International banking May 2015 (UGB 322)

Discuss the income opportunities available to international banksand critically evaluate international banks operations in foreign markets to maximize shareholder value.Critically discuss the challenges regulators face when regulating international banks

ASSIGNMENT COVER SHEET UNIVERSITY OF SUNDERLAND

BA (HONS) BANKING AND FINANCE

Student ID: 149080615/1

Student Name: Tran Quyet Thang

Module Code: UGB 322

Module Name / Title: International Banking

Centre / College: Banking Academy of Viet Nam

Centre / College: Banking Academy of Viet Nam

Assignment Title: Individual assignment

Students Signature: (you must sign this declaring that it is all your own work and all sources

of information have been referenced)

Title page

International Banking

UGB 322

Banking Academy, Vietnam Submitted on 15 May, 2015 Prepared by: Quyet Thang Tran Student ID: 149080615/1

Table of Contents

Title page i

Part A: Discuss the income opportunities available to international banks and critically evaluate international banks operations in foreign markets to maximize shareholder value 1

1 The income opportunities available to international banks 1

2 Operations of international banks in foreign markets to maximize shareholder value 2

Part B: Critically discuss the challenges regulators face when regulating international banks 5

1 The reasons to explain why banks need to be regulated 5

2 The challenges for regulators when regulating international banks 6

References 10

Appendices 14

Appendix 1 - The collapse of Banco Ambrosiano bank 14

Part A: Discuss the income opportunities available to international banks and critically evaluate international banks operations in foreign markets

to maximize shareholder value

This report will discuss the income opportunities available to international banks Furthermore, the international banks operations also are investigated to see how international banks maximize shareholder value

1 The income opportunities available to international banks

There are different types of services which international banks provide including:

 Money transmission and cash management

 Credit facilities – loans, overdrafts, standby lines of credit and other facilities

 Syndicated lending (only available to large companies and multinational firms)

 Debt finance via bond insurance (only available to large companies and multinational firms)

 Other debt finance including asset-backed financing

 Domestic and international equity (the latter typically only available to large companies and multinational firms)

 Securities underwriting, fund management services, risk management and information management services

 Foreign exchange transactions and trade finance

(Casu, 2006)

By offering customers various financial products, international banks can get different types of incomes such as net interest income, non-interest incomes - net fee and commission income and net trading income and investment income Claessens et al.’s (2011) results show that foreign banks tend to have higher interest margins than domestic banks in developing countries, while the opposite is true in developed countries by using data from national banking markets in 80 countries The reason may be the inefficient economic systems of developing countries and international banks have many experience, well-train staffs, etc According to Garza-García (2010), the main determinants of higher interest rate margins in developing countries are mainly

capital adequacy, the interaction between credit and interest rate risk, the implicit interest payment, the opportunity cost of holding reserves and level of tax Additionally, non-income interest has high proportion for international banks’ income For example, by examining the role of non-interest income on bank profitability and bank risk for 967 Asian banks from 1995 to 2000, Lee et al.’s (2014) research indicates that non-interest income activities play a strong role in reducing bank risk and the pursuit of multiple revenue sources in Asian banks is associated with the reduction in risks Asian banks is associated with the reduction in risks Furthermore, Tennant and Sutherland’s (2014) results show that the banks which tend to profit most from fees are large, operate in more than one market According to Meslier et al.’ (2014) results, in emerging countries, foreign banks generally suffer from insufficient knowledge of the local market and disadvantage

in terms of collecting soft information so they specialize in non-interest income generating activities rather than traditional intermediation activities

In summary, based on the current situations and the development of economic systems in foreign markets, international banks decide the income structures such as focusing on non-interest income

in developing and emerging markets

2 Operations of international banks in foreign markets to maximize shareholder value

There are several reasons for banks to go abroad First of all, banks often follow their customers

to decide the oversea locations of their brands and subsidiaries and one of the important determinants of banks’ oversea expansion which is often ignored: characteristics of customers (Chou & Shen, 2014) Furthermore, by expanding to other countries, banks can find out many opportunities for business For example, international banks can take advantages of low capital costs in emerging market or low-regulation countries The Morrision and White’s (2009) results show that important externalities arise between the two countries’ regulators even when the banks that they regulate do not compete with one another at all and in the case of international banks, the charter provides valuable certification for the multinational bank and enables it to operate with lower capital requirements, and to pay lower deposit rates In addition, another benefit from becoming international banks is that globalization is making it increasingly easy for corporations

to shift profits to low-tax countries (Zucman, 2014) By enjoy these benefits from going abroad, international banks can gain the income and reduce the cost so that they can achieve objective – maximizing shareholder value

There are several ways for a foreign bank enter in a new market such as a correspondent bank relationship, a representative office, a foreign branch bank or a subsidiary bank The bank will choose the entry mode based on the current situation of this market For example in China, the greater the difference in borrower quality between the developed and underdeveloped regions, the more likely it is that the foreign bank pursues Greenfield investment in the developed region; while

in the underdeveloped region if the market size in this region is large enough, the foreign bank intends to take stakes in a domestic bank (LI, et al., 2013) Moreover, Hryckiewicz & Kowalewski’s (2010) results show that foreign banks tend to locate their branches in more developed emerging countries and only during periods of global economic expansion; while during the global financial crisis, the entrance of foreign banks using Greenfield investments or acquisition into emerging markets This is consistent with the findings of Claeys and Hainz (2014)

- Market entry by Greenfield investment is unlikely to be attractive in established market economies where only few firms are new entrants in the credit market and by acquiring an existing bank is subject to considerably higher uncertainty in emerging markets, where it is more difficult

to determine the quality of the target bank’s credit portfolio

With the globalization of competition and capital markets and a tidal wave of privatizations, shareholder value rapidly is capture the attention of executive and will more than likely become the global standard for measuring business performance (Rappaport, 1999) Maximizing shareholder value means international banks want to improve the performance as much as possible

By investigating a large sample of commercial banks in 14 Asia – Pacific economies between 2003 and 2010, the results of Fu, et al (2014) indicate that shareholder value is positively linked to improvements in both cost and profit efficiency, and the influence varies over time

To investigate performances of international banks in foreign markets, the operations of their subsidiaries will be considered According to Deyoung and Nolle (1996), foreign-own banks were less profit-efficient than U.S-owned banks, primarily due to higher input inefficiency A research paper shows that 2 year after acquisition in Central and Eastern Europe countries, the market share

of foreign banks starts to grow (Havrylchyk & Jurzyk, 2011) By investigating the long-term relationship between bank profitability and banking market structure in the context of 70 countries over the period 1992-2006, Chen and Liao (2011) find that foreign banks are more profitable than domestic banks when foreign banks operate in a host country with less banking competitiveness and when the parent bank is highly profitable in the home country

In some countries, banking systems are not efficient like high-income countries and regulations are low restrictions These are advantages for big banks from developed countries to entry and gain profit A research paper shows that subsidiaries are more likely to outperform parent banks

in developing markets and foreign banks perform better in emerging markets than developed countries (Kowalewski, 2014) Furthermore, Lee, et al.’s (2012) results indicate that a lower level

of economic development enhances the positive effect of the foreign bank ownership on the income, profit and overhead expenses of domestic banks

However, besides these advantages, international banks also have to face different types of risks such as political risks, country risks, operational risks, etc Some types of political risk include state actions to promote state-owned companies; actions to tap into the cash flow of companies operating within national borders; and the building of trade barriers (Culp, 2012) Political risks can bring significant impacts on activities of international banks For example, financial securities’ and banking law harmonization policies that European countries have implemented together with minimizing of exchange rate risk, have spurred cross-border bank lending activities within the European Union (Papaioannou, 2005) Furthermore, by operating in many markets with a lot of subsidiaries or branches, international banks may find difficulty to manage all offices and staffs around the world For example, the failure of Bank of Credit and Commerce International (BCCI), this bank located in more than 400 offices in 73 countries and registered in two countries- Luxembourg and the Cayman Islands - with different audited accountants (KANAS, 2005) This leads to massive fraud in this bank Moreover, there are other risks such as country risks, market risks…banks need to consider carefully

In a word, in emerging markets and developing countries, foreign banks are likely to have better income, higher net interest margins than domestic banks It means that performance of foreign banks in the host countries brings many benefits for shareholder value However, the world is changing According to Claessens & Horen (2012),with a number of emerging markets becoming more and more similar to high-income countries and realizing that being cultural close is a major asset in cross-border banking, it might well be that in the future banking groups from these countries will start to play an increasingly important role, especially in other developing countries

In conclusion, most of international banks can gain profit in foreign markets in order to maximize the shareholder value However, besides these benefits, international banks also have to face many

types of risk when operating in a new market It means that to ensure the efficient operation and have good business results, international banks need to focus on risk management so that the negative impacts can be minimized as much as possible

Part B: Critically discuss the challenges regulators face when regulating international banks

Banks have an important role in the economy and the operation of international banks help the international trades around the world become easier by providing services like payments, transferring money…Besides, the benefits from banks’ operation, there are a lot of risks that banks face and the failure of banks can lead to a collapse of whole economy or a financial crisis Furthermore, banking activities become more complex with every passing day Therefore, to make all systems work efficiently, the regulations needs to be carried out and this is a big challenge for regulators

1 The reasons to explain why banks need to be regulated

To understand the challenges for regulators to regulate international banks, the reasons for regulating will be considered In terms of risk, banks have to confront different types such as credit risk, market rate, and exchange rate risk, etc Banks are vulnerable to self-fulfilling panics because their liabilities (such as demand deposits and certificates of deposit) are short term and unconditional, while their assets (such as mortgages and business loans) are long term and illiquid (Chari & Phelan, 2013) Therefore, banks will face liquidity risk and bank run These kinds of risk both banks and international banks have to take higher levels compare to other institutes because

of special transactions, activities that banks conduct Moreover, the failure of banks can cause the systemic risk and bring about a lot of negative impacts to the economy A test about the interconnectedness between banks and insurers shows that a 20% shock in banking system leads

to an 11% shock in the insurance system while in the opposite direction, the effects are negligible (Hua, et al., 2014) Furthermore, one of the significant role of banks is to provide the payment system Disruptions in the payments system carry the risk of resulting in significant disruptions in aggregate economic activity (Benston & Kaufman, 1995)

2 The challenges for regulators when regulating international banks

In this part, the difficulties that regulators meet when regulate the international banks will be mentioned According to Andrew Bailey (2013), the banking system has become more fragmented

or “balkanised”, with a preference for banks to subsidiaries in countries beyond their home state, and for regulators to wish for – and achieve – the location of more capital and larger pools of liquid assets in their jurisdictions Furthermore, multinational firms can artificially shift profits from high-tax to low-tax jurisdictions using a variety of techniques, such as shifting debt to high-tax jurisdictions (Gravelle, 2015) Therefore, it is hard for regulators to control a bank with the headquartered office in other countries Firstly, the problem comes from deposit insurance schemes National deposit insurance systems may protect domestic and foreign depositors alike, but the amount of insurance available is invariably too small to cover the size of the deposit that are usual in international banks (Krugman, et al., 2011) Gruble (1979) reviews existing policies designed to reduce the problem raised by the fact that in the most countries deposits in local branches of foreign banks are not covered by the deposit-schemes of the host countries Secondly, regulators find difficulty setting reserve requirements (RRs) that all banks can follow This problem needs all countries have to take responsibilities because each country looks at bank capital

in different ways The large variation in how central banks implement RRs around the world suggests that a consensus has yet to emerge on what constitutes an optimal reserve requirement strategy (Carrera, 2013) Like RRs, it is hard to carry out regulatory requirements such as minimum capital and assets restrictions which all banks can obey National bank regulators usually monitor the balance sheets of domestic banks and their foreign branches on a consolidated basis; but they are less strict in keeping track of banks' foreign subsidiaries and affiliates, which are more tenuously tied to the parent bank but whose financial fortunes may affect the parent's solvency (Krugman, et al., 2011) Furthermore, the raise of international banks cause the frustration of supervising banks of central banks One famous case about this issue is the collapse of Banco Ambrosiano, Italy's largest privately owned banking group in 1982 (Appendix 1).There was much subsequent discussion about the relative responsibilities, if any, of the Vatican, the Bancad’Italia and Italian government for recompensing the losses of non-domestic creditors of Banco Ambrosiano (Goodhart, 2011)

In emerging markets, there are a lot of challenges for regulators to carry out policies in order to manage the international banks and protect the economy Rashid (2011) shows that foreign banks

are fundamentally different from domestic banks and increased foreign bank presence can adversely affect the supply of credit to the private sector or make credit more volatile Firstly, an emerging economy will tend to have a weak supervisory structure with the difficulty of producing information and enforcement problems, aggravated by the lack of protection for supervisors (Vives, 2006) Because of high development, international banks can easily recognize the weakness in the economic systems of the host countries and take the benefits For example, in the countries with low regulations, banks can enjoy low costs for operation It means that international banks can cut down the prices for services that they offer customers According to Song (2004), there are several challenges for regulators in emerging countries including:

 licensing policy for foreign banks

 the issue of how to monitor the local establishments of large international banks

 have an understanding of when and to what extent parent-banking organizations will support their local operations in terms of difficulties or crisis

 where the majority of the banking market is dependent on foreign banks

 systemic risk associated with cross-border banking

Another significant challenge for regulator is the new financial products which banks, in particular international banks provide in order to attract customers and expand the market Increasing securitization (in which bank assets are repackaged in readily marketable forms) and trade in options and other "derivative" securities has made it harder for regulators to get an accurate picture

of global financial flows by examining bank balance sheets alone (Krugman, et al., 2011) In the financial crisis 2007-2008, the rocket increase of U.S sub-prime mortgages was not concerned by the regulators In the Washington Post, Ritholtz (2011) shows that one of causes is “innovative” mortgages products including 2/28 adjustable-rate mortgages, interest-only loans, piggy-bank mortgages (simultaneous underlying mortgage and home-equity lines) and the notorious negative amortization loans (borrower’s indebtedness goes up each month) were developed to reach more subprime borrowers Because of loose regulations for this financial product, it leads to the financial crisis

In addition, by considering the U.S economy, Kero (2013) finds that financial innovation increases bank appetite for risky investment both in the prime and secondary markets and that this effect is stronger in environments with low aggregate macroeconomic risk It means that when international