What is a financial center? Definition and meaning
A financial center is an area – maybe a district or city – where there is a high concentration of financial institutions. Financial centers have a highly-developed commercial and communications infrastructure where huge volumes of international and domestic trading transactions are conducted. The world’s most important financial centers are New York, London and Tokyo.
Regional and national financial centers interact with the leading centers and may function as business feeders or provide local access to them.
An offshore financial center, often called an OFC, is a smaller, lower-tax, and less stringently regulated jurisdiction whose clients are mainly non-residents. The ‘Big 7’ offshore financial centers are Ireland, Hong Kong, Liberia, Singapore, Panama, Switzerland and Lebanon.
These are the six characteristics that help an area transform from a local market into a global hub. 1. The business environment including political and economic policy. 2. The extent and quality of the infrastructure provided for financial market activity. 3. The quality of financial market regulation, and conformance to international best practice. 4. Availability of qualified personnel. 5. Connectivity centers that link the financial center with the rest of the world. 6. Critical mass.
The Financial Times’ glossary of terms defines a financial center as:
“City in which a large amount of a country’s financial transactions take place, and where the main exchanges are located.”
Participants in a financial center
In a financial center there are institutional investors including investment managers, financial intermediaries such as asset management funds, brokers and banks, and central banks.
Trading takes place at specialized exchanges and involve clearing houses, although a significant number of transactions take place OTC (over-the-counter), i.e. directly between participants.
New York is North America’s major financial center, Europe’s is London, and Asia’s is Tokyo. In these images, you can see the financial districts of each city.
Companies that operate in financial centers offer a wide range of financial advisory services, such as those related to M&A (mergers and acquisitions), reinsurance, private equity, and several other areas of finance.
The financial center in a changing world
The financial center league tables are likely to change significantly over the next twenty years as emerging economies like China and India grow.
With progressive globalization and the increase in online trading, it is likely that the need for financial centers will decline as we go further into the 21st century.
What could only be conducted in a financial center in the 20th century, today can be done by somebody in a cabin on top of a mountain in the Swiss Alps, in a remote research station in Antarctica, or in the middle of the Sahara desert hundreds of miles from the nearest town, as long as they have access to the Internet.
Experts predict that even though many transactions will be feasible online from anywhere in the world, the three main centers will probably remain important.
The Global Financial Centers Index (GFCI) ranks the world’s major financial centers according to competitiveness. It is published every six months by Z/Yen Group and is sponsored by the Qatar Financial Center Authority. (Image: Adapted from longfinance.net)
Europe’s financial centers
In Europe, financial centers began in 11th century England at the annual fair of St. Giles. Later the Champaign Fairs emerged in France.
The City State of Venice hosted the first proper international financial center – it started off as a tiny entity in the 9th century and gradually grew, reaching its peak in the 14th century.
English Common Law was the first globally to attempt to enforce regulations on the dangerous practice of fractional reserve banking. Much like Silicon Valley has been the cradle of innovation for technology and electronic gadgets, London has been the cradle of innovation for finance.
The first two banks to function in a similar way to modern banks were Barclays, which was established in 1690 and is currently Britain’s second largest bank, and the Bank of England, established in 1694.
During this time, the City of London became an important financial center. The Royal Exchange, which was founded in 1565 by Sir Thomas Gresham as a center of commerce for the City’s merchants, gained Royal patronage in 1571.
In the 18th century, London grew rapidly, reflecting a growing national population and the early stirrings of the Industrial Revolution, as well as the city’s role at the center of the mighty British Empire.
Throughout the 19th century, London (The City) was the world’s main business center. In 2008, it came first in the Worldwide Centers of Commerce Index. Today, the insurance industry is focused around the City’s eastern side, around Lloyd’s building. Canary Wharf, 2.5 miles (4 km) to the east hosts a secondary financial district.
London today is the world’s largest center for foreign exchange markets, derivatives markets, money markets, issuance of international debt securities, trading in precious and base metals, and international bank lending.
Since Britons voted to leave the European Union on June 23rd, 2016, many fear that financial institutions will move across the channel to Paris or Frankfurt.
The International Financial Centers Development Index is compiled once a year by the Xinhua News Agency with Dow Jones & Company and the Chicago Mercantile Exchange. Since its inception in 2010, New York has held the number one spot. (Image: Adapted from sh.xinhuanet.com/shstatics)
USA’s main financial center
During the 19th century, Philadelphia looked like it would eventually become the USA’s major financial center. Unfortunately for that city, national politics erased its advantage in the 1830s and 1840s, setting the stage for New York to start establishing itself as the center of American finance.
Before the Civil War, Philadelphia was home to America’s largest banks – the Second Bank of the United States, The First Bank of the United States, the Bank of North America and the Bank of Pennsylvania.
The first US stock exchange was founded in Philadelphia in 1790. In 1792, a group of New York traders met and considered setting up a security business. These twenty-four men were the founders of the New York Stock Exchange.
In 1817, the New York merchants were not happy about the state of their stock exchange. One of their members was sent to Philadelphia to see how trading was done there. The merchant returned to New York and reported on what he had witnessed in Philadelphia.
Not long after, the New York Stock and Exchange Board was formally established – it was inaugurated in Wall Street.
From a troubled beginning, the New York Stock Exchange turned into a Goliath of a trading area, where billions of dollars worth of stocks and bonds are today traded each day.
New York City’s financial center is located in the island of Manhattan, specifically around Wall Street, a 0.7-mile-long (1.1 km) street running eight blocks. The area is known as the Financial District of Lower Manhattan.
Today, the term ‘Wall Street’ refers to the financial markets of the USA as a whole, the US financial sector, or New York-based financial interests.
New York City is home to the two largest stock exchanges in the world by total market capitalization: 1. The New York Stock Exchange (NYSE), and 2. NASDAQ (National Association of Securities Dealers Automated Quotations).
Several other major exchanges are located in New York City, including the New York Board of Trade, the New York Mercantile Exchange, and the former American Stock Exchange.
Video – Building a modern financial center
This City of London video explains what it takes to turn a district of a city into a major financial center.