Emerging financial markets
The development of financial market is vital in fostering the growth of economy in all of these emerging economies. Financial market plays a vital role in its ability to influence the rate of investment and minimising financial strain by making finance available to the businesses in the market. A stable financial market works well for the businesses as it opens up channels for the firms to obtain capital. The increase in liquidity in the market allows forms to venture into profitable investment which increases the firm networks or output.
Banks versus stock markets
There has been a debate in favour of either bank based or stock market based financial markets as means for the market to access resources. In fundamental nature, the performance of stock markets and financial institutions provide a good ground for studying the growth of firms as they play a complementary role in providing credit for firms to fund their growth in form of capital investment (Bley, 2007, p.212).
The role of banks
One of the most significant roles of a bank is to encourage savings from the larger community and thereafter avail this capital to firms in form of credit. In this, banks play a significant role in providing liquid finance for investment and expansion. Banks cushions financial markets from the instabilities of unrestricted financial structures which have fragile regulation from internal organs and lack transparency. In addition, banks help markets to deviate from reliance on foreign debts for investment (Dimitris, 2000, p.19). The subsidiary role played by the banks in risk management helps to create an economic worth for every investment being undertaken by a firm. In addition, banks acts as facilitators of economic activities in a financial market by providing credit to firms and helping in management of the resource allocations in forms of wise investments.
The economies of scale applied in banks in pooling together of resources at a low cost and thereafter gathering and analysing of information regarding the potential investment plans acts a form of control and management in the existing businesses. In the emerging markets, banks have the advantage of being in close contact with the investors and the source of capital from the customers who save with them. They therefore act as a bridge which links the source of capital to where it is required. In their process, banks transforms risk imposed to them by the investors who want to get interests from their savings by passing the funds to firms which borrows capital from them (Blake, 2000, p.32). This principle of adjoining the surplus from consumer spending to investments guarantees increased availability large volumes of low cost capital for investment.
Banks utilise constant reserves to stabilise the net flow of capital in an economy. In this respect, they will continue to play a vital role in harmonising the flow of capital for investment in the emerging economies. In absence of banks, these economies will remain in a highly vulnerable field due to the fluctuations in international economy. There is therefore a logical need to develop strong local banking systems. This is only possible if these economies maintain a good fraction of their financial market especially banking sector under the ownership and control by the domestic market. This is because, in an event of a downturn in foreign economy, the foreign investors might pull out their investment leaving the market at a worse off position due to lack of capital. It is therefore very important for these markets to have well-designed sets of established local institutions which can come together with the governments in these economies in responding to any fluctuations in the capital market.
The role of stock market
There has been a considerable increase in the vibrancy of the stock market in most of the emerging markets since the beginning of 1990s. For most of these emerging markets, the capital market has expanded for more than twice the size for the last two decades. The development of stock market in emerging markets has played a significant role in achieving financial liberalization and forming a channel through which foreign capital can flow into these markets. The net flows in equity that is attracted in form of foreign investment offers a vital source of capital that is used for development by these firms (Board, 2002, p.25). In their essence, capital markets are intended to accelerate the growth of an economy by offering an enhanced field for local savings and raising the investment quality. Stock markets have the capacity to foster economic growth by providing good way for upcoming firms to raise capital at a reduced cost. This reduces the dependency on capital financing from banks which reduces the danger of inflation.
The advantage of stock market financing is that, it allows firm to undertake long term financing by availing money from individual persons to the firms in forms of shares and bonds. As a result of this, increased savings are passed to the firms who later inject this capital to its investment plans. In addition, stock market ensures through the takeover of stocks that the money invested remains in the hands of the firm. In a free market, the stocks instil a discipline in financial utilisation and guarantees effectiveness in use of assets of a firm. These emerging financial markets have embraced financial relaxation which encourages transparency, and financial accountability thereby reducing the negative effects of risky burrowing. These improvements in the stock market minimises the cost of acquiring credit from stock market which eventually increases the flow of cash and the size of sock based financial market. One of significant in the stock markets is that, the level of market capitalisation is not dependent on the size of a country (Neiman, 2000, p.29). The significance of stock market is determined by the capitalisation ratio which refers to the worth of the local equities transacted in the stock market in relation to the GDP of that country.
Therefore the two are equally important as they play a big role in mobilizing resources for investments by firms through the application of their efficient and cost reduction mechanisms. In one hand, in order to cushion the emerging financial markets from the negative effects unavailability of finance posed by unexpected fluctuations in the stock-based market financing, the markets should have strong banks which will maintain cash flows in the financial market at such moments. In the other hand, strong and stable capital markets are necessary in order to help firms have an alternative source of capital due to the restrictions from banks in accessing finance and the negative effects of inflation. In actual fact, emerging economies should be more interested in building a low cost, and flexible financial markets which will foster a more rapid mobilisation of resources (Robert, 2006, p.5). In addition, the formation of strong institutions that will support a complementing relationship between these two financial organs can move the economies to greater heights by enhancing the mobilisation of resources. The complementary aspect of a financial market has a greater capacity to impact in growth of investment and in these emerging markets. This requires application of diversified financial tools which will ensure the existence of a suitable environment for the two systems to coexist harmoniously and create diversity. In a financial market, diversity will go along way in reducing risks and harmonise market volatility (Ghosh, 2004, p.40). For stock market to thrive, the government of these economies is required to stipulate necessary policies that will encourage savings in form of stock market investments.
In summary, the development of the development of the financial markets through both the stock market and financial institutions like banks has a lot of influence in determining the opportunities available for growth by the forms. The two organs intermediate in transferring savings into investments by making it available to firms and should be given equitable focus by policy makers in order to influence a stable economic growth.