INTERNATIONAL BANKING RISKS (Types of International Banking Risks …
INTERNATIONAL BANKING RISKS
What is international risks? :bulb:
Possibility of loss caused by some unfavourable / undesired event in international business operations.
Types of International Banking Risks
:star:One of the oldest risk
:star:Risk of direct or indirect loss resulting from inadequate or failed internal processes, people & systems or from external events.
: Losses by inefficient management, by physical causes, by personnel failure
Market environment, Credit situation, other risk condition
:star:Risk of losses in on and off balance sheet positions arising from movements in market prices/ rates
when the financial system suffers from a failure that is caused by other forms of risks
:female-student:most financial crises have resulted from
:female-student:most banks manage with short-term focus, attempting to avoid portfolio losses on a daily basis.
:female-student:Best Practise : Value at Risk and Expected Shortfall
:star:Probability that a loan will not be repaid / there will be default in payment.
:star:Potential that a bank borrower / counterparty will fail to meet its obligations in accordance with agreed terms.
:star:Associated with the traditional lending activity
: focused on credit risk
: revealed loopholes / weaknesses
: provide effective regulations about addressing credit risk
Interest Rate Risk
:star:Exposure of a banking & financial condition to adverse movements in interest rates
Main source of return / profit
: Convert bank's liabilities ( deposits & borrowings) and turns them into assets (loans & securities)
:star:Liabilities are usually shorter than its assets
:star:Arises when financial institutions act as asset transformers ( lend out long-term & refinance short-term)
- sets out the requirements that an authorized fin. institution (approval to use an internal model ; must meet for regulatory capital purposes.
:star:Methods for measuring sensitivity of bank income - income gap analysis, duration gap analysis
:star: Known as currency risk.
:star: Financial risk that exists when a financial transaction is denominated in a currency other than currency of origin country.
:star:Risk of investment value changing due to changes in currency exchange rates.
:star:Due to an adverse movement in exchange rates (in a short / long position)
:star:usually affects international businesses (export & import), affect investors making international investments (FDI, real estate)
:star: Exists when foreign subsidiary of MNC maintains financial statements in a currency other than the reporting currency.
:star:Refers to political risk
:star:Many foreign loans are paid in US dollars and repaid with dollars.
:star:If political environment is unstable:
:red_flag:threaten foreign investments - investors out
:red_flag:native currency declines rapidly
:red_flag:gov. will impose capital controls to prevent losses arising from sovereign risk
:star:Political actions and instability may make it difficult for MNCs to operate efficiently.
:star:when bank has to meet its obligations as they come due, without incurring losses
Funding liquidity risk
:pencil2:when a firm is unable to obtain sufficient fund to meet cash flow obligations
Market liquidity risk
:pencil2:inability to conclude a large transaction near the current market price
:star: The risk can be minimized by enhancing domestic banks' size & minimizing debt to equity ratio
:star:due to long distance between countries
:star:goods are despatched by shipping or airways
:star:differs from one country to another
:memo: such as language, value of time, lifestyle
Internal Risk Assesment
Credit Scoring System (Traditional)
:fireworks:can be found in virtually all types of credit analysis
:fireworks:to pre-identify certain key factors weigh that determine & probability of default & combine/ weigh them into quantitative score
:fireworks:probability of default
Value at Risk (VaR)
:fireworks:to measure minimum loss of value on a given asset over a given time period
:fireworks:powerful in assessing the risk exposure of portfolio of assets because it takes into account the correlation among different assets.
Credit Default Option (CDO)
:smiley:Credit Spread- purchase of one option & sales of another option in the same class and expiration but diff. strike price
:smiley:option to buy protection (payer) or sell protection (receiver) as credit default swap on specific reference credit with specific maturity
:smiley:on single credits are extinguished upon default without any cash flows
Credit Default Swap (CDS)
:smiley:financial swap agreement that the seller will compensate the buyer in the event of loan default or other credit event.
:smiley: seller insures the buyer against some reference loan defaulting
:smiley:Buyer makes a series of payments (CDS fee/ CDS spread)
:smiley:Anyone can purchase a CDS
:fireworks:Credit Spread Swap (CSS) - type of swap contract in which one contractual party makes a fixed payment to other counterpart in exchange pay the floating spread that corresponds to the actual underlying credit spread of 3rd party
Credit Forward Agreement (CFA)
:lock:Hedges against an increase in default risk on a loan/decline in credit quality of a borrower after determined and issued loan.
:lock:specifies a credit spread
:explode:refers to complex process of transforming individual loans into assets that may be purchased by investors.
:explode: to reduce their exposure to individual financial risks.
: :explode:investors prefer - diversify their respective portfolio & gain entry into multiple financial risks.
:explode:estimate that the world market in ctedit derivatives is doubling in size each year
Supervision & Regulation on IB
Single Bank / Multiple Bank Supervisors
:warning:Single bank supervisory authority is the fear of competition in laxity between multiple bank supervisors.
:warning:Two/more bank supervisors stress the benefits of a competition in ideas among multiple bank supervisors.
Bank Supervisory Role of Central Bank
:male-student::skin-tone-2:Central bank will have first-hand knowledge of the condition and performance of banks.
:male-student::skin-tone-2:Can help it identify & respond to the emergence of systematic problem in a timely manner.
:male-student::skin-tone-2:Disadvantage - stress the inherent conflict of interest between supervisory responsibilities and responsibility for monetary policy.
:male-student::skin-tone-2:critical during economic recession, pursue a too-loose monetary policy to avoid adverse effects on bank earnings & credit quality
Scope of Supervisory Authority
:checkered_flag: Financial conglomerates operate in banking, securities & insurance sectors are among the most powerful MNCs in many countries.
:checkered_flag:necessary to supervise such entities effectively and in particular to insure that supervisory oversight of risk management by such conglomerates is not fragmented, uncoordinated/ incomplete.
:checkered_flag:Result in an undue concentration of power that would otherwise be dispersed among several agencies.
:checkered_flag:Increase the likelihood of regulatory capture & retard financial innovation.
Supervisory Approach of Countries
:cherries:More importantly, supervisors who have direct contact with the banks and therefore represent the main line of defense against unsafe & unsound banking practices.
:cherries:Seek to detect & assess activities and practises.
:cherries:Primary - to assessing the riskiness of banks through examination process. (Hard to qualify, cross-country data are thin at best)
: enforcement powers, degree of disclosure supervisory authorities must comply with, independence of supervisory authorities
:cherries:Last aspect of supervision is independence. - Supervisors are legally liable for their actions.
:cherries:Gov. bank - used as vehicle for financing government-owned / favoured enterprises & projects.
:christmas_tree:the act/process of transforming profits earned from a criminal or illegal activity into legal profits.
: Placement, Layering, Integration
:christmas_tree:Financing of terrorism: carrying out transactions involving funds that may/ may bot be owned by terrorists, or have been, or intended to be, used to assist the commission of terrorism.
Prevention measures AMLA:
:notebook:Develop a customer acceptance policy and procedures
:notebook:Conduct customer due diligence (reasonable care) & obtain satisfactory evidence in its records.
:notebook:Conduct ongoing customer due diligence
:notebook:Keep all records and documents of transactions
:notebook:Provides training & guidance to staff in the operation
Basel Committee on Banking Supervision (BCBS)
:maple_leaf:Established by the central bank governors of 10 countries in 1974.
:maple_leaf:Provides forum for regular cooperation on banking supervisory matters.
:maple_leaf:Obj- To improve understanding of fundamental supervisory aspects & increase quality of banking supervision worldwide.
:maple_leaf:Purpose- To encourage convergence toward common approaches and standards.
:maple_leaf::Members: Argentina, Australia, China, Indonesia, Japan.
:maple_leaf:Formulates comprehensive supervisory standards and guidelines & recommends statements of best practice in banking supervision in expectation that others will take steps to implement
:maple_leaf:Aim to improve banking sector's ability to absorb abnormal situation / shocks arising from financial & economic stress.
Offshore Financial Centres (OFCs)
:!:Measures included interest rate ceilings, high effective tax rates, capital controls.
:!: Exist in large part, offer financial market participants tax, regulatory & supervisory advantages not available in their home markets.
:!:Highlight many of the challenges internationally cooperative supervisory group face in encouraging transparency and disclosure.
Banking and the World Trade Organization (WTO)
:money_with_wings:GATS and ANNEX specify general principles that govern cross-border trade in financial services.
:money_with_wings:Also specify the restrictions that may be imposed on trade in services for prudential purposes.
:money_with_wings:Difference between prudential & protective measure - both of which restrict trade in financial services may be difficult to determine.
Islamic Banking Supervision and Regulation
: Prohibition against the payment & receipt of a fixed on predetermined rate of interest
5 essential elements to be fulfilled in order to make contract:
Buyer, Seller, Asset, Price, Ijab Qabul
:<3:Systems of operation:
:sunflower:Assets and liabilities sides of a bank's balance sheet are fully integrated.
:sunflower:Depositors act as capital providers by providing funds & bank acts as an entrepreneur by accepting them.
:sunflower:Banks are allowed to accept demand deposit that yield no returns. Deposits are repayable on demand at PV.
:sunflower:Bank may grant short-term interest-free loans
:sunflower:Does not mandate specific reserve requirements
:four_leaf_clover:Bank liabilities are divided into: Demand deposits, Investment deposits.
:four_leaf_clover:Choice of the window is left to the depositors.
:four_leaf_clover:Demand deposits are assumed to be placed as Amanah.
:four_leaf_clover:Investment deposits used to finance risk-bearing investment projects with depositors' full awareness.
:four_leaf_clover:Not guaranteed by the bank & reserve requirement are not applied to them.