The Reasons, Regulation, and Supervision for International Banking - Coursework Example

INTERNATIONAL BANKING Customer’s Name Customer’s Grade Course Customer tutor’s Name 10th November, 2010 Introduction International banking is the process where foreigners, both individuals and companies are allowed by financial institutions to use services of these financial institutions. The international monetary fund states that, “international financial services make it possible for companies to operate smoothly across the globe and this kind of diversification of trade in recent times has been elevated by the growth of multistate banking” Scharfstein (1996)1. According to Scharfstein (1996)2, the initiation of banks on the global arena started in the early 1970s gave way for the globalization of trade and became more and more evident during the nineteen nineties and international flow rose significantly. An international financial system makes it possible and also can be a possible threat of instability to a nation both developing and developed countries. Banks can act as a vehicle to economic transition or can on the other hand be an instrument for draw back to the enhancement of economy of a country. The Encarta encyclopaedia (2009)3 states that, “As banks continue making international loans several experts think that there must be a bigger worldwide collaboration concerning control and regulations in order to decrease the associated risk of these banks failing to repay”. In the year nineteen eighty eight the Basel Committee on Banking Supervision, which is a union of regulators of international banking located in Switzerland, took an early imitative in creating Basel Capital Accord4. “The accord established a global standard for assessing the financial soundness of banks and required banks to maintain a minimum ratio of capital to risk assets because many banking experts believe that this accord could become the primary tool for strengthening the safety of international banking”5. The formulated accord was then taken over by many states. In order to be successful in ones exporting and importing activities, one needs to know how to finance their imports and exports and how to get paid in the long run6. The banker can do this and should be the key member in ones business and part of the advisory team. The expansion of internet and the invention of e-banking are key features that have helped in increasing the number of banks that companies can work with for purposes of international banking requirements7. Reasons for International Banking International trade is propelled by such services by e-banking and foreign exchange. Example of the services includes asset management, development project funding, equity market analysis, assessment and insurance. However, the order and procedure of day in day out of every bank’s routine is outlined in every banks policy. According to Gale, D. (1991, p.284)8 no matter what environment a certain company might be operating in, there might be several brands or products which the bank offers to various categories of clients in order to suit their needs and preferences. Some of the clients who use international banking services includes; manufactures multinational companies, capital equipment importers and exporters and so on. Some of these services might include import letters of credit and so on. Many individuals and companies use international banking for a number of reasons. Majority of this clients use the services because of enhancing their security and as away of transferring wealth9. Tax evasion penalty avoidance by the customers is always avoided by customers sorting out the issue with the bank. Many traders like taking advantage of the economies of countries which have stable economy through transacting through the international banks10. In order to void lawsuits many wealthy individuals around the world are fond of securing their money and wealth in the offshore banks11. This definitely doesn’t mean that these individuals are criminal, but it is just that they avoid the risk of losing all their treasures to unavoidable court suits. Because multi state banks lend and borrow money to traders and individuals on international portfolio, they therefore become less affected by the local interest fluctuations of their home country. Sometimes the multi state banks have endeavoured in giving better interest rates than some of the stable local banks. As Gale, D. (1991, p.282)12 indicates, most international banks provide an easier alternative for clients wit well known good transaction record top carry out their day to day business in a well fabricated and smooth way across the world and such clients do not need several bank accounts in all the countries they do business but the bank carries transaction o behalf of them. In addition, Gale, D. (1991, p.285)13 notes that, “international banks provide a wide variety of financial services to accelerate international trade, banks offer payroll services to companies with employees and contractors and that they also offer letters of credit to make sure that the companies involved are able to pay each other for the services they share”. Banks also offer finance services to help businesses that are in the verge of falling as a result of high costs of importation from other countries14. Accordin to Chui and Maddaloni, (2004)15 the procedure of having an account in an international banking institution usually includes the following: 1. The bank identifies you and identifies anyone who has interest in your money16. 2. Bankers normally ask clients about their intentions17. 3. They ask several questions to the client to ascertain the exact reason why the customer intends to have the account18. 4. They ask questions to find out where the clients money will be originating from and the intended quantity from the source19. 5. Banks ask for references20. 6. To ascertain the reputability of the individual or company21. 7. Analysis is done on how risky a customer can be in terms of payment of loans22. Central Banking and Prudential Supervision Banks have very crucial role in the growth and up keep of a countries economy23. First, of all, they help to deal with the information gap that usually exists between the borrowers and the investor and as they engage in continuous monitoring & research to ensure they apply the best practice to ensure the safety and management of their services and funds24. Second, the strategies of dealing with dangers and losses which cannot be avoided cannot be exaggerated at a specified point in time as well as cover to money depositors in relations to unanticipated expenditure shocks which arises from assets and liability which do not match due to their mismatch in maturity25. Banks are prone to risks and runs. Banking gives a boost to the growth of a countries economy. Fourth, they play a significant role in enhancement of a country’s governance26. They are usefulness is unquestionable and critical to the entire financial system of nations and the whole globe. We cannot comfortably discuss about international banking without putting any emphasis in the World Bank. According to a report compiled in the Encarta (2009), the bank grants loans only to member nations, for the purpose of financing specific projects, they stipulate that before a nation can secure a loan, advisers and experts representing the bank must determine that the prospective borrower can meet conditions stipulated by the bank27. As Diamond, D., and P. Dybvig (1983, p. 402) asserts that, “most of the prevailing conditions are put in place to ensure that loans are used productively and that these loans will be repaid”28. The bank will also require the borrower to be able to secure a loan for the particular project from any other source on equally reasonable terms and that the prospective project is economically sound29. To ensure that chances of loosing the money banks, makes sure that the borrowing governments guarantee that the money borrowed is directed through a private channel within their jurisdiction30. Diamond, D., and P. Dybvig (1983, p.402) also notes that, “after the loan has been taken by the beneficiaries, the bank finds a routine of accounting reports from both the observer and the subsequent borrower to ensure the funds are used, which therefore means that all banks constantly communicate with the World Bank”31. But we can also relate this report with the one made by Diamond (1984, pp. 331-4), saying that loans were given chiefly to European countries and were mainly used for the reconstruction of industries that were damaged during Second World War Since the late 1960s, however, most loans have always been granted to developing countries in Africa, Asia, and Latin America and that the bank has given specific focus on projects that could directly benefit the poorest people in these developing nations through assisting them in raising their productive activities and to gain access to necessities such as safe water and waste-disposal facilities, health care, family-planning assistance, nutrition, education, and housing among other necessities32. Diamond (1984, pp. 334) also asserts that the provision of loans for rural and agricultural has led to small scale and medium businessmen are involved directly in order to eliminate poverty in the developing countries which are the major beneficiaries of the loans in projects such as small scale farming enhancement, light industries enhancement, ecological concerns and energy development33. In trying to get acquainted to the various roles which banks play to a country’s economy it is important to mention the touch that banks have on the welfare and livelihood of the people34. The livelihood which is obtained from use of the loans is directed towards improvement of the people’s livelihood. This process is in most cases propelled by banks. Diamond (1984, pp. 383-4) argues that, “banks allow various information related problems to be solved”35. One important problem is that borrowers must some action in order to make proper use of the funds which they have borrowed; this action could be the level of effort or choice of project from among various different risky alternatives36. Diamond (1984, pp. 384)37 also says that, “the loan borrower can at times be forced to believe that, a low outcome is because of unavoidable circumstances but not because of improper initiation of corrective measures of action, the truth is that banks which are the lenders are not playing their right role in monitoring the borrower”. The financial market comprising of a variety of lenders, there is a problem normally referred to as the free-lender problem. Diamond (1984, pp. 384)38 also notes that, “everyone would always want to be a free-rider and thereby leaving another person somewhere to pay the monitoring fee but it is important to note that no monitoring can take effect if no effort of hiring a single agent to check and monitor this on behalf of the borrower”. Although the pain of hiring a single monitor can be taken, a question arises that that is to monitor this individual? Mediators more often than not have a collection of schemes for which they offer money they monitor the borrowers by creation of a promise to money lenders to have a fixed return39. If the money lenders are on the other hand not monitored, then it becomes extremely difficult to give in the returns by the borrowers40. Diamond (1984, pp. 393-4) asserts that, “banks should always have a clear way of monitoring and coming up with reports which can propagate information about the progress and for determining allocation resources efficiently”41. Among the most significant importance of all the financial institutions is to share out the risk evenly among many in order to ease the effect of lose to an individual or to a company42. In this case, it’s not only the monetary organizations that are associated to the risk, even individuals are not exempt43. This eventually makes both parties to be equally responsible so as to keep the risk level as low as possible44. Banking also has a vital role in transformation of maturity. Banks consolidate deposited money and use it as capital to raising more profits in the capital market in short term45. They then strategically try to channel these funds in long term asset investments46. According to Rajan, R. (1992, p.1400) this disparity allows companies and individuals to present risk pertaining` to depositors and at the same time exposes them to the chances of enabling their customers to get to withdraw money timely. Runs are situations when a bank does not have liquid cash due to much withdrawal by individuals47. Crises are usually very random as far as banking is concerned. These crises usually relate to the changes in the real economy. A paper by Bryant (1980, pp. 335-344)48 reveals that, “banks runs are self satisfying prospects”. For instance, he assets that, “if the assumption of first come first served, some assets will be multiple equilibriums, if everyone believes that a crisis will not occur, those with genuine liquidity will need to withdraw their money and these demands and needs can be met comfortably without liquidating assets”. Rajan, R. (1992, p.402)49 continues to say that, “if everyone thinks that a catastrophe might happen, then individuals will always be on their heals to beat the deadline of being left out in the withdrawal queue of the bank halls, and each of these 2 equilibriums can only happen because of the sunspots and variables”. Certain scholars do believe that sunspots certainly do not pose a vital effect on the actual statistics economy but these scholars believe that the late poses a negative affect to the depositor50. Prevalence of crises of finance has caused several individuals to think that the entire financial sector is exposed to shocks theories51. An eligible kind of imparity that can lay an effect on even a single institution can create a synergy and even spread through linkages from one bank to another until it reaches a time when the whole financial sector is affected which can even result to the suicide of the whole economy52. Banks also take part in boosting the economic growth. Gerschenkron (1962, p.24)53 puts forward an argument that, “banking systems in countries such as Germany have made it possible for an enhancement of a stable relationship between bankers who fund the industries more than a similar case occurring in a country like the United Kingdom”. Goldsmith (1969, p.36)54 also points out that, “despite many of the Germany’s manufacturing companies growing fast in than the scenario in their counterpart European country, UK ,in the past century, the pattern for growth were of similar kind and nature”. Allen and Gale (1999, Chapter 13)55 asks if the banks are doing better at giving financial to the implementation of projects in cases where there is an enhanced diversity of choices and opinions? Allen and Gale (1999, Chapter 13) argues that the advantage of financial markets is that they allow people with similar views to come together to finance projects and that this will be optimal provided the costs necessary for each investor to form an opinion before investment decisions are made are low and that for this reason, finance can be provided by the market even though there is great diversity of opinion among investors56. Intermediate finance encompasses the delegation of the decision of financing a company and giving the manager powers to use his discretion and wisdom in forming rational decision and following informed opinions from others57. There is always one clear challenge, the gap in knowledge between the investor and the bank manager, this particular designation turns out to be the most favourable one when all factors of supporting a view are well put forward and as a result there might be a chance of forging an agreement in both cases58. The analysis leads to an assertion that, Allen and Gale (1999, Chapter 13)59 put forward that, “systems based on market will lead to more creativity than systems based on bank”. Goldsmith (1969, p.36)60 says that, “in countries such as Germany and Japan where there has been terrible lack of a control mechanism for the money market has led to banks being left to play as an acting instrument for the outside activities for large corporations”. This system in Japan is referred to as main bank system. According to Goldsmith (1969, p.36)61 “the characteristics of this system are a long-term relationship between a bank and its client, the holding of both debt and equity by the bank, and the active inclusiveness of the bank should its client become financially distressed”. It has been widely argued that this main bank relationship ensures the bank acts as dedicated monitor and helps to overcome the agency problem between managers and the firm, however, the evidence of the level of effectiveness of the main bank system is mixed up62. Inter-Bank Relationships There is an emerging assumption that analyses the advantages and drawbacks of relations in banks. If on one hand, durable and tightly close association gives an enhanced admittance to firms and puts up with some of the major problems that typify lending associations, on the other hand they also lead to rise in inefficiencies which are always related to the restriction inconveniences63. Rajan (1992, p. 1400)64 says, the hold-up predicament refers to the likelihood that a linked bank uses the advanced secret it has about a particular firm to take advantage over it such as through aspects like extracting rents, therefore distorting the incentives for entrepreneurship and exhibiting an inefficient choice for new and even existing investment in that particular country. Rajan (p.1400)65 continues to assert that, “the soft budget constraint problem involves the inability of a relationship lender to totally commit to a particular course of action in advance and although it is optimal to threaten or to terminate the availability of credit in advance once the borrower has defaulted, the first loan becomes a (sunk cost). It should be expected that the lender will continue to expand credit, even when the borrower defaults”. New negotiation therefore provides a time related predicament and the risk to conclude credit creates a good inducement for the borrower to keep away from failure to pay the loan. Numerous bank associations can assist in evasion of the challenges of solitary bank interaction in the logic that these banks hold up and the soft budget restriction problems that are involved in single banking66. Borrowing from multiple banks can renew a health competition amongst banks which as a result can enhance the improvement of business incentives. It is ascertained by various scholars that, “if the refinancing procedure is made hard and unprofitable, then of course the logic of lending from multiple banks enables banks to find it hard to extend unproductive credit to their clients”67. On the same note “multiple-bank lending reduces entrepreneurial incentives to default strategically because it complicates debt renegotiation”. Many interactions between economists are of frequent and recurrent nature. In such a situation, agents may develop and establish relationships, and outcomes of equilibrium may be different from those that rise from the anonymous market68. For example, determinants of the interest rate on inter-bank market loans are investigated. This is normally done using regression analysis. Alternatively marching methodology can be used. In this case, banks will be ranked according to size and other bank features. The Rise of the Conglomerate Bank According to International Monetary Fund (2003, p.1)69 a conglomeration is a combination of 2 or more organizations involving in very different endeavours or businesses coming together to strike a deal and start to operate under one single structure. According to International Monetary Fund (2003, p. 18)70 organizations which involve in conglomerate association stand for organizational forms that have been growing interest to researchers, much of the theoretical literature on conglomerates, which was initially stimulated by observations of a (conglomerate discount), which focuses on the internal organization of conglomerates and efficiency of resource allocation across divisions and that the problems between the centre and division managers have been identified as potential sources in inefficiency in general resource allocation and distribution. As banks make more and more loans on international fronts many scholar believe that in order for it to be successfully then there is need to enhance the global cooperation especially on regulatory standards in order to lower the risk accrued as a result of a particular bank failure. Andrew W. Mullineux (2002, p.24)71 stated that, “the general objective of financial institutions must be to create new opportunities for global investment through international financing of the investors”. This therefore means that this institutions should make it possible for free flow of finance especially to the investors who are going to utilize it well in enhancing the well-being of people in the respective beneficiary country. In order to achieve this, risks and benefits, Andrew W. Mullineux (2002, p.24)72 says, pecuniary and social and dis-benefits for example, poverty and environmental degradation must be accurately measured and a regulatory and supervisory system must be put in place to assure stability of price without distorting the price mechanism. Mullineux (2002)73 also asserts that, “there is much to desire as far as achieving of the laid objectives is concerned, but so far there is a lot that is being done to enhance the achievement of risk reduction regarding the negative factors which affects the progress of international banking”. Regulation and Supervision in International Banking Supervision and Regulation of banks play an important role in getting rid of all the threats which can predispose the banking sector to systemic instability74. Side by side to this, safety in the banking sector, has to be integrated to the banks policy and global and national’s bank control regulations75. Scharfstein (1996)76 says that, appropriate auditing and accounting regulations are vital in making sure that the financial statements reveals each financial institution's state of business. Managerial approaches are also determinants from a nation to the next, although there is no one stand alone model which can be appropriate for a bank mostly if political interference is considered. Banks have a vital role of holding a position in economies. They create and sustain money deposits from the public. This is why nations have laid stringent measures to control banking and the interests of the clients and the bank. It therefore means that the bank should get concerned about how to enhance the efficiency of its equity of intermediation and its general operations77. The role of the bank system has for along time now remained a vehicle to channelling of funds to the priority sectors of the economy in a given country. It is quite clear that banks plays an intermediary function as consolidator of deposits and then as a lender of credit. Therefore if it happens that there arises lack of accountability and transparency from the banks business of any given bank then the resultant thing is the fall of the bank because banks survive on good reputation however smaller or bigger they are78. Lack of loyalty, trust and attachment to the bank by the clients always predisposes as loss of confidence in the entire financial system79. Diamond (1984, pp 278)80 states that, “the focus of power is firmly related to the preceding stakeholder which leads to the strength and independent of the central bank’s supervisory and regulatory roles, particularly if extended to the entire monetary sector, it can end up being considered as hazardous to monitoring system on which the countries democracy puts much reliance on. Gale, D (1991) asserts that, in a country such as Turkey, a vital role of the auditors is to ascertain the tax payment adherence81. In other countries however, bank supervisors also are charged with the role of controlling the flow of foreign exchange amongst other roles of the individual82. A wide diversity of ideas from various groups does exist in relation to how banks control their practice and duties. Sharpe, S. (1990)83 says, before imposing rules and regulations, one must answer the following questions, the first one is that, is there any hypothetical or chronological validity to the claim that banks are intrinsically unstable and prone to runs? Second question is that, if the banks are unstable, how then has the private sector been dealing with such instability? If you attempt to solve this quiz it will remain clear tat banks play a pivotal role in the growth of economy today. Therefore, there needs to be stringent measures and policies to protect banks and promote their businesses. These measures can create a fragmentation of the monetary markets. Therefore great care should be executed when dealing with the banking framework. This is chiefly vital as the economic structure develops and becomes more included. There is a necessity to jointly harmonize the policies within international context and also create a level playing field so as to enable the local financial institutions to have a favourable chance of also competing84. Broad supervisory authorities need to be instituted in order to deal with the monitoring aspects of the financial institutions that are in trouble, incompetent or abusive management, abuses and credit concentrations. Together with the necessary regulatory framework, it is imperative to be acquainted with that parameter that cannot prevent every inappropriate banking traditional practice. Allen and Gale (1999, Chapter 13)85 say, good regulation and supervision can help to minimize the great impact of moral hazard and relative price shocks upon the financial system and that the principal types of regulations required to ensure the establishment of a sound financial system and the problems caused by their absence should be analysed. Policy should feature, therefore, the acceptable conduct for banks, or, on the other hand, forbidden deeds. The Central Bank Supervisory Role The central bank therefore plays a very significant role in supervision. It ensures the safety and soundness of the banking system and the legal interests of the depositor86. It also maintains stability of the currency and eventually promotes economic development. The central bank also transforms the way of financial management to defuse systemic financial risks87. The central bank also ensures that companies issue credit according to market forces and ensures that companies set terms and conditions for their operations88. The central bank also promotes and maintains high standards of conduct and management through its supervision activities89. It gives rules that promote high ethical standards as well as professional standards90. In general, the laws and policy of public administration can impact on the entrepreneur’s mind as far as making the right choice for business is concerned. The central bank’s independence could in a way shelter the role of monetary institution supervision from being controlled by the external players and agencies as well as protecting these institutions from the risk of falling prey to regulatory personnel because of a misconduct91. Spectral supervisors might be less helpful in monitoring the general danger that complex financial groups get predisposed to. In trying to define the corporate policy of bank is vital before thinking of establishing a workable program for banking supervision92. At the same time, acts of strengthening the legal framework have to originate from dissimilar tracks. The framework has to be executed if success is desired93. Hazards of International Banking Banking has its own hazards. Dewatripont and Maskin (1995, p.520-528)94 point out that, “banking has its drawbacks and a banker will always ponder on the defect which political unrest ahs on the banking sector”. He continues to say that, “other individuals might also ask themselves if the bank that they are going to deposit there money is in a country that has high rated of corruption, some other factors that one considers include the bank’s efficiency and smart in investments”. Dewatripont and Maskin (1995, p.530)95 continues to say that, “just as domestic currency changes in value, so does foreign currency and if you invest your money in a foreign bank in the form of the foreign currency then you loose money”. Conclusion Many banks nowadays maintain a very strong money laundry policy in order to check the scourge of increasing terrorism among other factors. Organizations and Individuals are supposed therefore to be very vigilant with the kind of offshore banks they engage or carry out business with. Although it is quite clear that banks plays an intermediary function as consolidator of deposits and then as a lender of credit. Lack of accountability and transparency from the banks business should be minimized by having stringent measures against these challenges. Lack of loyalty, trust and attachment to the bank by the clients always predisposes loss of confidence in the entire financial system. Therefore as banks make more and more loans on international fronts many scholar believe that in order for it to be successfully then there is need to enhance the global cooperation especially on regulatory standards in order to lower the risk accrued as a result of a particular bank failure. References Allen, F., M. Chui and A. Maddaloni, (2004). Financial Systems in Europe, the USA, and Asia, Oxford Review of Economic Policy 20, 490-508. Bolton, P., and D. Scharfstein (1996). Structure and the Number of bankers, Journal of Political Economy 104, 21-25. Bryant, J. (1980). A Model of Reserves, Bank Runs, and Deposit Insurance, Journal of Banking and Finance 4, 335-344. Decentralized Economies, Review of Economic Studies 62, 541-555. Dewatripont, Mathias & Maskin, Eric (1990). ‘Contract renegotiation in models of asymmetric information.’ ULB Institutional Repository, 2013-9579. Diamond, D., (1984). Financial Intermediation and Delegated Monitoring, Review of Economic Studies 51, 393-394. Diamond, D., and P. Dybvig (1983). Bank Runs, Deposit Insurance, and Liquidity, Journal of Political Economy 91, 401-402. Gale, D. (1991). Optimal Risk Sharing through Renegotiation of Simple Contracts, Journal of Financial Intermediation, 1, 283-285. Gerschenkron, Alexander. (1966). Economic backwardness in historical perspective. University of California: Praeger. Goldsmith, Raymond. (1969). Financial structure and development. USA: Yale University Press. International Monetary Fund. (2003). Bank consolidation, internationalization, and conglomeration: trends and implications for financial risk. USA: University of California press. Mullineux, Andrew W., 2009. ‘Admissible monetary aggregates for the euro area’. Journal of International Money and Finance, 28(1) 99-114. Padilla, A.J. and M. Pagano (1997). Endogenous communication among lenders and entrepreneurial incentives. Review of Financial Studies, 10, 205-236. Rajan, R. (1992). Insiders and outsiders, Journal of Finance 47, 1400. Sharpe, S. (1990). Banking and understanding contracts: model of client association. Journal of Finance 45, 1069. Appendix An overview of the financial system Financial markets Source: Allen, F., M. Chui and A. Maddaloni, (2004). Financial Systems in Europe, the USA, and Asia, Oxford Review of Economic Policy 20, 490-508. Read More