CHAPTER 6 : ISSUES IN INTERNATIONAL BANKING ( Subprime Crisis : :star:…
CHAPTER 6 :
ISSUES IN INTERNATIONAL BANKING
Subprime Crisis : :star:
As mid-2007, many experts believed that the crisis would be contained on issuers who had overloaded on subprime loans.
Referred to as near-prime, non-prime, and second-chance lending.
Making loans to people who may have difficulty maintaining the repayment schedule.
2. Roots of The Subprime Crisis
There are a number of theories as to what led on the mortgage crisis.
Many experts and economists believe it came through the combination of a number of factors in which subprime lending played a major part.
3. Housing Bubble
The current mortgage meltdown began in 2001 and peak in 2005.
Economic bubble that occurs in local or global real estate markets.
Defined by rapid increases in the valuations of real property.
4. Historically Low Interest Rates
US housing bubble was caused in part by historically low interest rates.
The Federal Reserve Board cut short-term interest rates from about 6.5% to 1%.
5. Housing Market Correction
Adding to the growing crisis was the prediction by many economists business writers in 2005 and 2007 that there would be a housing market correction because of the over-evaluation of homes during the bubble period.
6. The Rise of Subprime Lending
Subprime borrowing was a major factor in the increase in home ownership rates and the demand for housing during the bubble years.
The US ownership rate increased from 64% in 1994 to an all-time high peak of 69.2% in 2004.
7. Declining Risk Premiums
A Federal Reserve study in 2007 reported that the average difference in mortgage interest rates between subprime and prime mortgages declined from 2.8% points in 2001 to 1.3% points in 2007.
This means that the risk premium required by lenders to offer a subprime loan declined.
6.0 INTERNATIONAL BANKING EVOLVEMENT
:check: As the country mature economically the credit role of banks diminishes, while the role of the money and capital markets becomes more important
:check: it is supposed to have positive impact on an industry`s efficiency, quality of provision, product development and innovation
:check: Competition is generally considered a positive force in most industries
:check: The banking industry has been undergoing major consolidation in recent years
:check: The development has contributed to increased competitive pressures on banks, particularly in the economically more advance countries
:check: It does not accept deposits from residents of the country where it is located
:check: Another form of presence is the indirect installation for example natural presence in the foreign country by collaborating with local institutions
A. CONNECTED BANK
:checkered_flag: The foreigner bank decides its presence in the principal capital of the bank in the other country.
:checkered_flag: This presence is subsidiary
:checkered_flag: The local bank maintains its name and the control in its administration
B. CONSORTIUM BANK
:checkered_flag: The consortium bank is common MNC in the form of joint venture with shareholders from two or more banks of different nationalities.
:checkered_flag: it is an autonomous legal entity and in international joint venture, normally between a foreign MNC and a domestic firm
:checkered_flag: The MNC usually provide the superior technology, management know how, capital, access to finance
:checkered_flag: the domestic firm provides a knowledge of local conditions and access to distribution channels
C. OFFSHORE BANKING
:checkered_flag: The banking is installed in a foreigner country, in order to provide services not to residents of the local country
:checkered_flag: The state of installation places as a condition that the activities are offshore, which means that they concern transactions in exchange between residents who are not physical or legal agents
D. CROSS-BORDER BANKING
:checkered_flag: Contrary to the off shore banking activities, in the cross border banking transactions, the banking and financial institutions include themselves organically in the financial system of the country where they are located
:checkered_flag: With the policy of globalization, liberalization or integration of the financial industry, the ability to provide cross-border financial services has become increasingly significant and the need for a physical presence in target markets has been reduced
6.3 ISLAMIC BANKING ISSUES
:star:Started in earnest in the 1970 with personal initiative of the concerned muslims to address the problem for riba'.
:star: the pioneers included :individual ,professional bankers , Islamic economists , religious scholars.
:star: Began to change in late 70s with recognition at the state level for need to develop riba' free financial system.
:star: Islamic bankers organized themselves through International Association of Islamic Bank and followed by establishment the Accounting and Auditing Organization for Islamic Financial Institution for achieve standardization in Islamic banking practices.
Asian Financial Crisis
All these factors contributed to the build-up of severe weaknesses in the undercapitalized financial system, whose most visible sign is a growing share of non-performing loan (NPLs).
The adverse consequences of these distortions were crucially magnified by the rapid process of capital account liberalization and financial market deregulation in the region during the 1990s, which increased the supply elasticity of funds from abroad.
First-sudden shifts in market expectations and confidence were the key sources of the initial financial turmoil, its propagation over time and regional contagion
Second-fundamental imbalances caused the currency and financial crisis in 1997
The root of the Asian Crisis
Focus in the context of regulatory inadequaciws and close relations between public and private banking
Many studies focused on structural distortions in the pre-crisis Asian financial and banking sectors including
a) Lax supervision and weak regulation
b) Low capital adequacy ratios
c) Lack of incentive-cimpatible deposit insurance schemes
d) Insufficient expertise in the regulatory institutions
e) Distorted incentives for project selection and monitoring
f) Outright corrupt lending practices
g) Non-market criteria allocation
h) Semi-monopolistic relations between banks and firms had restrained price signals
ISSUES IDENTIFIED THAT MAY HELP CONSOLIDATION & GROWTH OF IB:
Term used for types of Islamic financing products.
Modus operandi of financial instrument and documentation.
Pricing formulas for Islamic financial products
:question: VOCABULARY OF IB
Different international bank uses different terms among them.
Example: to stand for financing via sales on deferred payment(Murabahah = bai'bithaman ajil)
:question: MODUS OPERANDI OF FINANCIAL INSTRUMENT AND DOCUMENTATION
1.Daily practices of implementation may vary from institution to institution.
:question: PRICING FORMULAS FOR ISLAMIC FINANCIAL PRODUCTS
Concern are address to pricing total financing , fee , commission of financial products together with syariah principle.
:question: PUBLIC AWARENESS
Islamic products concepts is feasible but there are problems occurs.
The problem are be expedited through :
a. Public education & awareness campaign
b. Inclusion of IB concept in school curriculum.
c. Making Islamic financing course a part of business administration program.
d. Offer full fledged undergraduate programs in Islamic financing.
:question: TRAINING OF BANKING PROFESIONALS
Lacks of qualified manpower is one of the biggest problems
So , pioneers in IB developed their financial instrument and thoroughly trained their staffs.
the nature of financial instruments will affect banking in 3 ways:
a. Islamic bankers will be forced to adopt an outreach approach in pursuit of economic apps of fund in marketplace.
b. Follow- up & monitoring Musharakah financing.
c. The need of aggressive marketing of Islamic financial products & follow-up consideration will add new dimension
:question: SHARIAH AUDIT ON SHARIAH SUPERVISION
In early phase of IB, professional bankers took the lead. But they were not well- versed in Shariah.
Therefore, the IB model emerged as Banking under Shariah Supervision.
It practically was done through delegating authority for Shariah matters respective Shariah boards, absolving Islamic bankers of their responsibility in Shariah violations.
:question: FINANCE GAP BETWEEN IB AND SME
It was found 2 main players possessed traits that could lead them into the Grey Zone.
It caused them to conduct decision making with limited sources of information & form the wrong perception about the observed matters.
EXAMPLE: IB ( Few branches, Newly operated, Lack of product knowledge, Lack of skilled workers)
SME( Lack of expertise, lack of understanding)