WTO AND FINANCIAL SERVICES

"WTO AND FINANCIAL SERVICES"




PAPER


PRESENTED


BY





DR G RAGHAVAN,


PROFESSOR OF FINANCE,


SDM INSTITUTE FOR MANAGEMENT DEVELOPMENT, MYSORE


IN THE



NATIONAL WORKSHOP


ON


EMERGING ISSUES UNDER WTO AND IPR REGIME



21st AND 22nd OCTOBER 2005


SPONSORED BY



MINISTRY OF HUMAN RESOURCES DEVELOPMENT, N DELHI


AND


ORGANISED BY



DEPARTMENT OF ECONOMICS AND CO-OPERATION


UNIVERSITY OF MYSORE










WTO AND FINANCIAL SERVICES


World Trade Organisation


The importance of trade and services for poverty reduction need not be
reemphasized. Trade and services are the key opportunities for developing
countries to help themselves, by generating growth and reducing dependence
on aid over time.

The challenges facing developing countries are to restore economic growth
and create jobs, while maintaining macroeconomic stability, persevering
with domestic economic reforms, and ensuring that trade and services are
mainstreamed or integrated into economic policies and strategies for
poverty reduction.

In WTO, every member, even the weakest developing country has one vote.
With no weightaged voting, members have more power of influence.

Power relationships in the trade and service diplomacy have changed. Almost
three out of four of the 148 members of the WTO are from the developing
world. They want to be sure that they get a square deal. They are resolved
to be more assertive than in the past in pursuit of their interests.

If the developing countries are to sign on to new multilateral trade and
services negotiations, they will do so only if they can be confident of
gaining more generous access to the markets of the industrialized countries
especially for products and services in which they have a competitive
advantage.


There are some ten benefits arising out of the efforts of World Trade
Organisation


1. The system helps promote peace
2. Disputes are handled constructively
3. Rules make life easier for all
4. Freer trade cuts the costs of living
5. It provides more choice of products and qualities
6. Trade and services raise incomes
7. Trade and services stimulate economic growth
8. The basic principles make life more efficient
9. Governments are shielded from lobbying
10. The system encourages good government
The WTO Agreement on Financial Services
The deal in a nutshell
The most evident practical change, in many countries, will be the
appearance of more foreign banks, securities firms and insurance companies
in the market; the availability of banking, securities and insurance
services sold across the border by overseas companies; and the provision of
asset management and other financial services by wholly, or partially,
foreign-owned companies.
The other side of the picture is that for countries which are actual or
potential exporters of financial services, opportunities for their banks,
securities firms and insurance companies are going to be considerably
enhanced through this agreement. For those already present in overseas
markets, the conditions under which they do business may be improved or
their ability to offer new financial products and services enhanced.
The nature of the commitments include, in some cases, improvements in the
number of licences available for the establishment of foreign financial
institutions; guaranteed levels of foreign equity participation in
branches, subsidiaries or affiliates of banks and insurance companies;
removal or liberalization of nationality or residence requirements for
members of the boards of financial institutions; and the participation of
foreign-owned banks in cheque clearing and settlement systems. While the
emphasis in the schedules of commitments is on opening up markets and
binding entry conditions, the WTO services agreement recognizes the need
for adequate prudential regulation of all banking and insurance service
providers.
Background on Services in the WTO
The General Agreement on Trade in Services (the GATS) was one of the major
achievements of the Uruguay Round and now forms an integral part of the
World Trade Organization's legal framework. The GATS covers all service
sectors, including financial services, and is composed of two elements. The
first element is the set of rules and disciplines which apply to all WTO
Members; the second is the "schedules of specific commitments".
The "schedules" are analogous to the tariff schedules which govern the
market access commitments of each WTO Member with respect to merchandise
goods. The services schedules, each of which amounts to a legally-
enforceable, binding undertaking on the part of the Member concerned,
contain commitments on individual service sectors and service activities
which define the conditions for access to the market.
Key principles are: Most-Favoured Nation (MFN) which guarantees that a
Member will not discriminate among Members supplying a service, and
"national treatment" which guarantees that governments through their
regulations and laws do not discriminate in favour of domestic service
providers at the expense of overseas or foreign-owned service providers.
Where Members have been unable to guarantee MFN treatment in a particular
service activity they have entered a so-called "MFN exemption" - though
these are normally very limited in number and scope. Where full National
Treatment cannot be accorded, or other limitations on market access are
imposed, the fact must be entered in the national schedule.
It was never expected, indeed never possible, that the schedules of
services commitments resulting from the Uruguay Round negotiations could
create immediate free-trade in services worldwide. These commitments are a
first instalment of liberalization which will be extended progressively
through further rounds of services negotiations. Just as important is the
binding nature of the commitments so far made. They provide secure and
predictable conditions for trade in services and, more especially, for
overseas investment by services companies.
How does the Financial Services agreement work?
In effect the agreement means that the best offers negotiated over the
years and members will again have an opportunity to modify or improve their
offers on financial services schedules.
The Protocol to which the new financial services schedule is open for
acceptance in order to allow Members time for domestic ratification
procedures. During the period prior to entry into force Members have
undertaken not to take measures which would be inconsistent with their
future commitments

What must be the starting-point of any discussion of the financial sector
today is the crisis – a crisis that began with difficulties in Asia but has
now become a global economic and financial concern from which no country
and no sector is entirely spared. The financial sector in many ways
exemplifies the powerful – but also uncertain – forces that are shaping our
globalizing world. In recent years, governments the world over have moved
to open up and deregulate many aspects of their financial sectors. At the
same time, technological advances in telecommunications and informatics
have radically changed the way financial services are delivered across
borders - breaking down national barriers, and shrinking distances and
time. These forces have combined to transform the financial sector from a
predominantly local to a global industry - all in less than two decades.
Thus, nations representing over 95% of the trade in banking, insurance,
securities and financial information have brought financial services into
the realm of international rules. It is through these international rules,
agreed by all members, that business can best gain the certainty needed to
plan their future international activities.
The World Bank has compelling evidence that competition in financial
services creates stronger domestic capital markets in developing nations -
more efficient capital allocation and more access to banks, securities
firms and insurance providers for businesses and individuals are sure ways
to speed economic growth.

There is no such thing as a "one-size-fits-all" model for financial reform.
However, the experience has shown that trade liberalization and domestic
reform in the area of financial services can and should be mutually
reinforcing. Adequate prudential regulation and supervision, enhanced
transparency and corporate governance, strengthened competition policy,
proper legal and accounting systems are all preconditions to benefiting
from liberalization.

Direct investment by British and Spanish banks in Mexico has strengthened
the financial system and benefited the country in the last financial
crisis. India has recently approved foreign investment in the insurance
business that will ultimately lower prices and increase choice and enable
people to insure those who are currently uninsured

The ICC (International Chamber of Commerce) and the FLG (Financial Leaders
Group) are convinced that the opening up of financial services will provide
a powerful impetus to growth in all economic sectors[...] Liberalization
will be indispensable for the financial world of the future, considering
the heavy demand for capital in an increasingly global economy." 

Issues and Lessons for Developing Countries
The internationalization of financial services is an important issue for
the strengthening and liberalizing of financial systems in developing
countries. The elimination of discriminatory treatment between foreign and
domestic financial services providers and the removal of barriers to the
cross-border provision of financial services opens the door to the entry of
foreign suppliers. There has been considerable support for the view that
this favors the building of financial systems that are more stable and
efficient by introducing international standards and practices. At the same
time, there have been concerns about the risks that internationalization
may carry for some countries, particularly in the absence of adequate
regulatory structures. If one were to examine various factors affecting the
relative costs and benefits of internationalization and provides an insight
into the diversity and significance of the effects of internationalization
on domestic financial systems, one would come out with the following main
findings:
Internationalization of financial services can help countries build
more robust and efficient financial systems by introducing
international practices and standards; by improving the quality,
efficiency and breadth of financial services; and by allowing more
stable sources of funds. Given the present state of institutional
development of many developing countries' financial systems, these
benefits could be substantial.


Empirical evidence shows that increased competitiveness enhanced
through financial sector openness spurs economic growth. Evidence also
suggests that it is the number of foreign entrants in the market
rather than their market share that has a positive effect on the
functioning of national banking markets. Increased competition may
imply a reduction in domestic bank profits, but banking customers gain
through reduced net interest margins, lower costs of fee-based
services and the availability of a greater variety of services.


Foreign and domestic financial institutions differ in their
performance, interest and operational focus. Analysis suggests that
reasons for foreign entry, as well as the competitive and regulatory
conditions found abroad, differ significantly between developed and
developing countries.


The extent of the benefits of internationalization depends largely on
how it is phased in with other types of financial reform, particularly
domestic financial deregulation and capital account liberalization.
The experience of the European Union, in particular, shows that
internationalization and domestic deregulation can be mutually
reinforcing.


The degree of capital account liberalization can determine the
potential gains and benefits of internationalization.
Internationalization does not, however, require moving to a fully open
capital account. Analysis suggests that internationalization of
financial services results in less distorted and less volatile capital
flows while also promoting financial sector stability.


Experience shows that it is vital to strengthen the supporting
institutional framework in parallel with domestic deregulation and
internationalization: this is particularly true of the regulatory and
supervisory functions of the state but it also applies to the use of
the market in disciplining financial institutions. Both factors can
play a crucial role in minimizing the potential risks of opening up,
particularly when it comes to dealing with large non-performing loans.


Multilateral agreements like GATS allow countries to add credibility
to their plans for financial system liberalization. In particular,
agreements can help with the sequencing of reform. Authorities may
liberalize domestically today and, through agreements, commit to
future internationalization after allowing a period of time to
strengthen financial regulation and supervision.

Financial Services Trade, Capital Flows, and Financial Stability – an
empirical study



A study undertaken by Messrs.Masamichi Kono and Ludger Schuknect, reveals
that trade policies regarding financial services are an important—but often
neglected—determinant of capital flows and financial sector stability.
Financial services trade liberalisation which promotes the use of a broad
spectrum of financial instruments and allows the presence of foreign
financial institutions whilst not unduly restricting their business
practices, results in less distorted and less volatile capital flows, and
promotes financial sector stability. The study finds significant evidence
in favour of this claim through an empirical analysis of GATS commitments
in 27 emerging markets. For example, countries which experienced financial
crisis during 1991-97 show a combined indicator of financial services trade
restrictiveness three times as high (= less favourable for financial
stability) as countries without a crisis.

The study's findings have two important policy implications. Firstly,
liberalising international trade in financial services can be a market-
based means to improve the "quality" of capital flows and to strengthen
financial systems. This would complement other policies, including
financial regulation. Secondly, even in countries where the financial
system is weak, and where immediate, full-fledged financial sector
liberalisation is not advisable, certain types of financial services trade
could be liberalised, as such trade strengthens the financial system
without provoking destabilising capital flows


Conclusions:

These are some important aspects of the financial services agreement
passionately followed up by the World Trade Organisation. However, still
there are some lingering doubts in few minds – protection of native
financial institutions in respective countries and their traditional
systems and unrestricted powers to restrict free capital flows in times of
distress in their countries' interest. To ensure a level playing field and
also to ensure that the best comes out ultimately, such dialogues have to
be encouraged on an ongoing basis.

Before I wind up this thought sharing on this chosen subject, I would like
to place on record my deep and sincere thanks to the University of Mysore
for providing me with this opportunity at this august gathering
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Financial Services Trade, Capital Flows and Financial Sector Stability –
vital links





























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Capacity
- Transparency and information
- Regulation & supervision
- Infrastructure & market development, risk management


Efficiency
- Competition
- Technology transfer
- Skill transfer & development

Financial services trade

Financial sector stability

Capital flows
- Quantity
- Structure (term, instrument)
- Volatility