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GUEST BLOG: How financial markets can affect your business

By Business & Finance
26 October 2016
entrepreneur financial markets business

By Ben Barlow, freelance finance writer

The financial markets play a fundamental part in the accumulation of capital, and the production of goods and services.

To create the optimal business environment, it helps to have a booming economy, and according to experts ETX Capital, the reasons for this are simple. When a country is doing well, their currency is competitive, goods are cheap to import, borrowing institutions are happy to lend, and consumers have a high disposable income. In such circumstances, companies have the capacity to thrive.

To build this economy, well-developed, smoothly operating financial markets are essential. They help to shape a system that is both healthy and efficient, and there is a strong correlation between financial market development and economic growth.

Speaking on this in their 2001 book, experts Demirguc-Kunt and Levine explain: “Researchers have provided additional findings on the finance-growth nexus and have offered a much bolder appraisal of the causal relationship; firm-level, industry-level, and cross-country studies all suggest that the level of financial development exerts a large, positive impact on economic growth.”

This relationship exists because effective financial markets direct the flow of capital, in the form of savings and investment, in a manner that facilitates the accumulation of it, and promotes the production of goods and services. Where such a structure exists, businesses have the opportunity to flourish.

WHAT ARE FINANCIAL MARKETS?

Before we go any further, it’s important to explain what financial markets are. The triumvirate of markets, instruments, and institutions provide potential investors with the chance to put their money into areas that they hope will deliver a tidy turnaround. These can vary widely, and it is this diversity that allows them to develop strategies that work for the individual.

Combined, the three contribute to economic growth, and the larger they are, the better for their host country. America offers a prime example of this, with its financial system commonly held up as a pinnacle of achievement. Its markets conduct a countless number of daily transactions, and its financial services industry is extensive and exquisitely well developed. Considering this, it is little wonder that it is the richest country in existence, with its economy representing around 24.5% of the gross world product.

WHY ARE INSTITUTIONS IMPORTANT?

As we mentioned above, financial markets play a fundamental part in the accumulation of capital, and the production of goods and services. This makes them very important to businesses. For those who wish to thrive, understanding them is key.

However, the interplay between the two is not easy to explain. Let’s start with the price of credit and returns on investments. Both of these act as signals to producers and consumers, and in doing so help to direct funds from savers to the consumers, businesses, governments, and investors that would like to borrow capital.

This is done by pairing those who are willing to pay the highest price or interest rate with those who have the ability to lend, and it doesn’t only happen on a domestic scale; the financial markets also facilitate the flow of capital between countries.

This relationship exists because effective financial markets direct the flow of capital, in the form of savings and investment, in a manner that facilitates the accumulation of it, and promotes the production of goods and services

Healthy financial markets have the added boon of reducing search and transaction costs within a country. This is because they allow a broad spectrum of financial products to be offered, with the effect of varying both risk and pricing structures. As a result, both borrowers and lenders are able to find a partner that matches their needs as closely as they could desire.

This benefits investors as well as individuals, businesses, and governments in need of funds, because when it becomes easy to ascertain what the cost will be for the borrower, investors can assess the price of financing, and weigh it against their likely return. The outcome is that they can make the best investment choice, and thus reap their reward on the financial market.

Looking at it in this light, it could be said that the financial markets thus channel the allocation of credit throughout a country’s economy, and in doing so stimulate the production of goods and services. 

HEALTHY FINANCIAL MARKETS

In order to weigh the importance of financial markets to promoting a healthy business environment, it’s important to look at what happens where these are poor or ill-developed. This is a scenario that can be seen in multiple developing nations, and these limited financial markets, instruments, and institutions frequently correlate with poorly defined legal systems.

As a result, the very raising of capital becomes an increasingly expensive venture, and the return on savings and investments tends to be pitiably low.

Healthy financial markets have the added boon of reducing search and transaction costs within a country

The fallout from this echoes through every echelon of the system. Limited information is commonplace, as is a dearth of financial transparency. Market participants thus struggle to make informed decisions, and the risks they run are exaggerated because of this. Compared to their more developed counterparts, investing in them carries a far higher risk.

Unfortunately, this increased risk is not something that can be reduced by diversification; a common strategy within more developed markets. The financial assets, savings, and investment products on offer are far more limited, and simply don’t provide the opportunity to try this.

The result is thus: there is little trading activity and few alternatives, and these mean that the search to find a suitable product becomes much more complex and costly. This hinders rather than helps the economy, limiting growth.

UNDERSTANDING THE FINANCIAL MARKETS?

Most successful business owners understand the importance of keeping a weather eye on their environment, and one essential facet of this is the financial market. The development of these strongly correlates with how easy or hard it will be for your business to thrive, and this means that they can provide an important clue when it comes to knowing which direction to take your enterprise in at any given time.

As one expert explained: “Long-term results are consistent with much of the literature in that we find a positive relationship between financial development and economic growth. These results therefore indicate that the primary channel for financial development to facilitate growth over the long run is through physical and human capital accumulation.”

For your business, this means one very simple thing: keep an eye on the financial markets, and you can stay ahead of the game.

About the blogger

Ben Barlow is a freelance finance writer specialising in stocks and shares, forex and ISAs.

After studying business at Lancaster University, Ben worked at a number of financial institutions in London and New York and is now following his passion for writing.