic environments of countries where they operate. This will help them to get
their costing and pricing right and minimize instances of losses for the company.

 EMERGENCE OF GLOBAL FINANCIAL MARKET

 First, various financial institutions including banks and institutional investors have
expanded their activities geographically. In this process, they acted as an intermediary
to channel funds from lenders to borrowers across national borders.

 Second, the more mature securities markets have gained a clear cross-border
orientation. In many instances, newly issued securities are designed and offered to the
public in such a way as to maximise their appeal to international investors.

 These developments reflected the progressive dismantling of controls on cross-border

financial flows as well as the liberalisation of national financial markets more
generally.

 It resulted in an augmentation of the range of borrowing and lending possibilities

available to economic agents throughout the world. In particular, there was a marked
expansion of the range of financial possibilities available for financing current
account deficits and recycling current account surpluses.

 In the process of developing globalisation of financial markets seen over recent

decades, both technological advances and financial innovation played a key role. In
the past few decades, information systems have become able to compute and store
more data more rapidly. Telecommunications networks have extended their
ramifications and augmented their capacity while more reliable data exchange
protocols have made it possible to connect computing machines in more efficient
ways. As a result, cross-border financial deals have become both easier and more
secure, effectively lowering the barrier constituted by distance, be it determined by
geography or other factors.

 THEORIES OF INTERNATIONAL FINANCIAL MANAGEMENT

 1. Theory of Purchasing Power Parity- Purchasing power parity (PPP) is a theory
which states that exchange rates between currencies are in equilibrium when their
purchasing power is the same in each of the two countries. This means that the exchange
rate between two countries should equal the ratio of the two countries' price level of a
fixed basket of goods and services. When a country's domestic price level is increasing
(i.e., a country experiences inflation), that country's exchange rate must depreciated in
order to return to PPP.

Economists use two versions of Purchasing Power Parity: Absolute PPP and Relative
PPP.

a) Absolute PPP - The basis for PPP is the "law of one price". In the absence of
transportation and other transaction costs, competitive markets will equalize the price
of an identical good in two countries when the prices are expressed in the same
currency.

For example, a particular TV set that sells for 750 Canadian Dollars [CAD] in
Vancouver should cost 500 US Dollars [USD] in Seattle when the exchange rate
between Canada and the US is 1.50 CAD/USD. If the price of the TV in Vancouver
was only 700 CAD, consumers in Seattle would prefer buying the TV set in
Vancouver. If this process (called "arbitrage") is carried out at a large scale, the US
consumers buying Canadian goods will bid up the value of the Canadian Dollar, thus
making Canadian goods more costly to them. This process continues until the goods
have again the same price. There are three caveats with this law of one price.

Assumptions of Absolute form of PPP

• No transportation costs and no barriers to trade.

• There must be competitive markets for the goods and services in both countries.

• The law of one price only applies to tradeable goods; immobile goods such as houses,
and many services that are local, are of course not traded between countries.

b) Relative PPP - Relative PPP refers to rates of changes of price levels, that is,
inflation rates. This proposition states that the rate of appreciation of a currency is
equal to the difference in inflation rates between the foreign and the home country.

For example, if Canada has an inflation rate of 1% and the US has an inflation rate of 3%,
the US Dollar will depreciate against the Canadian Dollar by 2% per year.

2. Fisher Effect
• The Fisher Effect is an economic theory created by economist Irving Fisher that describes
the relationship between inflation and both real and nominal interest rates. The Fisher
Effect states that the real interest rate equals the nominal interest rate minus the expected
inflation rate. Therefore, real interest rates fall as inflation increases, unless nominal rates
increase at the same rate as inflation.

• The Fisher Effect can be seen each time you go to the bank; the interest rate an investor
has on a savings account is really the nominal interest rate. For example, if the nominal
interest rate on a savings account is 4% and the expected rate of inflation is 3%, then the
money in the savings account is really growing at 1%. The smaller the real interest rate,
the longer it will take for savings deposits to grow substantially when observed from a
purchasing power perspective.

Nominal Interest Rates and Real Interest Rates

• Nominal interest rates reflect the financial return an individual gets when he deposits
money. For example, a nominal interest rate of 10% per year means that an individual
will receive an additional 10% of his deposited money in the bank.

• Unlike the nominal interest rate, the real interest rate considers purchasing power in the
equation.

• In the Fisher Effect, the nominal interest rate is the provided actual interest rate that
reflects the monetary growth padded over time to a particular amount of money or
currency owed to a financial lender. Real interest rate is the amount that mirrors the
purchasing power of the borrowed money as it grows over time.

3. International Fisher Effect

• The International Fisher Effect (IFE) is an economic theory stating that the expected
disparity between the exchange rate of two currencies is approximately equal to the
difference between their countries' nominal interest rates.

• According to the IFE, countries with higher nominal interest rates experience higher rates
of inflation, which will result in currency depreciation against other currencies. 

• This theory was named after U.S. economist Irving Fisher.

• IFE uses interest rates rather than inflation rate to explain why exchange rate changes
overtime.

• IFE is calculated as:

• E=i1 – i2 / 1 + i2
 • Where, E=the percent change in the exchange rate

• i1=country A’s interest rate

• i2=country B’s interest rate

For example, if country A's interest rate is 10% and country B's interest rate is 5%,
country B's currency should appreciate roughly 5% compared to country A's currency.
The rationale for the IFE is that a country with a higher interest rate will also tend to have
a higher inflation rate. This increased amount of inflation should cause the currency in
the country with a higher interest rate to depreciate against a country with lower interest
rates.

4. Interest Rate Parity

• As per Interest Rate Parity, exchange rate between two countries currency depends on
rate of interest of two countries.

• For example Ram is having Rs.1, 00,000 with him. He has two options: either to invest in
Bank of India at 12% rate of interest or to invest in the bank of USA at 8% rate of interest
for 1 year. If current spot rate is $1= ₹50.

• If he invest in India he will get a return of ₹1, 12,000(1, 00,000+12,000). But if he invest
in USA he has to first convert the ₹1,00,000 in terms of dollars (1,00,000/50 = $2000).
He will get a return of $2,160 ($2000+160) after one year. Suppose the forward rate after
1year is $1= ₹51. The investor will get the return in terms of rupees = ₹1,
10,160($2160×51). It means it is beneficial to invest in India.

• Interest Rate Parity is a theory in which the interest rate differential between two
countries is equal to the differential between the forward exchange rate and spot
exchange rate.

• Forward exchange rate (Forward Rate) – Exchange rate fixed today for exchanging
currency at a future date.

• Spot exchange rate (Spot Rate) – Exchange rate on currency for immediate delivery.

• The theory establishes the break even condition where the return on a domestic currency
investment is identical with the return on a foreign currency investment covered against
exchange risk.

INTERNATIONAL MONETARY SYSTEM - EVOLUTION

 An Overview International monetary system is defined as a set of procedures, mechanisms,
processes, institutions to establish that rate at which exchange rate is determined in respect to
other currency. To understand the complex procedure of international trading practices, it is
pertinent to have a look at the historical perspective of the financial and monetary system. The
whole story of monetary and financial system revolves around 'Exchange Rate' i.e. the rate at
which currency is exchanged among different countries for settlement of payments arising from
trading of goods and services. To have an understanding of historical perspectives of
international monetary system, firstly one must have knowledge of exchange rate regimes.
Various exchange rate regimes found from 1880 to till date at the international level are
described briefly as follows:
Monetary System before First World War: (1880-1914 Era of Gold Standard): The oldest
system of exchange rate was known as "Gold Species Standard" in which actual currency
contained a fixed content of gold. The other version called "Gold Bullion Standard", where the
basis of money remained fixed gold but the authorities were ready to convert, at a fixed rate, the
paper currency issued by them into paper currency of another country which is operating in
Gold. The exchange rate between pair of two currencies was determined by respective exchange
rates against 'Gold' which was called 'Mint Parity'. Three rules were followed with respect to this
conversion:
• The authorities must fix some once-for-all conversion rate of paper money issued by them into
gold.
• There must be free flow of Gold between countries on Gold Standard.
• The money supply should be tied with the amount of Gold reserves kept by authorities.
The gold standard was very rigid and during 'great depression' (1929-32) it vanished completely.
In modern times some economists and policy makers advocate this standard to continue because
of its ability to control excessive money supply.
The Gold Exchange Standard (1925-1931): With the failure of gold standard during First
World War, a much refined form of exchange regime was initiated in 1925 in which US and
England could hold gold reserve and other nations could hold both gold and dollars/sterling as
reserves. In 1931, England took its foot back which resulted in abolition of this regime.
Also to maintain trade competitiveness, the countries started devaluing their currencies in order
to increase exports and demotivate imports. This was termed as "beggar-thy-neighbor" policy.
This practice led to great depression which was a threat to war ravaged world after the Second
World War.
Allied nations held a conference in New Hampshire, the outcome of which gave birth to two
new institutions namely the International Monetary Fund (IMF) and the World Bank, (WB) and
the system was known as Bretton Woods System which prevailed during (1946-1971) (Bretton
Woods, the place in New Hampshire, where more than 40 nations met to hold a conference).
The Bretton Woods Era (1946 to 1971): To streamline and revamp the war ravaged world
economy & monetary system, allied powers held a conference in 'Bretton Woods', which gave
birth to two super institutions - IMF and the WB. In Bretton Woods modified form of Gold
Exchange Standard was set up with the following characteristics :
• One US dollar conversion rate was fixed by the USA as one dollar = 35 ounce of Gold
• Other members agreed to fix the parities of their currencies vis-àvis dollar with respect to
permissible central parity with one per cent (± 1%) fluctuation on either side. In case of crossing
the limits, the authorities were free hand to intervene to bring back the exchange rate within
limits.
During Bretton Woods regime American dollar became international money while other
countries needed to hold dollar reserves. US could buy goods and services from her own money.
The confidence of countries in US dollars started shaking in 1960s with chronological events
which were political and economic and on August 15, 1971 American abandoned their
commitment to convert dollars into gold at fixed price of $35 per ounce, the currencies went on
float rather than fixed.
Post Bretton Woods Period (1971-1991): Two major events took place in 1973-74 when oil
prices were quadrupled by the Organization of Petroleum Exporting Countries (OPEC). The
result was seen in expended oils bills, inflation and economic dislocation; thereby the monetary
policies of the countries were being overhauled. From 1977 to 1985, US dollar observed
fluctuations in the oil prices which imposed on the countries to adopt a much flexible regime i.e.
a hybrid between fixed and floating regimes. A group of European Nations entered into
European Monetary System (EMS) which was an arrangement of pegging their currencies within
themselves.

THE CURRENT EXCHANGE RATE ARRANGEMENTS

At present IMF (International Monetary Fund) categories different exchange rate
mechanism as follows:
Exchange arrangement with no separate legal tender: The members of a currency union share
a common currency. Economic and Monetary Unit (EMU) who have adopted common currency
and countries which have adopted currency of other country.
Currency Board Agreement: In this regime, there is a legislative commitment to exchange
domestic currency against a specified currency at a fixed rate.
Conventional fixed peg arrangement: This regime is equivalent to Bretton Woods in the sense
that a country pegs its currency to another, or to a basket of currencies with a band variation not
exceeding ± 1% around the central parity.
Pegged Exchange Rates Within Horizontal Bands: In this regime, the variation around a
central parity is permitted within a wider band. It is a middle way between a fixed peg and
floating peg.
Crawling Peg: Here also a currency is pegged to another currency or a basket of currencies but
the peg is adjusted periodically which may be pre-announced or discretion based or well
specified criterion.
Crawling bands: The currency is maintained within a certain margins around a central parity
which 'crawls' in response to certain indicators
Managed float: In this regime, central bank interferes in the foreign exchange market by buying
and selling foreign currencies against home currencies without any commitment or
pronouncement.
Independently floating: Here exchange rate is determined by market forces and central bank
only act as a catalyst to prevent excessive supply of foreign exchange and not to drive it to a
particular level.

ECONOMIC AND MONETARY UNION

Economic and Monetary Union (EMU) represents a major step in the integration of EU
economies. It involves the coordination of economic and fiscal policies, a common monetary
policy, and a common currency, the euro. The European Monetary System (EMS) was the
pioneer of Economic and Monetary Union (EMU), which led to the establishment of the Euro. It
was a way of creating an area of currency stability throughout the European Community by
encouraging countries to co-ordinate their monetary policies. The decision to form an Economic
and Monetary Union was taken by the European Council in to bethe Dutch city of Maastricht in
December 1991. The Treaty of Maastricht laid down a set of criteria met by member states if
they were to qualify for the EMU. Its main criteria was Curbing inflation, GDP, Limiting
publicCutting interest rates, Reducing budget deficits to a maximum of 3% of borrowing,
Stabilizing the currency‘s exchange rate. The Maastricht Treaty laid down the three-stage
process (First stage (1st Jul 1990) Second stage(1st Jan 1994) Third stage(1st Jan 1999)) in
which EMU was established.
Stage One of EMU
 Complete freedom for capital transactions

 Increased co-operation between central banks

 Free use of the ECU (European Currency Unit)
 Improvement of economic convergence
Second Stage of EMU
 Establishment of the European Monetary Institute

 Ban on the granting of central bank credit

 Increased co-ordination of monetary policies
 Strengthening of economic convergence
 Process leading to the independence of the national central banks to be completed at the latest
by the date of establishment of the European System of Central Banks.
Third Stage of EMU
Irrevocable fixing of conversion rates
 Introduction of the euro
 Conduct of the single monetary policy by the European System of Central Banks Entry into
effect of the intra-EU exchange rate mechanism (ERM II)
 Entry into force of the Stability and Growth Pact
The management of Economic and Monetary Union involves many actors with different
responsibilities. As well as the governments and central banks of the Member States, the
Council, the European Commission, the European Parliament and the European Central Bank all
have roles to fulfill. The management of EMU involves three main areas of macroeconomic
policy-making: monetary policy, fiscal policy and economic policy coordination.

INTERNATIONAL FINANCIAL SYSTEM/ GLOBAL FINANCIAL SYSTEM

• The international financial system is the worldwide framework of legal agreements,
institutions, and both formal and informal economic actors that together facilitate
international flows of financial capital for purposes of investment and trade financing

•  Since emerging in the late 19th century during the first modern wave of economic
globalization, its evolution is marked by the establishment of central
banks, multilateral treaties, and intergovernmental organizations aimed at improving
the transparency, regulation, and effectiveness of international markets.

• In the late 1800s, world migration and communication technology facilitated

unprecedented growth in international trade and investment. At the onset of World War I,
 trade contracted as foreign exchange markets became paralyzed by money
market illiquidity. Countries sought to defend against external shocks with protectionist
policies and trade virtually halted by 1933, worsening the effects of the global Great
Depression until a series of reciprocal trade agreements slowly reduced tariffs worldwide.
Efforts to revamp the international monetary system after World War II improved
exchange rate stability, fostering record growth in global finance.

• A series of currency devaluations and oil crises in the 1970s led most countries to float
their currencies. The world economy became increasingly financially integrated in the
1980s and 1990s due to capital account liberalization and financial deregulation.

• A series of financial crises in Europe, Asia, and Latin America followed with contagious
effects due to greater exposure to volatile capital flows. The global financial crisis, which
originated in the United States in 2007, quickly propagated among other nations and is
recognized as the catalyst for the worldwide Great Recession. A market adjustment to
Greece's noncompliance with its monetary union in 2009 ignited a sovereign debt crisis
among European nations known as the Eurozone crisis. The history of international
finance shows a U-shaped pattern in international capital flows: high prior to 1914 after
1989, but lower in between. The volatility of capital flows has been greater since the
1970s than in previous periods.

• Both individuals and groups may participate in the global financial system. Consumers
and international businesses undertake consumption, production, and investment.
Governments and intergovernmental bodies act as purveyors of international trade,
economic development, and crisis management. Regulatory bodies establish financial
regulations and legal procedures, while independent bodies facilitate industry
supervision. Research institutes and other associations analyze data, publish reports and
policy briefs, and host public discourse on global financial affairs.
INTERNATIONAL FINANCIAL INSTITUTIONS (IFIs)
• An international financial institution (IFI) is a financial institution that has been
established (or chartered) by more than one country, and hence is subject to international
law. Its owners or shareholders are generally national governments, although
other international institutions and other organizations occasionally figure as
shareholders. The most prominent IFIs are creations of multiple nations, although some
bilateral financial institutions (created by two countries) exist and are technically IFIs.

• Immediately following World War II, the major capitalist powers, dominated by the U.S.
and Britain, met at Bretton Woods, New Hampshire to establish multilateral institutions
to manage the postwar restructuring and expansion of the global capitalist economy. Two
international financial institutions (IFIs) emerged from the July 1944 meeting: the
International Bank for Reconstruction and Development (World Bank) and the
International Monetary Fund (IMF).

• At first, the IFIs concentrated on the reconstruction of the war-devastated European

nations. Soon, however, the U.S. reconstruction effort (known as the Marshall Plan)
overshadowed the IFI’s own initiatives in Europe, and by the late 1940s the IFIs had
shifted their focus to former colonial regions. The integration of the low-income
countries (LICs) of the South into the global capitalist market has been the chief objective
of the IFIs for nearly a half century. Since the late 1970s the World Bank and IMF have
 also provided structural adjustment loans (SALs) that are used to support economic
reforms.

• The principal function of the World Bank is to provide development loans for projects
that are too large or too risky for private banks to finance. Four regional multilateral
development banks (MDBs) complement the work of the World Bank: the African
Development Bank (AFDB, founded 1963), the Asian Development Bank (ADB-1966),
the European Bank for Reconstruction and Development (EBRD-1991), and the Inter-
American Development Bank (IDB-1959).

• The MDBs obtain 80 percent of their funds by tapping world capital markets and the
remaining 20 percent by assessing member governments. Most of their loans are near
commercial interest rates, although the poorest nations are eligible for low- or no-interest
development loans from the World Bank and the regional MDBs. Unlike the MDBs, the
IMF depends solely on quota payments from member nations.

EUROBANKS
• A eurobank is a financial institution that accepts deposits and makes loans in foreign
currencies.

• It is not necessary for a "eurobank" to be located in Europe; it can in fact be located

anywhere in the world. For example, an American bank located in New York which
holds deposits and issues loans in Japanese yen (JPY) would be considered a eurobank.

• Eurobanks may operate in their own country, such as the American bank in the example
above, or they may operate in a country outside their home.

• The emergence of eurobanks has done much to facilitate trade and investment between
countries. In the past, cross-border trade was hampered by a lack of
international intermediaries capable of accommodating transactions involving multiple
foreign currencies. This is especially true because, despite the growing importance of
these economies, some of the currencies of these nations are still not widely traded
on global currency markets. As such, emerging economies often find it necessary to
conduct international trade using foreign currencies.

Benefits of Eurobanks
• One important benefit of euro banking is that these institutions can often offer lower
interest rates for foreign borrowers of U.S. dollars. That is mostly because euro currency
markets are less regulated than U.S. banks and American bank deposits.
 • Another benefit is that euro banking helps to facilitate cross-border transactions, with
transactors needing access to deposits of both dollars and local currency in different
regions throughout the world.

BANK FOR INTERNATIONAL SETTLEMENTS (BIS)

• Bank for International Settlements (BIS) is a bank for central banks.

• Founded in 1930, Headquartered in Basel, Switzerland.

• Bank for International Settlements is the oldest global financial institution and operates
under the auspices of international law. But from its inception to the present day, the role
of the BIS has been ever-changing as it adapts to the dynamic global financial community
and its needs.