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Move over New York, London is the new No. 1

/ Source: Business Week

London has officially dethroned New York as the world's top financial center, according to an index released this month by the Geneva-based World Economic Forum.

The WEF's 2009 Financial Development Index ranks 55 countries on the sophistication and stability of their financial systems and markets. The nations were evaluated according to more than 120 criteria, ranging from the favorableness of their institutional and business environments to the size of their equity and bond markets, and from their technology infrastructure and human capital to the ease of obtaining consumer and commercial loans.

Perhaps the biggest surprise in this year's study—the second release of an annual index launched in 2008—was that Britain rose to the No. 1 spot despite its economic troubles, up from No. 2 last year. Britain was buoyed by the relative strength of its financial markets, particularly in foreign exchange and derivatives, and by its world-beating insurance coverage.

The other headline news—though perhaps not as surprising—was that the U.S. fell from No. 1 in 2008 to No. 3 this year. While the country is still by far the world's wealthiest, financial instability and a noticeably weakened banking sector pulled down its scores. The No. 2-ranked country, Australia, jumped nine rungs in the rankings, thanks to its greater financial stability, low sovereign debt, and ready access to consumer credit.

France and Germany fall out of top 10 The results of the study will undoubtedly fuel the ongoing debate as to whether London or New York is the top dog in global finance and markets. Britain's elevation to No. 1 could be short-lived. The country continues to be weighed down by recession, while the U.S. reported a return to growth in gross domestic product during the third quarter of 2009. Britain's institutional environment also could weigh on its ranking next year: The government has been criticized in recent months for excessive intervention in the financial sector, and there is rising concern over increased regulation and higher tax rates, which could encourage London-based hedge funds and other financial intermediaries to move elsewhere.

To be sure, the total scores for most developed nations fell sharply, due to the effects of the credit crisis—and those that suffered the most from lowered financial stability were among the largest industrialized economies. France and Germany, which held top slots in last year's index, fell out of the top 10 altogether, landing at 11th and 12th place, respectively. The sheer size and global nature of these countries' financial systems exposed them more than others to the effects of the downturn.

The fall of such countries as France and Germany allowed developing nations such as Brazil, Chile, and Malaysia to close the gap on their Western counterparts. Nouriel Roubini, an economics professor at New York University and the leading academic for the study, wrote in a summary: "For some of these developing countries, it was a result of learning from the mistakes of past financial crises, while for others it reflected the relative lack of complexity and global integration of their financial systems."

Yet emerging economies have a way to go before they catch up with more developed rivals. Some suffer from underdeveloped infrastructure, murky legal and regulatory regimes, or weak corporate governance. Few score well on financial access for consumers and small businesses, as measured by the availability of credit and the penetration of retail banking services such as savings accounts, microcredit, ATMs, branch offices, and point-of-sale financial services.

Top nations still hold a vast advantage Aside from the relative strengthening achieved by developing countries, the most intriguing result for the researchers who put together this year's study was that Australia leapfrogged over the U.S. "While we expected the relative stability of the Australian banking system to strengthen the country's ranking, we were surprised at just how significantly its overall ranking jumped," says James Bilodeau of the World Economic Forum, who co-authored the study with Roubini.

Apart from Australia, all of the countries in this year's top 10 saw significant declines in their overall scores. This highlights how badly the economic crisis shook most major financial systems. What allowed countries such as Britain and the U.S. to remain near the top of the list, despite big hits to their financial stability, was the breadth of other factors taken into consideration. Although their markets have been volatile, these and other top-ranked countries still offer deeper pools of capital, more financial transparency, and a host of other institutional and infrastructural advantages that will likely keep them among the leaders in financial development for years to come.

Still, this is no time for complacency. "The drop in scores for both the U.K. and the U.S. indicate that their leadership is potentially in jeopardy," says Bilodeau. "The potentially worrisome finding is the degree to which scores have dropped and their lead relative to other countries has diminished."