International Bank Regulation

1. International Bank Regulation ShwetambariHeblikar Kyle Briggs

2. Bank Failure • When unable to meet its obligations to its depositors • Loans not repaid, Liquidity, Assets/Liabilitiesunbalanced, ect. • “Run on the bank” (Depositors withdraw from bank) • Assets believed to decline in value • Even if assets are sound, negative expectations may lead to financial panics • Effects travel through financial system • One bank’s problems may easily spread to sounder banks

3. Consequences of Bank Failure • Bank risk vs social risk • A bank can afford a higher level of risk than society can afford • Banks can pass risk to other banks for a price and so on • Ultimately, society must pay the price of risk • Sub-prime Mortgage crisis 2007 • Unregulated nature of global banking leaves the world financial system vulnerable to bank failures on a massive scale • Great Depression • Many of the precautionary bank regulation measures taken by governments today are a direct result of their countries’ experiences during the Great Depression

4. U.S. Safeguards • Deposit insurance (FDIC) • Losses up to $250,000 • Member banks required to make contributions to cover costs • Reserve requirements (Fed) • Capital requirements and asset restrictions • Minimum required levels of capital to reduce risk of failure • Bank examination(Fed, FDIC, Office of the Comptroller) • Lender of last resort (Fed) • Borrow from Fed’s discount window

5. International Banks • An international bank is a financial entity that offers a variety of financial services such as payment accounts and lending opportunities to foreign clients. • Additionally, International banks should also be able to offer information on the following value added trade products and services such as Prepayment and structured pre-export facilities, export receivables financing, government backed insurance and guarantee programs, providing credit support or enhancement, global trade management and many more value added services. • The need to regulate international banks arises due to the fact that any change of variance of rules may result in conflicting transactions • In order to have supervisory standards across countries the Basel Committee was formed

6. Basel Committee • The Basel Committee was formed by the central bank governors of the group of ten countries at the end of 1974. • Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide. They meet regularly 4 times a year. • The committee was never formed with an intention of being a legal force but instead works as supervisory authority. • It has certain standards and principles to ensure best practice which are suited to member banks’ own national systems. • To achieve “a better coordination of the surveillance exercised by national authorities over the international banking system”. • One of the main objectives of the committee’s work has been to close gaps in international supervisory coverage in pursuit of 2 main principles: • No foreign bank can escape supervision. • Supervision should be adequate. • In September 1997, the Basel Committee issued its Core Principles for Effective Banking Supervision, worked out in cooperation with representatives from many developing countries. That document sets out 25 principles deemed to describe the minimum requirements for banks, and cross-bordering banking. The Basel Committee and the IMF are monitoring the implementation of these standards around the world.

7. In 1975, the Basel Committee reached an agreement, called the Concordat, which allocated responsibility for supervising multinational banking establishment between parent and host countries. • TheConcordat called for sharing information and granting of permission for inspections by or on behalf of parent authorities on the territory of the host authority. • The Basel Committee has located loopholes in the supervision of multinational banks and brought these to the attention of national authorities. • The Basel Committee has recommended, for example, that regulatory agencies monitor the assets of banks’ foreign subsidiaries as well as their branches. • In 1988, it suggested a minimum prudent level of bank capital (8% of the assets) and system for measuring capital. • The committee revised framework in 2004 • Basel Committee’s aim was to achieve “ a better coordination of the surveillance exercised by national authorities over international banking system” • The Committee's members come from Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. Countries are represented by their central bank and also by the authority with formal responsibility for the prudential supervision of banking business where this is not the central bank • The Committee reports to the central bank governors and heads of supervision of its member countries.

8. Basel II • International banking regulation is justified by the adverse consequences of banks taking excessive risks. It therefore proposes three reforms: requiring banks to retain a proportion of any loan that they originate, so as to reduce the risks of moral hazard; insisting that the risks involved in the financial products in which banks trade are transparent; and reforming Basel II so that the amounts of regulatory capital that banks are required to hold are less pro-cyclical than is currently the case. • In June 2004 Basel II was initially published to create an international standard that banking regulators can use when creating regulations about how much capital banks need to put aside to minimize risks that banks face. • Basel II provides as a standard and acts as a protection against problems that might arise should a bank collapse. In reality, Basel II attempts to accomplish this by setting up rigorous risk and capital management requirements to ensure that banks abide by the strict rule that a bank holds capital reserves suitable to the risk that the bank is exposed to.

9. Difficulties in Regulating International Banking • Banks can shift jurisdictions • US regulations are diminished due to offshore banking. • Countries compete for banks by keeping regulations low • No deposit insurance. • National deposited insurance is too small to cover the large deposits in international banks. • No reserve requirements • US can set requirements for its overseas branches, but one country cannot solve this alone. Countries can’t agree on level of reserve requirements. • National governments don’t watch foreign branches closely • US regulators track foreign branches less. Who regulates an American branch in Germany dealing in British pounds? US, Germany, or UK? • What central bank provides help?

10. New challenges • Emerging economies • Capital markets of poorer, developing countries (such as Brazil, Mexico, Indonesia, and Thailand) that have liberalized their financial systems to allow private asset trade with foreigners • Increasing securitization and derivative markets • U.S. sub-prime mortgage crisis 2007