Global financing and exchange rate mechanisms

Global Financing: Minimizing Risk

In a world plagued by financial instability and economic volatility, operating in a global marketplace can introduce financial risks, especially among international financial institutions interested in global financing operations. Most international financial institutions today focus their efforts on networking and building systems that minimize risk and maximize economic stability (Homaifar, 2003). This paper analyzes the subject of global financing and the exchange rate. Specifically this paper will focus on the roles international financial institutes like World Bank, IMF and ADB for example, have with regard to global financing operations and risk management.

Global Financing

International financial institutes have a significant influence on financial operations and risk management between international corporations. The U.S. dollar has for decades remained one of the most utilized forms of international currency. Following creation of the European Union however, the "euro" is increasingly establishing its presence as a dominant form of currency financial institutions and international organizations can use to trade with and leverage their operations (Homaifar, 2003). Global banks, like the European Central Bank or ECB for example, as well as other international financial institutions including World Bank, IMF and ADB can influence how dominant a currency is in the international market many ways (Homaifar, 2003; Bertuch-Samuels & Ramlogan, 2007). One way they can do so is by actively promoting the use of a defined currency abroad, such as the euro (Bertuch-Samuels & Ramlogan, 2007).

International currency such as the euro implied use of currency among residents of differing countries; if the euro were to become an international form of currency such as the U.S. dollar, it could have a tremendous impact on foreign exchange rates, equalizing the playing field and perhaps raising the value of foreign dollars (Bertuch-Samuels & Ramlogan, 2007). This is important to financial operations and for political and economic purposes because the country issuing the currency gains more leverage and control over exchange rate fluctuations, especially as the "prestige" of the currency used grows to new markets (Bertuch-Samuels & Ramlogan, 2007).

Global banks that promote the use of international currency can bestow many advantages on the country generating the currency (Blount, 1998). For example, the use of the euro as an international form of currency would lend greater legitimacy and political as well as economic power to countries that comprise this economic union (Bertuch-Samuels & Ramlogan, 2007). Transaction costs as well as interest rates are likely to decline, which for world banks would result in more opportunity for revenues and greater financial profitability as domestic capital markets become more efficient and active (Bertuch-Samuels & Ramlogan, 2007).

Global financial institutions also benefit because they would have the ability to "finance current account deficits" within their own currency and "avoid the need to accumulate foreign reserves" (Bertuch-Samuels & Ramlogan, 2007).

Risk Management

As with any new political or economic development certain risks are incurred. For example, when a global financial institution promotes the internationalization of a country's currency, it must also support any risks associated with the currency's use (Bertuch-Samuels & Ramlogan, 2007). These risks may involve price or exchange rate fluctuations that expose the country to "volatile capital flows" resulting in economic instability rather than stability; a chain effect occurs, where as the country's currency fluctuates, macroeconomic stability declines and therefore leads to limited political choice and direction (Bertuch-Samuels & Ramlogan, 2007). The best way to minimize such risks is to ensure a country who internationalizes its currency has a strong social foundation and political system in place to manage monetary risk (Blount, 1998; Homaifar, 2003). Policies need be established that dictate how currency is used (Homaifar, 2003).

Trends in international banking suggests that within Europe while the euro may still be the standard currency used, often throughout the world and in international banks generally, much of currency is denominated in the form of dollars (Bertuch-Samuels & Ramlogan, 2007; Homaifar, 2003). The United States dollar has represented the gold standard among international financial institutions because the U.S. has relatively little exchange rate fluctuation, which lowers the potential risk within the international financial marketplace. To gain operational independence and affirm prices will remain stable, banks want to ensure the currency they use is issued in a country that is stable and holds prestige (Homaifar, 2003). This can easily be assessed by evaluating a country's financial systems, determining whether the banking systems are strong and offer policies and provisions for conducting business using foreign currency as well as domestic currency (Homaifar, 2003;Lim, 2006). The more standard and stable a currency, the more likely global financial institutions are to relinquish any concerns about market barriers so that capital can move more freely between countries and organizations conducting business (Lim, 2006).

Conclusions & Commentary

Financial institutions operating internationally face risk in many forms, including the risk of interest rate increases or foreign exchange rate volatility when working with various currencies (Homaifar, 2003). Multinational banks however, can minimize the risks associated with global financing by evaluating the cost-benefit of doing business with organizations and using various instruments, and analyzing alternate hedging vehicles for managing operations.