Chapter 5: INTERNATIONAL BANKING RISKS (Types of International Banking…
Chapter 5: INTERNATIONAL BANKING RISKS
Types of International Banking Risks
Foreign Exchange (FOREX) Risk
known as currency risk.
is a financial risk that exists when a financial transaction is denominated in a currency other than the currency of the origin country.
if the exchange rate of the foreign currency falls, both the interest payments & the principal repayment will be worth less than when the loan was given that reduces bank's profits.
currency must be converted to another currency to make a certain investment.
known as political risk.
many foreign loans are paid in US Dollars & repaid with dollars.
it will affect international banking & financial institutions' behavior.
unstable political environment will affect in changes of government policy
Interest Rate Risk
defined as the exposure of a banking & financial condition movements in interest rates.
main source of return/profit is converting bank's liabilities.
eg: deposits & borrowings turns into assets.
the bank makes profit by paying lower interest rates on its liabilities.
creates interest rate risk which in the case of interest rates will rise in the banks that causing the bank to pay more for its liabilities.
arises when bank has to meet its obligations as they come due without incurring losses.
two types of liquidity risk
Funding Liquidity Risk: when a firm is unable to obtain sufficient funds to meet cash flow obligations.
Market Liquidity Risk: inability to conclude a large transaction near the current market price.
is probability that a loan will not be repaid or there will be a default in payment.
potential that a bank borrower or counterparty will fail to meet its obligations.
Basel I: focused on credit risk where the financial institutions are required to maintain their capital.
Basel II: revealed numerous in accurately managing credit risk during financial crisis.
Basel III: provide more effective regulations about addressing credit risk.
due to long distances between countries.
goods are dispatched by shipping or airways
sea & transport are exposed to many types of additional risks.
risk of losses in balance sheet position arising from movements in market prices.
such as :<3: interest rates :<3: exchange rates :<3: securities prices :<3: commodity prices
2 types of market risk
Systematic Market Risk: caused by movement in the prices of all market due to macro factors.
eg: changes in economic policy
occurs when financial system suffers from a failure.
Unsystematic Market Risk: the price of one instrument moves out in line because of events related to the issuer of instruments.
eg: law suit against the issuer.
culture differs from one country to another.
the language, value of time, customs & lifestyles.
business firm faces additional risks.
one of the oldest risk that banks faced
risk of direct or indirect loss resulting from external events.
Internal Factors: losses or breakdown caused by inefficient management.
such as :check: physical causes :check: personal failure :check: misleading information :check: liability for accidents and others.
External Aspects: market environment, credit situation & other risk condition.
Supervision and Regulation on International Banking
Single Bank Supervisor or Multiple Supervisors
key policy decision is whether there should be a single bank supervisory authority or multiple bank supervisors
the strongest reason for some to advocate a single bank supervisory authority is the fear of competition in laxity between multiple bank supervisors
Bank Supervisory Role of the Central Bank
countries must also decide whether to assign responsibility for bank supervision to the central bank
can help it identify and respond to the emergence of a systemic problem in a timely manner
those pointing to the disadvantages of assigning bank supervision to the central bank stress the inherent conflict interest between supervisory responsibilities and responsibility for monetary policy
Scope of Supervisory Authority
financial conglomerates that operate in the banking, securities, and insurance sectors are among the most powerful MNCs in many countries
the most significant argument against a supervisory authority with broad scope is that it would result in an undue concentration of power that would otherwise be dispersed among several agencies
this would increase the likelihood of regulatory capture and retard financial innovation
Supervisory Approach of Countries
these dimensions include enforcement powers, the degree of disclosure supervisory authorities must comply with, and the independence of supervisory authorities
it is proportionately more common for the high-income countries to provide greater independence to bank supervisors than countries in the three other income groups
Anti-Money Laundering (AMLA) Regulations
can be defined as the act or a process of transforming profits earned from a criminal or illegal activity into legal profits
example:- drug trafficking, arms smuggling, trafficking in stolen art, body parts, nuclear secrets, and weapons, money used by terrorist groups, kidnapping for ransom, etc
3 stages of money laundering
placement of currency into a banking and financial institutions eg commercial bank, brokerage house, investment bank.
the movement of funds from one institution to another institution in order to disguise the original source and ownership of the funds
the time when the funds, having been laundered are reinvested into a legitimate business
prevention measures of AMLA
appoint one or more officers at the senior management level to be the compliance officer responsible for the submission of suspicious transaction reports to the Financial Intelligence Unit in Central Bank
provides training and guidance to staff in the operation of procedures and controls relating to anti-money laundering
The Basel Committee on Banking Supervision (BCBS)
provides a forum for regular cooperation on banking supervisory matters
to improve understanding of fundamental supervisory aspects and increase the quality of banking supervision worldwide
the purpose is to encourage convergence toward common approaches and standards
Offshore Financial Centres (OFCs)
included interest rate ceilings, restrictions on the range of products supervised financial institutions could offer, capital controls and high effective tax rates
provision of some or all of the following services including low or zero taxation, moderate or light financial regulation, banking secrecy and anonymity
Banking and the World Trade Organization (WTO)
the purposes is a country may implement regulatory measures in contravention of its GATS obligations and commitments so long as they are taken for prudential reasons, including the protection of depositors, policy holders
Islamic Banking Supervision and Regulation
the assets and liabilities sides of a bank's balance sheet are fully integrated
the depositors enter into a Mudharabah, profit sharing contract with the bank to share the overall profits accruing to the bank's business
depositors act as capital providers or financier by providing funds and bank acts as an entrepreneur by accepting them
the enters into Mudharabah contracts with agent-entrepreneurs who search for investable funds and who agree to share profits with the bank according to a certain percentage stipulated in the contract
bank liabilities are divided into two windows
:star: demand deposits
are assumed to be placed as Amanat (safekeeping), thus they are considered to belong to the depositors at all time
cannot be used by bank as the basis to create money through fractional reserves
:star: investment deposits
used to finance risk-bearing investment projects with depositors. full awareness
All banking & financial institutions are exposed
to the same form of risks and most of the time
the failure of one bank will give impact to
Thus, that’s why today’s global banking
system concerns about risks and seeks ways to
deal with them such as with risk management.
In general, International Banking involves in business risk implies the possibility of some unfavorable event happen in the future.
However, the degree of such risk is not the same,
it differs from one institution to another
institution & from one country to another
Managing risks can limit the probability of bank failure.
Hence, all types of banking and financial institutions have to continuously strengthen their global position so as to become more competitive and sustainable.
INTERNAL RISK ASSESSMENT OF INTERNATIONAL BANKING
Credit Scoring System
Can be found in virtually all types of credit
Is essentially to pre-identify certain key
factors that determine & probability of
default & combine / weight them into a
The traditional approach
Value at Risk (VaR)
To measure the minimum loss (of value) on a
given asset / portfolio over a given time
period at a given confidence level either 95%,
97.5% or 99%.
Powerful in assessing the risk exposure of a
portfolio of assets because it takes into
account the correlation among different
The modern approach
Credit Default Option (CDO)
CDO is an option to buy protection or sell protection as a credit default swap on a specific maturity.
A credit spread / net credit spread involves a purchase of one option and a sale of another option in the same class & expiration but different strike prices.
Credit Default Swap (CDS)
CDS is a financial swap agreement that the seller of the CDS will compensate the buyer in the event of a loan default or other credit event.
Seller of the CDS insures the buyer against some
reference loan defaulting.
In the event of default the buyer of the CDS receives compensation usually at the face value of the loan & the seller of the CDS takes possession of the defaulted loan.
Credit Forward Agreement (CFA)
Hedges against an increase in default
risk on a loan or decline in credit quality of a
borrower after the loan rate is determined
and the loan has been issued.
The CFA specifies a credit spread i.e a risk
premium above the risk-free rate to
compensate for default risk on a benchmark
bond issued by the borrower.
Refer to the complex process of transforming
individual loans into assets that may be
purchased by investors.
Bank coordinate these transactions to reduce
their exposure to individual financial risks.
There has been an explosive growth in the use
of credit derivatives in recent years.
Banking crises, rapid structural change and the continuing globalization, liberalization and integration of international banking have led national and multilateral policy makers to focus increased attention on the crucial role of banking supervision.