International Banking in the New Era: Post-Crisis Challenges and Opportunities: Volume 11

Table of contents

(19 chapters)
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International banking refers to the activities of providing financial services (banking) to clients (both institutional and individual) located in many different countries. This encompasses a wide range of activities, including transactions with foreigners and domestic residents relating to deposits and lending in domestic and foreign currencies, facilitating foreign currency transactions and foreign exchange risk hedging, participating in international loan syndications, and facilitating international trade finance for clients.

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This chapter investigates the roles played by the Wall Street investment banks and commercial banks in triggering the worst financial crisis the markets have ever witnessed. The chapter also examines the shortcoming of the rating agencies, as well as failures of financial regulators during and after the crisis. The author proffers that the financial derivatives and other exotic financial instruments – including CDS, asset-backed securities (ABS), and collateralized debt obligation (CDO) – are not, in themselves, the financial “weapons of mass destruction” as it is being alleged. The author places the blame for the financial crises squarely and unreservedly at the doorstep of the unscrupulous and reckless institutional market practitioners, the unprofessional attitude and approach of the rating agencies as well as the regulatory failure on the part of the financial regulators and other gate keepers.

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Purpose – This chapter compares the stability of the U.S. Dual Banking system's two bank groups, national and state banks, in light of the current financial crisis. The goal of the chapter is to answer three distinct questions: first, is there a difference in the (balance sheet) fragility between the two groups and, second, to what extent has the balance sheet fragility of both groups changed after the escalation of the financial crisis beginning in August 2007? Building on that, the third question asks to whether or not the respective regulatory agencies of both bank groups are responsible for these changes in balance sheet fragility in light of the financial crisis.

Methodology – To answer these questions the chapter uses U.S. Call Report data containing full quarterly balance sheets and P&Ls of all U.S. commercial banks over the period 2005–2008. Anecdotal evidence as well as univariate and multivariate difference-in-difference methodology focusing on the immediate pre-crisis period Q1/2005–Q3/2007 and the crisis period Q3/2007–Q4/2008 are applied.

Results – Highly significant and robust results show that, ceteris paribus, national banks reduced their potential balance sheet fragility after the escalation of the crisis in August 2007 by reducing lending and liquidity creation stronger than state banks. Anecdotal evidence supports the empirical findings. Although both FDIC and OCC did not anticipate the adverse effects of the crisis, the OCC publicly showed an earlier reaction to liquidity-related problems than the FDIC.

Originality – The chapter is the first of its kind to analyze bank fragility around the escalation of the financial crisis and the role of the regulatory agencies. The chapter holds especially interesting policy implications in the light of the current discussion about the future regulation of the banking markets.

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We consider recent events in financial markets and the subsequent responses by monetary and fiscal authorities, which are impressive for their scale, innovation and flexibility in the face of sharply deteriorating circumstances. Internationally, the economic malaise brought perverse responses not least being the apparent quest for higher capital adequacy requirements than was thought necessary before the downturn. Where possible the uniqueness of the responses by authorities in the Asia-Pacific region is highlighted. Other features impeding recovery cannot be dealt with immediately. Among these, the most important is the valuation procedures associated with accounting rules.

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It is commonly believed that banks are in special need of regulation to prevent financial crises, and the recent sub-prime crisis would tend to support such views. Yet it is clear that a series of perverse incentives exist in the banking industry. Incentives for bankers to take on too much risk lead to financial crises, and then a lack of a bankruptcy process for large financial institutions lead to massive taxpayer bail-outs. This chapter canvasses the issues surrounding the sub-prime crisis and explores arguments relating to regulation and the political economy of the recent crisis. As long as the political cost-benefit of having inefficient banking regulation dominates an economic cost-benefit of having efficient regulation, we can expect that perverse incentives will remain and financial crises will be a regular feature of the economic landscape.

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This research chapter argues lawyers, not just bankers, for good and bad have been involved in all aspects of the current financial crisis. Indeed after examining and assessing various civil causes of action related to the “Mortgage Meltdown” and its aftermath, it appears if lawyers had been less involved or had raised warnings about legal risks as well as economic ones, whether the financial impact would have been so disastrous and widespread. Indeed by raising cautionary flags earlier, lawyers might have better served both the clients’ and the public's long-term interests. This view thus complements issues related to criminally prosecuting mortgage fraud that has also seen explosive growth and where lawyers have again played central roles. Lawyers have been involved at the back end too in terms of legislation or resolving issues such as bankruptcies and foreclosures.

The chapter examines several causes of action the media have reported being raised by various parties and how they illustrate the role lawyers, regulations, and legislation have played in the origins and evolution of the current crisis. The cases explored involve individual parties and class actions. The chapter also analyzes in detail a case representing opposite ends of the origination and foreclosure closure spectrum by describing a derivative shareholder suit against corporate officers and directors actively involved in creating the subprime mess, who were then sued for covering up the inevitable results from failed loans in the reports to shareholders. It thus illustrates the legal complexities emerging from the abuse of complex financial and organizational structures impacting many investors. Finally the chapter concludes by arguing there is a public policy need not only for financial regulatory reform but also for a tightening in the professional standards and regulatory penalties imposed on lawyers involved in such transactions.

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Purpose – The global financial crisis of 2007–2009 has highlighted the need for reform of financial regulation in several jurisdictions across the globe, including the United Kingdom and the United States. This chapter argues that the reforms need to be comprehensive and will therefore have to cover several aspects of financial regulation.

Design/methodology/approach – The chapter critically examines some of the areas where reforms are most needed. This involves consideration of the merits and demerits of multi-functional or universal banking. It also involves consideration of the systemic and other problems that arise as a result of the increasingly international nature of banking and other financial services. Moreover, it examines the need for regulators to understand and keep pace with financial innovation. Furthermore, it involves discussion on the need to improve corporate governance and remuneration policies in banks and other financial services providers as well as the need for adequate arrangements for dealing with bank insolvencies and collapses.

Findings – Market fundamentalism and over-reliance on the alleged self-correcting powers of the market have led to excessive deregulation and liberalisation in world financial markets. Financial regulatory reforms will therefore have to be substantial and comprehensive to properly address the problems caused by excessive financial liberalisation.

Originality/value – The chapter examines significant issues that academics, regulators and policy makers should consider when devising or implementing reforms designed to prevent, or reduce the impact of, financial crises in the future.

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Purpose – To discuss, from the perspective of developing countries, recent proposals for reforming international standards for bank capital requirements.

Methodology/approach – After evaluating, from the viewpoint of developing countries, the effectiveness of capital requirements reforms and progress in implementing existing regulatory accords, the chapter discusses the procyclical effects of Basel regimes, and suggests a reform proposal.

Findings – Minimum bank capital requirements proposals in developing countries should be complemented by the adoption of an incremental, size-based leverage ratio.

Originality/value of chapter – This chapter contributes to enlarge the academic and policy debate related to bank capital regulation, with a particular focus on the situation of developing countries.

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Among divergent approaches to understand the global financial crisis, Minsky's Financial Instability Hypothesis has gained increased attention. In part, the chapter draws upon Minsky's notion that the seeds of instability are sown when banks, households, and firms move from hedge to speculative and then into Ponzi financial positions. Financial innovations such as securitisation contribute to this transformation. In addition, the paper will discuss the findings arising from an analysis of interviews that focus on securitisation related issues after the sub-prime crisis with practitioners who were closely involved in regulation and risk-management. The paper highlights the need for fundamental reform in the financial sector with a more consistent regulatory platform and enhanced supervision, to facilitate rapid healing from the damage arising from the financial crisis in Australia.

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Purpose – This chapter investigates the influence of bank loan underwriting practices on loan losses and identifies potential determinants of lending practices for five categories of loans: business, consumer, commercial real estate, home equity, and construction and land development loans.

Methodology/approach – Using data on the riskiness of lending practices obtained from the U.S. Federal Deposit Insurance Corporation (FDIC) bank examiner surveys from January 1996 to March 2009, I fit a two-step treatment effects model to measure the effects of underwriting practices on loan losses, controlling for the potential endogeneity of lending practices.

Findings – In the selection step, I find that for business loans, the likelihood that bank management will adopt low-risk lending practices increases with bank financial performance and management quality hierarchical complexity and decreases with market competition. Results for the selection of lending practices for consumer loans and three categories of real estate loans are similar to those found for business loans but show weaker statistical relationships to all explanatory variables. In the loss determination step, I find that lower (higher) risk underwriting practices are generally associated with lower (higher) gross loan charge-offs (as percentage of gross loans and leases) for five categories of loans: business, consumer, commercial real estate, home equity, and construction and land development loans.

Originality/value of chapter – This is the first study to model the determinants of loan underwriting practices with the practices being characterized in terms of their risk to the bank. In addition, this is the first study to consider the effects of the riskiness of lending practices on loan losses, controlling for the endogeneity of practices.

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Purpose – We discuss the microeconomic pros and cons of bankloan-backed securities and credit default swaps, that is, the passing on of bank loans or their default risk from originator to the general investor. By ‘micro’ we mean that our focus is on comparative advantages for banks versus other holders of the loans or risks, not the macro pros and cons of higher credit volumes.

Methodology/approach – We apply standard ideas from the corporate finance literature on the choice between loans versus public debt, related to information asymmetries and signaling at the time of origination. We also add new arguments related the possibly unhappy end of the loan.

Findings – Quite apart of the by now familiar quality-preservation incentive issue we think that securitization and CDS destroy value because they move loans and risks away from the party best informed about the risk and best placed to deal with default toward worse-placed parties.

Limitations – The analysis takes the volume of loans as given.

Practical/social implications – ABS and CDS should be confined to the highest-quality type of chapter where no information asymmetries exist, like in Europe where the traditional MBS have not caused problems for centuries.

Originality/value of the paper – To the best of our knowledge, the literature on bank loans versus public debt has not been applied to ABS/CDS before, whereas the issue of who is best placed to bear the risks has not even been raised elsewhere.

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This chapter investigates the effectiveness and the motivation behind the choice of different types of distress resolution strategies in the banking sector. This is a global study that analyzes key financial characteristics of distressed banks that were either acquired by other banks, divested assets, or were subject to government intervention, as well as the change in the financial profile of those distressed institutions from one year pre-deal to three years post-deal. The results show that governments intervene in the (relatively) best performers that only underperform in liquidity ratios, an indication of critical short-term flow problems. Distressed sellers, the underperformers of the three groups, enjoy much improved performance, in particular in cross-border deals. There is some evidence of foreign acquirers “cherry picking” the least distressed banks, though no significant differences in target performance remain post-deal between cross-border and domestic deals. These findings provide some useful guidance for policy makers globally and for future financial crises that impact the banking sector.

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Many banking efficiency studies have focused on conventional banks. Recently, Islamic banks have opened in many countries and operated in similar fashion to traditional banks. This chapter measures and compares Islamic banking efficiency to conventional banking efficiency represented by three European countries – Germany, Turkey and the United Kingdom. The study covers the period from 2005 to 2008 in measuring the X-efficiency using the non-parametric method, known as Data Envelopment Analysis (DEA). It reveals that Islamic banks are technically more efficient than conventional banks but are beset by lower allocative efficiency. This results in lower cost efficiency for Islamic banks in comparison to the more conventional banks in Europe.

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In recent years, foreign banks have significantly expanded their presence in many emerging countries. In our study, we use panel data to examine the economic determinants of foreign banks’ entry modes into emerging European countries during the period from 1994 to 2008. Our results suggest that a parent bank's choice of an organizational structure is a function of its strategic plans in the region and the countries’ characteristics. After further consideration of the financial crisis of 2007–2010, we find that as a result, parent banks tend to behave differently toward their foreign affiliates depending on its organizational structure. Our findings suggest that these differences are especially observable during periods of economic expansion and home financial distress.

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This chapter examines whether the geographic distance between subsidiaries of multinational banks and their headquarters is an important factor in determining the performance of the subsidiaries. Using various performance indicators of 340 subsidiaries in 54 emerging and developing economies from 69 global banks during the years 1994–2008, we find evidence that first, the distance constraint adversely affects loan growth, profitability, and performance of foreign bank subsidiaries, and second, the unfavorable information asymmetry faced by foreign banks, due to the distance constraint, in financing foreign clients cannot be fully overcome by establishing their presence abroad such as setting up their foreign subsidiaries. We further examine if the effect of distance is symmetric across different banks and countries and find the following various economic, financial, and institutional factors to affect the strength of distance constraints in the multinational banking activities: the entry mode of foreign banks, the history of presence in local markets, the existence of credit information institutions, the cultural similarity between the home and host markets, financial depth, financial crisis periods, the stock market development, the banking market structure in host markets, and the hierarchy of the subsidiary in the multinational banking conglomerate.

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DOI
10.1108/S1569-3767(2010)11
Publication date
Book series
International Finance Review
Editors
Series copyright holder
Emerald Publishing Limited
ISBN
978-1-84950-913-8
Book series ISSN
1569-3767