The risk associated with the international banking systems

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Risks Confronting the International Banking System in a
Contemporary Economy
.
Emmanuel Teitey, Ph.D
Kings University College- School of Business, Ghana
Contract: teitey2000@gmail.com
Cell Phone: +233-0548704485/0277430485
Ghana – West-Africa
June, 2019
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Abstract: Looking carefully at the economic history, we see two sorts of changes; some
banking regulation and economic institutions change slowly enough to allow us to
anticipate future outcomes fairly accurately. But from time to time, there are some very
rapid or significant regulatory or institutional changes. Such events usually emerge in the
aftermath of a deep crisis. This seems to be the case these days. New regulation and new
institutions are needed to build the international banking system.
Keywords: International, Banking, System, inflation, unemployment
Introduction: Risks Confronting the International Banking System in
a Contemporary Economy
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The challenges that banks face today are of the highest order. Sovereign debt crises are
destabilizing financial markets and the global economy. Much of the developed world is
experiencing sluggish economic growth, with rising inflation and unemployment. Capital
and liquidity are still not so easy to access and manage. Politicians and regulators are
writing new financial regulations at a rapid rate. The competition among financial
institutions is as tough as ever. Customers are knowledgeable and demanding. New
products have to be developed tested and launched delivery channels are more varied and
complex.
Furthermore, the banking system are faced with such an array of challenges, banks need
to modernize their business operating models and their technology components if they are
to benefit fully from the next period of growth. Indeed, it do not do so, they are likely to
fail not necessarily in the sense of going into liquidation, but in the sense of failing to
satisfy customers, failing to maintain revenue and profits and most important of all failing
to please shareholders by maximizing their value. The most fundamental challenge as
always is to generate strong revenues and healthy profits. This is no easy task in the
difficult economic conditions that prevail in certain parts of the world, especially in
Europe where the sovereign debt crisis continues and where banks still faces high credit
risks.
The sovereign debt crisis in peripheral Europe with risk of contagion and structural
political challenges across the whole euro zone, a period of fiscal consolidation in the
West with varying degrees of political buy-in commodity and food inflation across much
of the developing world, an unprecedented wave of social and political disturbance across
much of MENA(Middle East and North Africa) leading to regime change in many cases
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and the redirection of much of the financial surpluses of four of the largest surplus
countries in the world China, Japan, Saudi Arabia and Germany to meet domestic or
regional priorities. According to Flint (2011) amidst all of this, the G20 leaders are
attempting the complete restructuring and recalibration of the global financial system, he
added (Flint, 2011).
Problem Statement
The financial crisis in the fall of 1998 was the first post-World War II crisis in which
events in emerging market economies seriously threatened the financial stability of the
West, and where the origins of the crisis was clearly to be found in the workings of
liberalized markets and private sector institutions. The spark was the financial crisis that
overwhelmed many of the Asian economies in 1997 and spread to Russia in 1998 but the
centre of the conflagration was the near failure of the hedge fund Long Term Capital
Management (LTCM). More than any of the other problems in the fall of 1998 the threats
that LTCM`s difficulties posed to financial stabilities throughout the world illustrated
beyond all reasonable doubt that the international financial system had entered a new era.
This was not a problem of sovereign debt or macroeconomic imbalance, or a foreign
exchange crisis. Instead it was the manifestation of the systemic risk created by the
market driven decisions of a private firm and of the behavior of free financial markets.
The potential economy-wide inefficiency of liberalized financial markets was
indisputable.
Research Framework and Methodology
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Data on International banking systems in a contemporary economy was collected from
Secondary sources like Articles, Journals, Empirical literatures, Textbooks and Internet
sources for analysis on the International banking systems in a contemporary economy
Qualitative methodology was applied for this research paper. Descriptive research design
and analysis on the International banking systems in a contemporary economy were
employed to investigate the International banking systems. For the purpose of analysis, a
secondary data was used to analyse the various literature on International banking
systems in a contemporary economy.
The researcher obtained both primary and secondary data from the various case studies
for the analysis of the International banking systems. The primary data was in the form of
interviews with the concern officials. Secondary data was in the form of documents
obtained from the internet, literatures reviewed and other articles for the analysis of the
International banking system in a contemporary economy.
The research used qualitative data analysis methods, and trend analysis was also used in
analyzing the International banking systems. Trend analysis refers to an analysis of the
International banking systems for some conservative years, comparing the differences
within those stipulated periods and an analysis was performed to evaluate the
International banking systems in a contemporary economy.
Research Framework
To address this research paper about the future of the international banking system, it is
not an easy task at all, at least, I know that from time to time and mostly during crisis
periods banks and financial markets are considered the root of all evil. I have to accept
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that markets in general, especially financial markets do not function perfectly but I will
paraphrase Winston, (n. d.)Who says that the market mechanism could be bad but better
than any other economic and financial mechanisms that humanity has known until now.
Peering at the future of the largest risk facing the international banking system based on
our capacity to assess risks. We do this by using our inbred capacity to weigh
probabilities which is in our modern times supported my mathematical models (Winston,
n.d).
These ways out primarily took the form of the emergence of competitors to the US Dollar
as a settlement currency, the collapse of the Bretton Woods systems and the
establishment of international syndicate banks which began in 1964 under the pressure of
market forces, starting in the 80s financial sector deregulation gained ground by
loosening up legal and administrative restrictions. Almost all restrictions imposed up to
the 60s were removed. A new era dawned with markets enjoying more freedom. One
important result worth mentioning is that lending was no longer constrained by the
volume of deposits or holdings of liquid assets. Banks could borrow on the interbank
market at any time. Under the new circumstances, capital became the only factor
containing the size of banks Books (Goodhart, 2010).
Setting appropriate requirement for bank capital was challenging to regulators and it
remained so. On the other hand, a strong capital base is associated with the soundness of
a bank and this comes at a price in terms of profitability. Capital adequacy requirements
were unified under the Basel I Accord which set them at 8% and established risk
coefficients. But they were quickly watered down by the Basel II Accord which allowed
banks to assess their own risks through sophisticated models. Starting from the 80s credit
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expansion was relatively rapid. Independent central banks appeared to have tamed
inflation once and for all. New sophisticated financial instruments seemingly succeeded
in reducing risks to low level for ever. A new generation of investors emerged and took
on risks that they could not be afforded. Cross-border transactions increased rapidly at
unprecedented levels. After a period of several good years euphoria emerged at the
beginning of the 21st century (Ganqaher & Ga, 2009)
Main Findings of the Study
The empirical data analysis from the primary, secondary sources and the other literature
reviewed sources has shown the following risk facing the international banking system
and this was possible due to the results from the study enumerated as below:
Default risk means the failure of the borrower to pay the interest and principal amount
within the stipulated periods of time. The default risk has the capital risk and income risk
as its components. It means not only failure to pay but also delay in payment which also
leads to crisis.
Financial risk refers to the risk on account of pattern of capital structure. It is usually
measured by the debt equity mix of the firm. The variability of return and financial risk is
an avoidable risk to the extent that managements have freedom. A firm with no debt
financing has no financial risk. Financial risk is related to the debt and equity mix of
financing in the firm. The reliance of debt financing is also called financing leverage. It
has an important effect on shareholders return. Debt finance increasing the variability of
their returns.
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Business risk arises due to the uncertainty of return which depends upon the nature of
business. It will influence for the firm`s operating income. It relates to the variability of
the business, sales, income, expense, and profits. It depends upon the market condition
for the product mix, input supplies; strength of the competitor etc. The business risk may
be classified into two kinds like internal risk and external risk. Internal risk related to the
operating efficiency of the firm. This is manageable within or by the firm. Internal
business risk leads to fall in revenue and profit of the companies. External risk refers to
the policies of government or strategies of competitor or unforeseen situation in market.
This risk may not be controlled and corrected by the firm.
Liquidity risk refers to a situation wherein it may not possible to sell the asset. Liquidity
risk refers to inability to meet the liabilities of creditors when they want to withdraw their
money. Assets are disposed off at great inconvenience and cost in term of money and
time. Any asset that can be bought and sold quickly is said to be liquid. Failure of
disposable of an asset is called liquidity risk. Liquidity risk has a different meaning from
the point of view of banks and financial institutions.
Maturity risk will arise when the money was not received at the time of maturing of the
security. It is on long-term basis. It will happen when the term of maturity period of the
security is longer. The longer the term to maturity, the greater is the risk because
forecasting the environment for assessing conditions and situation becomes more and
more difficult.
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Interest rate risk: It is the difference between the expected interest rates and the current
market interest rate. The market will have different interest rate fluctuations according to
market situation, supply and demand position of cash or credit. The degree of interest
rate risk is related to the length of time to maturity of the security. If the maturing period
is long, the market value of the security may fluctuate widely. Further, the market
activity and investor perceptions change with the change in the interest rates and interest
rates also depend upon the nature of instruments such as bonds, debentures, loans and
maturity period and the credit worthiness of the security issues.
Inflation risk: Is also called as purchasing power risk. It is closely related to interest rate
risk since interest rate generally rises when inflation occurs. Inflation risk is more
relevant in case of fixed income securities; shares are regarded as hedge against inflation.
It is the risk that the real rate of return on security may be less than the nominal return.
There is always a chance that the purchasing power of invested money will decline or
that the real return will decline due to inflation. The return expected by investor will
change in real value of returns. Cost push inflation is caused by rise in the costs due to
rise in the input costs. Push and pull forces operate to increase prices due to inadequate
supplies and raising demand.
Currency risk/Exchange Rate Risk: Is also called as currency risk. It is associated with
the exchange rate fluctuations of foreign exchange on international transactions. The risk
is faced by the limited organizations which are involved in export or import business.
This risk will arise due to changes in currency exchange rates, may have an unfavorable
impact on cost or revenues. There is no exchange rate risk under the fixed exchange rate
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system. It refers to cash flow variability experienced by companies in international
exchange on accounts of uncertainty in exchange rates.
Call risk: It is associated with corporate bonds. The bonds are issued with call back
provisions and the issues will have the right of redeeming the bonds. The bondholders
face the risk of giving up higher coupon bonds. The reinvesting the proceeds at lower
interest rates may arise and incurring the cost and inconvenience of investment.
Discussion the Implication of the Study
This section forms the conclusion of this study and aims of the study as well as what has
been discussed in the literature will be discussed in relation to the secondary and primary
research that has been carried out. The chapter is going to take a conclusion view on the
study based on the analysis, information and result that has evolved during the course of
the study. Recommendations are also given at the end along with a proposal of areas that
will need further development and attention.
The end of this research has been to generally fit the aims and objectives of this study.
Recommendation for the future is however made to further improvement upon the
findings of this research. Based on the findings of the research, it is recommended that:
Banks, Investors, stakeholders and regulators should seek solution to effectively
manage the risks facing the international banking system.
There is the need for supervisors of financial institution to support the idea of
adequate capital to cover all risks.
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The plausible solution requires the collaboration of all parties including authorities
like the central banks, agencies, commercial banks, corporations and all and sundries
to get involves.
The long-term solution should be total restructuring of the international banking
system.
On the whole, the research feels that the objectives of this research have been met and
the recommendation for the risk facing the international banking system would
introduces a paradigm shift in the banking industry.
References
Flint,D.(2011).HSBC Holdings British Bankers Association’s Annual Conference,
London.
Goodhart, C. (2010).”The changing role of central banks”,BIS working papers
No.326.
Ganqadher,V&Ga,R.B.(2009).Investment Management: Including portfolio
management & security analysis. New Delhi: Anmol
Publications PVT.LTD.
Winston,C.(n.d.).The future of the international Banking system: Presentation of
Governor of the national Bank of Romania, Bucharest, 2 October, 2012.
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