Lecture 11: International Banking Flashcards
How are international banks facilitated?
Representative offices Offshore banking units Shell branches Foreign subsidiaries and affiliates Foreign branches Correspondent banking
Outline the five international lending products?
Project finance: the finance of large-scale projects (property developments etc).
Ship Financing: the financing of large vessels for the purpose of transporting oil and commodities.
Trade Finance: financing importing and exporting.
International Lease Finance: financing leasing of mobile capital goods such as aircraft, drilling rigs, medical equipment.
Commodity Financing : financing commodities traders (short-term debt) who handle products such as grains, oil and wool.
What is International Retail Banking and what has aided and hindered its growth?
Retail banking services: deposit accounts and consumer loans
- Used to be subject to high barriers to entry, high maintenance cost for banking network
- Deregulations and electronic banking aid the growth of retail banking services
Describe Private Banking
Private Banking: caters to high-net-worth individuals
- Products are typically less or not regulated (such as structured products) as clientele deemed to be sophisticated investors
- Aim to provide more personalised and customized solutions in wealth management including estate planning, philanthropy
Banking operations involve risk outline the five key forms of risk?
credit risk market risk liquidity risk interest rate risk operational risk.
What is the primary risk faced in international banking? and how is this risk categorised?
Country risk : The possibility of adverse outcomes resulting from the economic and political events of a foreign country
Divided into several categories: Transfer risk
Currency (or Forex) risk
Political risk
Sovereign risk
Describe Transfer Risk
Transfer risk : involves not being able to convert domestic currency into foreign currency
This occurs due to government exchange controls and may impair the ability of the borrower to meet repayment obligations.
Describe Currency Risk
Currency risk (or Forex Exchange risk) : derives from currency value changes
Loans denominated in a foreign currency will lose value if the currency in which the loan is made depreciates against the bank’s domestic currency.
Describe Political Risk
Political risk : concerns the possibility that political factors may impair a borrower’s ability to meet their obligations
This could involve civil unrest, turmoil, corruption and, possibly, government appropriation of foreign assets.
Describe Sovereign Risk
Sovereign risk : involves the possibility that a sovereign country may become unable or unwilling to service its foreign obligations
Describe the ways of reducing risk associated with international banking?
Third-party help: this involves obtaining the agreement of a third party to meet the obligations of the borrower if it defaults.
Pooling risk: this involves joining together with other banks to reduce the exposure of any single bank.
Diversification: this involves investing in loans whose returns are not highly correlated.
What are some key reasons why Australian markets began pursuing overseas activities?
Limited growth potential
Diversification
Access to different products, expertise and technology Service of multinational clients Following clients as they expand internationally
Obtain a more favourable regulatory and taxation environment
What benefits do foreign banks provide when operating in Australia ?
Foreign banks bring benefits such as employment opportunities, more product choices and increased competition.
Describe the Sub-Prime Crisis
The crisis began in late 2006 with the bursting of the US housing bubble triggered by the Fed raising rates and tightening credit.
This was followed by upward adjustment of low teaser interest rates on adjustable rate mortgages (ARM) made to sub-prime borrowers who were not able to pay the higher interest rates.
Although subprime mortgages accounted for less than 20% of total mortgages in the US, delinquencies, defaults and foreclosures spread rapidly.
Decline in home prices by as much as 30% to 50% in some locations (California, Florida Nevada and Arizona), accompanied by sharp recession and rising unemployment, amplified defaults and foreclosures beyond subprime loans.
Eventually manifested itself through liquidity issues in the global banking system triggered a global financial crisis during 2007 and 2008.
What triggered the crisis?
The mortgage lenders that retained credit risk (the risk of payment default) were the first to be affected, as borrowers became unable or unwilling to make payments. Major banks and other financial institutions around the world have reported losses of approximately U.S. $379 billion as of May 21, 2008. Owing to a form of financial engineering called securitization, many mortgage lenders had passed the rights to the mortgage payments and related credit/default risk to third-party investors via mortgage-backed securities (MBS) and collateralized debt obligations (CDO). Corporate, individual and institutional investors holding MBS or CDO faced significant losses, as the value of the underlying mortgage assets declined
Define and describe CMO?
Collateralized Mortgage Obligation (CMO): A complicated version of a MBS Consists of multiple tranches or groups of CMO owners The tranches differ in their risk exposure Investors in the highest priority tranche must receive their returns before the investors in the second highest priority tranche receive theirs (and so forth) Thus the higher priority tranches of CMOs are relatively safer than lower priority tranches, but they yield lower returns
Define and describe CDO?
Collateralized Debt Obligations (CDO): Can create a pool of lowest priority CMO tranches and write bonds off of them The highest priority tranche of a CDO may carry an investment grade rating despite the fact that their underlying claims are CMOs with junk bond status
Define and describe CDS?
Credit Default Swaps (CDSs): A lower rated bond is insured against default by a third party This increases the bond’s investment rating Basically, the firm issuing the CDS pays out a specified return in the event the bond issuing company fails A naked CDS is a purely speculative instrument: • Only pays out if the company covered fails, and the owner of the CDS has no financial stake in the company
Describe the unfolding of the great credit crisis ?
See Lecture too much writing :)
What was the effect of the great credit crisis on Bank Corporations
The earnings reported by major banks are adversely affected by defaults on mortgages they issue and retain. Banks value their mortgage assets (receivables) based on estimates of collections from homeowners.
Banks record expenses in the current period to adjust this valuation, increasing their bad debt reserves and reducing earnings. Rapid or unexpected changes in mortgage asset valuation can lead to volatility in earnings and stock prices.
The ability of lenders to predict future collections is a complex task subject to a multitude of variables. Additionally, a bank’s mortgage losses may cause it to reduce lending or seek additional funds from the capital markets, if necessary to maintain compliance with capital reserve regulatory requirements.
The
Describe the domino effect of the sub-prime mortgage crisis?
Losses by Banks (ie, leading to bank run)
Stock markets – contagious effects
US economy melt-down
Other economies affected
Compare and contrast the involvement of Bear Stearns, Lehman Brothers, Merrill Lynch , Goldman Sachs and Morgan Stanley in the demis of the large investment banks?
See Lecture :) (answer goes over 4 slides !!!)
What can policy makers do to avoid a similar crisis in the future ?
- Find appropriate regulations of financial products without stifling financial innovation;
- Review the coverage of regulated institutions and determine if unregulated and /or less regulated institutions should be more closely monitored;
- Come to terms with the issue of “too big to fail” , by identifying what constitutes a firm that is too big to fail and what special regulations should be applied to them;
- Scrutinize the rating agencies that were effectively giving the green light to many institutional investors to unwittingly invest in assets that proved to be toxic by rating them too highly;
- Find better ways to ensure that the public is fully aware of the financial contracts into which they enter, by increasing the transparency of the terms of the contracts and by requiring mortgage originators to maintain some stake in the successful repayment of the loans;
- Recognise the highly integrated nature of the financial markets internationally and come to terms with the need for greater cooperation among governments in regulating the markets and institutions in their respective countries
Outline the fundamental differences between Islamic banking and western concepts of finance?
Risk-Sharing (most important feature)
Emphasis on productivity as compared to creditworthiness
Moral dimension
Describe Risk Sharing as a distinguishing feature o Islamic Banking?
Promotes risk sharing between the provider of funds (investor) and user of funds (entrepreneur) • In case of profit: shared in pre-agreed proportion • In case of loss: financial losses borne by capitalist, entrepreneur loses his labour
Describe the Islamic Banking emphasis on productivity?
Under Profit and Loss Sharing banking, the bank will receive only if the project succeeds and produces a profit. Therefore, Islamic Banking is more concerned with the soundness of the project and the business acumen and managerial competence of the entrepreneur.
Describe the moral dimension of Islamic banking?
In the Islamic system, all economic agents have to work within the moral value system of Islam • Only kind of loan permitted under Islam: ‘a qard - el - hassan’ (good loan).
Cannot finance any project which conflicts with the moral value system of Islam. • Such as wine factory, a casino, a night club, or any other activity which is prohibited by Islam or is known to be harmful for the society • Somewhat similar to “Equator Principle” – see Lecture 3
By contrast to conventional banking: Conventional banking is secular in its orientation
What is the advantage of profit sharing modes?
Gives maximum weight to the profitability (productivity) of the investment rather than creditworthiness => allocation of funds will be more efficient
A more stable system compared to one based on a fixed interest rate on capital => cost of capital adjust itself automatically to suit changes in production and in other business conditions (such as deteriorate economic conditions). Hence, it prevents entrepreneur seeking funds and ensures harmony between the firm’s cash flow and its repayment obligations.
Contributes to financial stability =>depositors of Islamic Banks expected to be more vigilant about the performance of the Bank
Identify and describe the 3 deposits of Islamic banking?
Current account (alwadiah):
• No interest payments,
• Standard features: funds available on demand, debit card use for ATMs and EFTPOS transactions,
• Some ‘no-fee accounts’.
Savings account:
• No guaranteed interest, but share of bank profits,
• Bank losses are absorbed by reserves,
• Compared to alwadiah , less flexibility regarding withdrawals.
Investment account:
• Term deposit,
• Return = share of bank profit,
• Profit = a proportion of bank’s total profits, or
• Profit = a proportion of profits generated by a specific part of bank’s portfolio (e.g. car loans).
Considering the forms of deposits how do Islamic banks entice customers to deposit?
•
Prizes and bonuses - Accounts must not pay interest so pay “prizes” and “bonuses”. However, may be c ontroversial because of gambling element. • ‘Gifts’ – may be m onetary or non-monetary at the discretion of banks (for minimum balances, for example). They may be based on the bank’s returns from its investment activities (for example).
Define the lending term Musharaka
• Lender takes a direct equity stake in a project or business (direct equity participation). • Financier = ‘shareholder’ in borrowing company. • Increased risk compared to holding debt (Western approach). • Risk issue can be addressed through the creation of separate legal entities (joint venture approach).
Define Mudaraba
• Funding is made available to an entrepreneur (mudarib) who invests funds in the project. • Profits are shared on a pre-arranged basis. • Entrepreneur = investor ( rabbulmal ) only and thus responsible for all losses from investment. • This approach is comparable to Western non - recourse finance
Identify and describe the 3 approaches to Islamic mortgages ?
( 1) Murubaha : • Concept of ‘mark-up’ over original purchase price. • Halal , as selling for profit is acceptable for trade to flourish. • Vendor sells house to bank. • Bank sells house immediately to borrower at a higher price.
( 2) Ijara • Bank pays for the house and leases it to borrower. • The borrower ‘rents’ the house for instalments equal to the original price plus a ‘mark up’. • At maturity the borrower makes a final payment to the bank, often $1.
3) Diminishing Partnership Approach • Local community acts as a type of banker to provide finance. • Model akin to Western concept of credit unions.
Steps in diminishing partnership approach: i. Prospective buyer pays money into a partnership fund, administered by local community. ii. If partnership has sufficient funds, the house is bought in the name of the partnership. iii. Partner (buyer) has liability to partnership. iv. Buyer ‘rents’ house from partnership until liability is repaid.
Describe the Islamic version of bonds known as Sukuk
The sukuk is issued like a conventional bond. • Payments on sukuk may reflect musharaka or other lending approaches. • Despite pricing issues due to uncertain cash flows, sukuk are straightforward products. • The major difference between a sukuk and a conventional bond is that sukuk is backed by an asset.
Future of Islamic Banking
I don’t understand !!!!!!
