Is there a future for international banks?

Shahzad Haroon Salman khan Shehla Riaz Usman Ghani Sajid Khan Waqar khan Ibrar Zeshan shahzad Awan

GROUP MEMBERS

History of global financial crises impact of international banking The new Basel iii Key principles of the Basel iii Why supervisors take this national approach Coordination failure Financial Trilemma Cost of local capital and liquidity rules Ring-fencing how to keep international banks alive Recapitalization An illustration Concluding remarks Questions and answer

Outline of the presentation

Global financial crisis Traditional consolidated approach Stand-alone approach According to McCauley et al (2012) stand

alone approach was “this move from the international to the multinational bank model”.

History

International framework for liquidity risk measurement, standards and monitoring, presents the Basel Committee’s1 reforms to strengthen global capital and liquidity rules with the goal of promoting a more resilient banking sector.

The objective of the reforms is to improve the banking sector’s ability to absorb shocks arising from financial and economic stress,

The new Basel III

Capital requirements

Leverage ratio

Liquidity requirements

Key principles of the Base iii

This base iii framework is more costly as banks must have to maintain their capital and liquidity requirements so why supervisors follows this?

According to (Schoenmaker 2013) Coordination failure in international crisis management appears to be the root cause.

why supervisors take this national approach?

According to Freixas (2003) shows that national authorities only consider the local systemic effects of a bank failure. Cross-border externalities are ignored, this analysis were named by Freixas as “Financial trilemma’

Coordination failure

This states that the objectives of financial stability, international banking, and national financial autonomy are not compatible.

Financial trilemma

Recognising that international coordination is likely to fail,

supervisors have concluded that they must resolve the local operations of banks.

They have left the integrated, consolidated approach to supervision and apply capital and liquidity rules at the local level.

International banks then become a string of national subsidiaries within a multinational bank

Costs of local capital and liquidity rules

At the IMF, Eugenio Cerutti and others (2010) have done research on the impact of local capital requirements for a group of 25 Western banks operating in Central and Eastern Europe.

Under a scenario of a 2% decline in GDP and a 2% increase in interest rates, these banks need to raise extra capital of €45 billion in case of ring-fencing. The extra capital needed is only €25 billion without such ring-fencing.

Cont…..

Guarantee that (funds allocated for a particular purpose) will not be spent on anything else.

Ring-fencing

These local liquidity and capital holdings will be trapped in the national subsidiaries, as the national supervisors want to keep these extra safety valves at the national level, in particular when a crisis hits and liquidity and capital should be directed to where most needed.

It feels like not being able to use the firemen and water resources of a neighboring village, when the village’s fire brigade is fighting a raging fire.

CONT….

The solution is a supranational approach for supervision and resolution. The bottom line is to arrange an appropriate fiscal backstop through burden sharing (Goodhart and Schoenmaker 2009).

How to keep international banks alive?

Figure 1 shows the improvement in resolution

The starting point is that a recapitalization is efficient when the benefits (in the form of financial stability) exceed the costs. The solid diagonal in Figure 1 represents the line where benefits (B) and costs (C) are equal. The left dashed line measures the home country benefits.

Recapitalization cont….

In the supranational approach (all benefits in the home country and the rest of Europe are incorporated by the supranational body), area C, which indicates the area of inefficiency, is smaller under the supranational line than under the home country line.

Cont…

suppose the cost of recapitalizing an ailing bank is 100, benefits are 150 ,if only the home country benefits are taken into account: 80 (that is, 53% multiplied by 150).

Faced with a cost of 100, the home country decides not to recapitalize.

Although recapitalization is the optimal strategy (benefits exceed costs, there is no recapitalization.

supranational approach would see that the European benefits are 114 (that is, 76% multiplied by 150). This 76% of European benefits includes the benefits in the home country (53%) and other European countries (23%).

As these benefits now exceed cost, the European body recapitalizes the ailing bank, which is the efficient outcome

An Illustration

The Bank for International Settlements could play the role of supervisor for global banks (obviously the so-called ‘globally systematically important banks’) and the IMF the role of resolution authority for these banks. The IMF already enjoys the necessary fiscal backstop of its member countries.

Concluding remarks