The International Banking System - Essay Example

International Banking Name Course Name and Code Instructor’s Name Date Despite the fact that The Economist Newspaper predicted fifty years ago that t British Banks were on the decline, there was a prodigious expansion in the banking sector between 1963 and during the financial crisis that occurred in the year 2008. This was a period marked with high Returns on Equity, which yielded many returns to both shareholders and the employees especially for the most successful companies (Cetorelli, 2010). In addition, the pay for both the bankers and the employees increased tremendously. Despite the fact that in the year 1982 none of the richest Americans worked in the Finance sector, this trend changed drastically since according to a Fund Manager at Edelweiss, Dylan Grice, the Forbes Magazine indicated that indeed, 12 out of the 50 richest Americans were investors, Asset Managers or Financiers. Since the financial crisis that occurred in 2008, returns on equity have collapsed. According to Boston Consulting Group, the returns for most of the world’s biggest investment banks have reduced by half to about 13 per cent in America and to about 10 per cent in Europe and owing to new regulations, the returns are likely to decrease to between 6-9%. Views regarding the profitability and growth of international banking institutions have been so polarizing. The extraordinary growth that was experienced in the finance sector just before the start of the financial crisis in 2008 both fed and initiated a rapid rise in the private sector debt in various rich nations (Cetorelli, 2010). Where the banking assets increased tremendously from about 50 per cent of GDP during the 1960’s to about 200 per cent GDP during the late 2000’s. In nations, which had large international sectors in banking like for instance Britain, the Bank assets increased to about 5 times of the total GDP (Nishimura, Suzuki and Michie, 2012). In Switzerland and Iceland, the bank assets swelled to about 8 to 10 times of the countries’ GDP. In America on the other hand, the banking ratio of assets as compared to the to the GDP even more than doubled during the 15 years before the start of financial crisis to about 126%. Ahead of the financial crisis, balance sheets expanded faster and bank assets in major big economies grew steadily and the reasons attributed to the unusual growth were positive (Barth, Lin and Wihlborg, 2012). Twelve years before the financial crisis, world trade soared from 22 per cent to 33 per cent of the world’s GDP. Because large organizations started doing business in more nations since they needed large banks, which could accompany them across the borders by paying their employees, financing factories and hedging their exposure towards interest rate changes and currency movements. Bank and market deregulation coupled with financial innovation also played a great role in the growth of the financial institutions (Cetorelli, 2010). The cost of borrowing for most of the households in the rich world economies have been on the increase. Thee have been arguments by bankers who assume that the banking or finance industry will continue growing as fast as the economy that underlies have attributed this to the fact that the increasing wealth in both developing and rich countries well lead to the establishment of more financial assets that can be sold or bought (Cetorelli, 2010). They also insist that the increasing debt and banking penetration in developing nations as financial and legal systems mature will make it possible for individuals to borrow against the value of their assets and companies will be forced to sell shares and bonds in order to expand (Nishimura, Suzuki and Michie, 2012). There are powerful factors, which are known to hold back the banking industry’s growth, and profitability like for instance the disappointing economic growth exhibited in most of the rich worlds, which will prove to be more protracting, coupled with the low interest rates. Investment banking revenues are predicted to remain static in the near future and thus financial institutions are focusing on the identification of opportunities and performance levels in order to increase their market shares. There are various structural forces known to change the investment banking business like for instance a raft of regulations reflected through higher capital agreements or standards, which have not yet been, implemented (Cetorelli, 2010). This is attributed to the fact that the regulations which have not yet been implemented will make the financial institutions or banks to be prone to breaking up and become less able to utilize cheaper retail deposits so as to fund their business trading and take risks thus becoming less profitable (Nishimura, Suzuki and Michie, 2012). The march of progress is another threat that banking institutions face since they are under great pressure to offer their clients more as they charge less. New technologies have made it possible for banking jobs to be carried out by computers instead of bankers. Pricing junk bonds is made possible since the trading is electronically done by computers thus making their issuance to become even easier. Such an environment is prone to create both losers and winners and the main beneficiaries in such scenarios are the few big banks which will make it possible for them to both combine their investment banking and reap scale benefits through corporate banking trading (Kim and McKenzie, 2010). Geography is also bound to favour banking institutions having friendly regulators and big home markets. In order to succeed in banking business, institutions ought to have a reputation or an image for smartness and ensure that they dominate in equity banking (Nishimura, Suzuki and Michie, 2012). New regulations in the United States have made it difficult for both international and domestic banks to transact optimum business. It can therefore be genuinely argued that the most profitable days in the banking industry were in the past since the current regulations have made it so difficult for banks to get ROE of even between 15 to 20% (Cetorelli, 2010). New regulations have posed a great threat to investment banks and thus making business to go on the low. For instance, under the Basel 3 regulations, banks are required to possess equity buffers, which are about 3 times larger than their minimum as capital cushions. The rule requiring banks to have at least 7% of ROE was meant to discourage the banking institutions from either getting more complex or getting more bigger thus having a significant impact on their profitability (Kim and McKenzie, 2010). The new banking rules have already started taking toll on the financial institutions. For instance, banking institutions have started to boost their capital at a much faster rate than was expected by the regulators making the banking systems to become safer (Cetorelli, 2010). However, this comes at a cost since instead of requesting their shareholders for more equity in order to boost their ratio the banking institutions have cut back their lending and shed their assets (Nishimura, Suzuki and Michie, 2012). Secondly, in order to reassure their creditors and clients, many banking institutions and their investors have calibrated the scale of their capital charges by promising to increase the capital. Banks created low risk investments by simultaneously combining loans, which stood less chances of being defaulted into dodgy slices, and by using rating agencies to structure securities in order to attract high ratings. The old rules or regulations in banking turned the investment banks or institutions from being intermediaries to being proprietary traders. 2 decades ago, the investment banks were actually in the money moving business in which capital markets were used in moving funds from their savers to their borrowers thus avoiding risk in the banks’ balance sheet. However, a decade before the occurrence of the financial crisis, investment banks have changed from the business of moving business and money to mere storage banks (Nishimura, Suzuki and Michie, 2012). The Volker rule in America, which forces limits on the number of businesses that banks can transact, has threatened most banks through far-reaching impacts. There is also a significant litigation threat in both Britain and America in which most of the banks are paying many millions in form of compensation and fines for sins, which were actually committed in the past. Another threat that will arise from the implementation of the Volcker rule is that it will force the banking institutions to standardize most of their offered derivatives and thus push them onto clearing both the houses and the exchanges. This coupled with the capital rules which penalize long dated and complicated derivatives, which are written, by banks will deeply cut into the revenues (Cetorelli, 2010). Banks will also be forced out of profits due to reduced profits as a result of banning proprietary trading and high capital requirements, which do not pose a threat to the investment of big banks in future. The proposal set to separate the investment banking from the rest of the retail banking is another example of a set of rules worrying most of the European bankers. Such a proposal, if implemented, will aim at ensuring that the financing of investment banking business transactions cannot be done through retail deposits thus raising funding costs in the European banks. Britain and Swiss are prone to fall away while America is interested in the game (Nishimura, Suzuki and Michie, 2012). On the other hand, the European Investment banking sector in Washington D.C is prone to be affected due to a set of rules that are taking shape (Lessambo, 2012). Such rules will make it mandatory for all international or foreign banking institutions running in America to create local holding firms or companies for all their subsidiaries in America (Cetorelli, 2010). While the current laws or arrangement allow such foreign banking institutions to operate on low capitals or guarantees obtained from their mother companies, the set of rules set to be currently implemented will require such subsidiaries to run on their own liquidity and capital. The new capital requirements have seen Barclays and Deutsche bank deregister their major American holding financial companies in the past two years in order to avoid them. Despite the fact that the proposed rules may appear to be perfectly sensible to the American regulators, they are also bound to impose heavy additional costs on banking institutions (Nishimura, Suzuki and Michie, 2012). The financial globalization era would immediately cease if all the regulators were to force all international banks to locally hold their liquidity and capital. Despite the fact that there is less profitability in trading of equities, most of the banks are still carrying on despite facing stiff competition from established brokers who also engage in share trading (Nishimura, Suzuki and Michie, 2012). Given the fact that equity trading was the major source of investment for banking institutions, this has drastically fallen since 2007 due to the strong competition in share trading making it to form less than a fifth of the banks’ revenue and share of profits. The investors in share trading now prefer storing their money in banking institutions rather than buy shares because share trading hardly covers the total cost of capital (Cetorelli, 2010). The major challenge for most financial institutions is their ability of taking on the execution risks from the clients without necessarily dedicating a lot of capital to it, as this will greatly help them to possess a large size of the market (Kim and McKenzie, 2010). Through having great market shares in form of currencies or trading bonds, banks are able foresee the change in markets and thus be able to match the sellers and buyers thus giving them advantage in ascertaining how risky bespoke transactions can be. Banking institutions are able to invest in faster and better systems depending on the trading that it does. Due to this fact, small banks all over the world are really struggling in covering their fixed costs and thus they stand a higher risk of misjudging potential risks due to the amount that they spend on technology in order to remain current. In conclusion, not all the changes and regulations will make life harder for banking institutions. This is because despite the fact that simplification of derivatives and centralized clearing may cut margins by approximately 40%, they may also increase the trade volumes thus allowing the financial institutions to shed some of the risks, which they would have adopted on their balance sheets thus freeing capital. This will eventually enable the banking institutions to return to their major function making markets for their customers and intermediation in securities, a task they have long neglected. References Barth, J., Lin, C., and Wihlborg, C. 2012. Research Handbook on International Banking and Governance. London: Edward Elgar Publishing Cetorelli, N. 2010. Global Banks and International Shock Transmission: Evidence from the Crisis. London: Diane Publishing Kim, S., and McKenzie, M. 2010. International Banking in the New Era: Post-crisis Challenges and Opportunities. New York: Emerald Group Publishing Lessambo, F. 2012. The International Banking System: Capital Adequacy, Core Businesses and Risk Management. New York: Palgrave Macmillan Nishimura, S., Suzuki, T., and Michie, R. 2012. The Origins of International Banking in Asia: The Nineteenth and Twentieth Centuries. Oxford: Oxford University Press Read More