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CHAPTER 5 : INTERNATIONAL BANKING RISK (SUPERVISION AND REGULATION ON…

- - - - ✏ Whether the central bank should PLAY A ROLE IN BANK SUPERVISION
  - - - ✏ Countries must decide whether to assign responsibility for bann supervision to the central bank
        
        ➕ Central bank as bank supervisor -CB will have first-hand knowlege of the condition and performance of banks - can help identify and respond to the emergencd of systematic problem in timely manner
        
        ➖ Conflict of interest between supervisory responsibilities and responsibility for monetary policy - could become critical during recession - CB may be drawn to pursue a too-loose monetary policy to avoid adverse effects on bank earnings and credit quality and encourage bank to extend credit more liberally they warranted based on credit quality condition to complement and expansionary monetary policy
    - - ✏ Financial conglomerate (any group under command control who exclusive providing significant service in at least 2 different finance sector) - that operate in banking, securities amd insurance sector are among the most powerful MNCs in many countries
      - ➕ Supervisor with broad scooe to cover all financial services is necessary to supervise such entities effectively
      - ➕ To insure thay supervisory oversight of risk management by such conglomerates is not fragmented, uncoordinated or incomplete
      - ➖Supervisory authority with broad scope - would result in undue concentration of power that would otherwise be dispersed among several agencies - could increase probability of regulatory capture and retard (delay) financial innovation
    - - ✏This approach is quite important - interpret nd enforce the regulation governing banks, the regulation themselves become meaningless
      - ✏ It is supervisors who have direct contact with the bank and therefire represent main line of defence against unsafe and unsound banking practices
      - ✏ Primary supervisory approach - to assessing the riskiness of banks is through the examination process where hard to quantify, and cross-country data are thin at best
        
        ✏ However, new information o. 3 significant aspects of supervisory practices is available that can give one an indication of the relative effectiveness of supervision
        
        ✏Independence - refer to whether or not the supervisors are legally liable for their action
        
        ✏ Beimg subjected to legal liabilityfir their action significantly reduces the independence of supervisors
        
        ✏However, 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
        ✏ It is proportionately more common for high-income countries to provide greater independence to bank supervision tham countries in the three other income groups
    - - ✏ Money laundering - the act or process of TRANSFORMING PROFITS EARNED FROM CRIMINAL OR ILLEGAL ACTIVITIES INTO LEGAL PROFITS
      - ✏ Eg : Money earned from drug trafficking, arms smuggling, nuclear secrets
      - ✏ There are 3 stages of money laundering:
      - ✏ PLACEMENT - Placement of currency into banking and financial institutions . Eg : Commercial bank
      - ✏ LAYERING - Movement of funds from one institutions to another in order to disguise the original sourcd and ownership of the funds
      - ✏ INTEGRATION - time when the funds having been laundered and reinvested into a legitimate business
      - ✏ This guideline establish to address the requirement that must be conplied with by tje reporting financial institutions under AMLA to effectively combat money laundering and financing of terrorism activities
        
        ⛔ THE PREVENTION MEASURES OF AMLA
        
        ✈ Conduct customer due diligence (reasonable care) and obrain satisfactory evidence in its rexords, the identitt and legal evidence thereon
        
        ✈ Keep all record and documenr of transaction during customer due diligence procedures, for at least 6 years and to ensure the rerained document are able to create an audit trail
        
        ✈ Conduct ongoing customer due diligence to examine and clarify the economic background and purpose of any transaction
        
        ✈ Promptly submit a suspicious transaction report to the Financial Intelligence Unit in CB when any employees involves proceeds from an unlawful activity
        
        ✈ Appoint one or more officer at senior management level
        
        ✈ Provide training and guidance to staff in the operation of procedures and controls relating to anti-money laundering
        
        🔋The Basel Committee Banking Supervision (BCBS)
        
        ✏ Is a committee of banking supervisory authorities that was established by CB governors of tge grlup of ten countries in 1974
        
        ✏ Provide forum for regular cooperation on bakung supervisory matters
        
        ✏ Its objective to improve understanding of fundamental supervisory aspects and increase the quality of banking supervision worldwide
        
        ✏ Purpose of BCBS - to encourage convergence toward common approaches and standards
        
        3 more items...
        
        ✈ Develop a customer acceptance policy and procedures to address the establishment of business relationships with the customer
- - - - ✒Arise when bank has to meet its obligation as they come due, without incurring losses
      - ✒Two type of liquidity risk
      - • FUNDING LIQUIDITY RISK
      - • occur when a firm unable to obtain sufficient fund to meet cash flow obligations
      - • MARKET LIQUIDITY RISK
      - • Inablility to conclude a large transaction near the current market price
      - ✒Risk is considere to ne subject of great interest for regulators due to low liquidity ratio in one financial institutions that could effect entire system
      - ✒Risk has to be managed in addirion to market, credit and other risk
      - ✒Risk may be minimized by enhance domestic bank's size and minimizing debt to equity ratio
- - - - • Primarily focused on credit risk
    - - • Has revealed numerous loopholes (weakness) in accurately manage credit risk during funancial crisis
- - - - ✒International banking expose to FOREX risk because trade large amount of currencies. Eg the value of currency falls with respect to another
      - ✒If exchange rate of foreign currency falls, both the interest payments and the primcipal repayment will be worth less than when loan was given, which reduce a bank's profit
      - ✒Risk of investment value change due to changes in curremcy exchange rates
      - ✒Risk that investor have to avoid loss in foreign currency due to an adverse movement in exchange rates either in short or long position
      - ✒Risk - affected international business (import export) and affect investors making international investment (foreign direct investment and real estate)
      - ✒If currency must be converted to another currency to mae a certain investment, any changes in currency will cause that investment value to either decrease or increase when investment is sold and converted back into currency of origin country
      - ✒ Risk exist when foreign aubsidiary of MNC maintains financial statement in curremcy other that the reporting currency if consolidated entity
      - ✒Is a financial risk that exist when financial transactions is denominated in currency other than the currency of the origin country
      - ✒Also known as currency risk or exchange rate risk
- - - - ✒ Two types of method for measuring sensitivity of bank income to changes in interest rate
- - - - ❄ Also known as credit spread
      - ❄ Involve a purchase of one option and sale of another option in the same class and expiration but different strike prices
      - ❄ It is an option to buy protection (payer option) or sell protection(receiver option) as a credit default swap on a specific reference credit with a specific maturity
      - ❄ Buying a payer option is not a good protection against actual default
    - - ❄ Financial swap agreement that the seller of CDS will compesate the buyer (usually the creditor of the reference loan) in the event of a loan default (by debtor) or other credit event
      - ❄Seller of CDS insurer the buyer against some reference loan defaulting
      - ❄ Receive compesation in event of default the buyer of CDS usually at the face value of the loan and seller of CDS takes possession of default loan
    - - ❄ Hedges against an increase in default risk on loan or decline in credit quality of a borrower after the loan rate is determined and loan has been issued
      - ❄ Specifies a credit spread
      - ❄ Eg : Risk premium above the risk frrr rate to compesate for default risk on a benchmark bond issued by the borrower