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  3. Lecture International finance: An analytical approach (3/e): Chapter 7 - Imad A. Moosa

Lecture International finance: An analytical approach (3/e): Chapter 7 - Imad A. Moosa

Chapter 7 - International banking and the basel accords. The objectives of this chapter are: To find out why banks are assigned special importance and why banking is more regulated than other business, to consider the types of risk a bank is exposed to, to consider the pros and cons of banking regulation… Chapter 7 International Banking and the Basel Accords Objectives • To find out why banks are assigned special importance and why banking is more regulated than other business • To consider the

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  1. Chapter 7 International Banking and the Basel Accords
  2. Objectives • To find out why banks are assigned special importance and why banking is more regulated than other business • To consider the types of risk a bank is exposed to • To consider the pros and cons of banking regulation (cont.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 7-2
  3. Objectives (cont.) • To outline the regulatory functions and the forms of banking regulation • To evaluate the Basel I and Basel II accords Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 7-3
  4. Why banks are important • Banking regulation centres on the objective of minimising the possibility of bank failure because banks command more importance than other financial and non-financial firms • The failure of banks creates more turmoil in the economy than perhaps any other kind of firm Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 7-4
  5. Reasons for the special importance of banks • The difference between the degrees of liquidity of their assets and liabilities, which makes them highly vulnerable to depositor withdrawal and bank runs in extreme cases • Banks are at the centre of the payment system (they are the creators of money, the medium of exchange) (cont.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 7-5
  6. Reasons for the special importance of banks (cont.) • They face an asymmetric loss function, which is a consequence of handling other people’s money • The sheer size of the interbank market, resulting from the fact that banks deal with each other on a massive scale (cont.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 7-6
  7. Reasons for the special importance of banks (cont.) • The failure of banks leads to a reduction in credit flows to the rest of the economy, and hence adverse economic consequences • The levels of turnover and product innovation are high, making it unlikely that employees would experience full business and product cycles Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 7-7
  8. The kinds of risk facing banks • Financial risk  Credit risk  Market risk • Interest rate risk • Foreign exchange risk • Equity price risk • Commodity price risk • Energy price risk • Real estate price risk (cont.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 7-8
  9. The kinds of risk facing banks (cont.) • Non-financial risk  Operational risk  Other kinds of non-financial risk Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 7-9
  10. Examples of operational risk • Liquidity risk • Herstatt risk • Compliance risk • Processing risk • System risk • Human resources risk (cont.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 7-10
  11. Examples of operational risk (cont.) • Crime risk • Disaster risk • Fiduciary risk • Model risk • Legal risk Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 7-11
  12. Examples of other non-financial risk • Business risk • Reputational risk • Macroeconomic risk • Business cycle risk • Country risk • Political risk • Sovereign risk • Purchasing power risk Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 7-12
  13. Operational risk • The risk of loss resulting from the failure of people, processes, systems or from external events. • It is more diverse than either credit risk or market risk Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 7-13
  14. Types of operational loss events Event   Definition  Example        I nternal fraud   Losses due to acts of fraud  Bribes, credit fraud and theft   involving at least one     internal party.        External fraud  Same as internal fraud  Computer hacking and forgery  except that it is carried out    by an external party.        Employment  Losses arising from  Discrimination  practices and  violation of employment    workplace safety   and health and safety  laws.        Client s, products  Losses arising from failure  Product defects and misuse of  and business  to meet obligations to  confidential information  practices   clients or from the design    of a product.        Damage t o  Losses arising from  Terrorism, vandalism and  physical assets   damage inflicted on  natural disasters  physical assets by a  natural disaster or another  event.        Business  Losses arising from  Hardware, soft ware and  disruption and  disruptions to or failures in  telecommunications  system failures  systems,    telecommunication and  utilities.        Execution,  Losses arising from failed  Negligent loss or damage of  delivery and  transact ion processing  client assets and unapproved  process  with counterparties such  access to accounts  management   as vendors      Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 7-14
  15. Operational risk in the FX market • One reason for the increasing level of operational risk encountered in executing foreign exchange transactions is increasing diversity of the foreign exchange market, which is no longer dominated by commercial banks (cont.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 7-15
  16. Operational risk in the FX market (cont.) • The level of operational risk in the foreign exchange market has risen also because the increasing complexity and size of the market have made it necessary to introduce regular changes in trading procedures, trade capture systems, operational procedures and risk management tools Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 7-16
  17. Justification for banking regulation • Banking regulation can be justified on the basis of market failure such as externalities, market power, and asymmetry of information between buyers and sellers • The second justification for banking regulation is the inability of depositors to monitor banks Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 7-17
  18. Arguments against banking regulation • Some economists dispute the arguments typically presented in favour of bank regulation • There is significant scepticism about the role of regulation as a means of achieving financial stability • Regulators do not take into account the fact that risk creates value and that profits come from taking risk Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 7-18
  19. Regulation in the post-crisis era • While the proponents of banking regulation argue that their views have been vindicated by the global financial crisis, those who hold opposite views still argue otherwise • Some proponents of free banking assert that the impact of the crisis would have been worse if it were not for deregulation Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 7-19
  20. Regulatory functions • Macroprudential supervision is intended to limit financial system distress that might damage the economy • Microprudential supervision focuses on the solvency of individual institutions rather than the whole system • Conduct-of-business regulation is also justified in terms of consumer protection Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 7-20
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