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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 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 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 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 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 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 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 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 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 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 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 The pillars of Basel II • The Basel II Accord has three pillars: (i) minimum regulatory capital requirements (ii) the supervisory review process (iii) market discipline through disclosure requirements 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 7-46 Calculating capital against credit risk under Basel II • The standardised approach is structurally similar to what is found in the 1988 Accord Banks are required to classify their exposures into broad categories, such as the loans they have extended to corporate and sovereign borrowers and other 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 7-47 ... 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 The kinds of risk facing banks • Financial risk... 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 Arguments against banking... Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 7- 5 Reasons for the special importance of banks (cont.) • They face an asymmetric