International Banking

This article will focus on the practices of international banking and its position in the world economic system. As more financial institutions begin to participate in the global economic system, process improvement has led to the reduction of communication and information costs as a result of technology. One of the focal points for many multinational corporations is to have the ability to perform financial transactions outside of the United States. There tends to be a variety of information problems in the financial markets and those responsible for overseeing the processes attempt to find different ways to address the issues that arise. One such attempt explores long-term relationships between firms and banks. The purpose of the Basel Committee on Banking Supervision will be examined.

Keywords Basel Committee on Banking Supervision; Bank-Firm Relationships; Collections; Distance; International Banking; International Banking Federation; International Trade; Letters of Credit (LOCs); Wire Transfers

International Business > International Banking

Overview

As more financial institutions begin to participate in the global economic system, process improvement has led to reduced communication and information costs as a result of technology (Baldwin & Martin, 1999). "One variable that has been used in the international finance literature to proxy information costs is the (geographical) distance between two markets" (Buch, 2005, p. 787). Many have attempted to determine if there is a correlation between international asset holding and distance. Unfortunately, there has not been much research on the effect of distance on international financial relationships over a period of time. Although researchers (Portes & Rey, 2001) have found that some investors seek out nearby businesses in markets that exhibit correlation in business cycles, Petersen and Rajan (2002) reported that there has been an increase in the business being conducted between banks and their credit customers. What is important is the fact that international banking is a key factor in the way organizations, such as multinationals, conduct their business today.

One of the focal points for many multinational corporations is to have the ability to perform financial transactions outside of the United States. It is important for these corporations to have the ability to participate in the international trade process. Some of the key banking services that are needed include letters of credit, wire transfers, collections, and foreign exchange (Teller Sense, 2003). It is important for organizations to have the ability to wire deposits in a timely manner, have the credibility for banks to provide a letter of credit on its behalf, and collect payments quickly and easily.

In March, 2004, the International Banking Federation was established when the banking associations from Europe, the United States, Australia, and Canada united. The headquarters for the group was London. The purpose of this consortium was to provide an international forum to address issues such as legislation, regulations and other issues that affected the countries and the global banking system. One of the main objectives of the group was to increase the effectiveness of how the banking industry responded to national and international issues (Teller Vision, 2004).

One issue that this group may discuss is the ability for the market to absorb shocks in times of financial crises such as the crash of 1987, the Asian crisis of 1997, and the Russian crisis of 1998. One of the effects of globalization in the financial industry is that the banking sectors across the world have become interdependent across borders (Elyasiani & Mansur, 2003). Given the fact that the banking systems in different countries are not the same in structure and regulatory constraints, it is important that the international financial community is responsible and collaborate on what type of plan should be in place for the global financial market. Organizations such as the International Banking Federation need to develop a plan of action to address these types of events so that the members are not adversely affected when a crisis happens. They are responsible for minimizing the risk of a domino effect occurring.

Application

Banking Supervision

"The present international, regional, and national rules on banking supervision are strongly permeated by a high degree of fluidity directly descendent both from the revolution of principles and techniques steering the global financial markets, and from the connected difficulty of the nation States to face the new technological challenges" (Ortino, 2004, p. 715). Policymakers, experts, and scholars will need to analyze and evaluate the level of fluidity when attempting to implement policies and regulations to govern global financial markets. The changes in information technology have challenged the European States by requiring them to evaluate the political and economic systems that they have in place.

According to Ortino (2004), there are two specific features of the institutional order as it relates to banking supervision at an international level. First of all, national legislators are responsible for setting up the legal norms and developing the foundation for the proper power structure and procedures. Second, the powers of the banking supervision authorities are assigned by the banking sector. These features are encouraging banking supervision authorities to work together as well as with supervisory authorities in other financial sectors.

One entity that works at the international level is the Basel Committee on Banking Supervision. This entity was set up in December, 1974 by the central bank governors of the group 10 nations, and meets four times a year. The membership includes representation from countries such as Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom, and the United States. The countries meet in order to consult on economic, monetary and financial matters. The purpose of the committee is to discuss how to handle supervisory problems, such as global financial crises. Although the Committee coordinates the supervisory responsibilities among the national authorities and monitors the effectiveness of supervision of banks' activities, it does not have formal status as an international organization (Ortino, 2004). However, the establishment of the Basel Committee was a significant point in the history of international banking supervision.

G-10

In 1999, there was a section that was added to the Gramm-Leach-Bilely Act, which broadened the range of activities that banking institutions in the United States could participate in, especially those institutions that elected to become financial holding companies. Although this was a significant step, financial institutions in the United States still had a narrower range than most of the other countries that were members of the G-10 group. What are some of the differences between some of the countries?

As a rule, most G-10 countries have allowed their banks to provide a full range of securities market activities (i.e. underwriting, brokering, and dealing) versus performing the transactions through a subsidiary. Also, there are a few G-10 countries that will allow a full range of insurance activities. However, the main restrictions tend not to be on the types of insurance activities. Rather, many of the restrictions tend to focus on where the activities are performed (i.e. some of the activities are required to be performed via a subsidiary). In addition, there are also restrictions on real estate activities for banks based on the range of activities, whether or not the activities are performed at a subsidiary or bank, or both. Nolle (2003) provided research that compared which G-10 country banks were allowed to own nonfinancial firms and which nonfinancial firms were allowed to own banks. The results showed that most G-10 countries were allowed to own nonfinancial firms and nonfinancial firms were allowed to own banks. However, the United States is one of the countries that have greater restrictions on the above-mentioned combination of activities. Japan was the only country to have a greater level of restrictiveness than the United States.

"The United States supervisory system has the most complex structure in the G-10, and in several key respects its banking supervisory structure puts it among the minority of G-10 countries. However, in one key respect — the funding of bank supervision as practiced by the OCC — the U.S. is similar to the majority of G-10 countries" (Nolle, 2003, par. 10). Nolle's report (2003) “shows that nine of the 11 G-10 countries assign banking supervision to a single authority.” The United States and Germany were the only two countries that had more than one federal level bank supervisor. In addition, the United States is “one of four G-10 countries that assigns bank supervisory responsibility to the central bank. The majority of G-10 countries' bank supervisory authorities have responsibilities beyond the banking industry, either for securities firms, insurance firms, or both” (Nolle, 2003).

Importance of Supervision

The type of supervision is important because the type of funding received could have an effect on how bank supervisors make decisions, especially if there is an opportunity for some type of political influence. For example, “supervisory agencies that receive funding from the institutions they supervise may have less pressure to pursue a political agenda than supervisory agencies that are dependent on general government revenues” (Nolle, 2003). Nolle's report showed that the United States tends to have a hands-on approach in performing the bank supervision role. They tend to conduct on-site exams on an annual basis and have a good ratio of total supervisory organizational staff to the number of banks as well as a good ratio of banking system assets to the banking system. The United States' ratio of banking assets per supervisory staff member is the lowest among the G-10 countries. This finding indicates that there is a significant amount of coverage on the banking system activities on a per staff member basis. With the exception of Italy, all of the G-10 countries require an external audit as part of the bank supervision role. However, the United States does not require external auditors to report bank misconduct to the supervisory authorities, but there is a commitment to the external auditing process.

Contributions of the Basel Committee

The Basel Committee has made two major contributions since its inception. The first contribution occurred in 1975, when the Committee took a lead role in making sure that countries share responsibilities when making international banking transactions. The Basel Concordate was an agreement that established the foundation for this process. The first stipulation was that the parent and host authorities shared responsibility for the supervision of the foreign banking establishments. The second stipulation stated that the host authorities had primary responsibility for supervision of liquidity. The third stipulation indicated that the solvency of foreign branches and subsidiaries was the primary responsibility of the home authority of the parent and the host authority. The second major contribution was a standard that would assist in adequately measuring a bank's capital and establishing minimum capital standards.

Viewpoint

Firm-Bank Relationships

There tends to be a variety of information problems in the financial markets and those responsible for overseeing the processes attempt to find different ways to address the issues that arise. One such attempt explores long-term relationships between firms and banks. Some believe that these types of relationships are crucial to the structure of credit markets. As a result, Degryse and Ongena (2002) reviewed the firm-bank relationship and the structure of banking markets on a global level.

A firm-bank relationship is established when the two entities have a close interaction and the banker is allowed to observe and collect a variety of information about the firm. The banker has the opportunity to evaluate whether or not the firm can meet future financial obligations. Although the banker has a chance to observe how the relationship will benefit the lender in the long term, there are some advantages for the firm as well. For example, the firm can increase its access to credit at a lower cost and with less collateral if it has established a relationship with a bank. Also, the firm may have the opportunity to enter into complex and high risk projects as a result of having an established relationship with a bank. Finally, a firm's reputation and image may be seen as favorable due to an established and credible relationship with a bank.

The Down Side to Firm-Bank Relationships

Although this is seen as a positive endeavor, there is a down side. There may be some individuals who will become concerned with the type and amount of information a bank knows about a firm. "The ability for a bank to privately observe proprietary information and maintain a close relationship with its customer can also impose costs on the customer" (Degryse & Ongena, 2002, p. 404). For example, a bank can devise a campaign that will lock customers into maintaining a relationship with it and prevent customers from receiving competitive financing from another bank. This will lead to the original bank having a monopoly over the market as a result of having privileged client information. One solution to this type of problem would be for firms to enter into more than one bank relationship. The banks will offer competitive services, which will minimize the possibility of any one bank getting the upper hand and creating a monopoly situation.

Firms can diversify their financial portfolio by entering into relationships with banks across the world. There will be opportunities for banks to form consortiums and market to a variety of firms. The banks could come together and establish rules and regulations for different types of organizational projects around the world. The Second European Banking Directive and the 1994 United States Riege-Neal Act created large international banking markets. “Established bank-firm relationships are very important in the current development of the financial system across the world” (Degryse & Ongena, 2002).

Conclusion

Many have attempted to determine if there is a correlation between international asset holding and distance. Unfortunately, there has not been much research on the effect of distance on international financial relationships over a period of time. Some of the key banking services that are needed include letters of credit, wire transfers, collections, and foreign exchange (Teller Sense, 2003). It is important for organizations to have the ability to wire deposits in a timely manner, have the credibility for banks to provide a letter of credit on its behalf, and collect payments quickly and easily.

In March, 2004, the International Banking Federation was established when the banking associations from Europe, the United States, Australia, and Canada united. The purpose of this consortium was to provide an international forum to address issues such as legislation, regulations and other issues that affected the countries and the global banking system. One issue that this group may discuss is the ability for the market to absorb shocks in times of financial crises such as the crash of 1987, the Asian crisis of 1997, and the Russian crisis of 1998. One of the effects of globalization in the financial industry is that the banking sectors across the world have become interdependent across borders (Elyasiani & Mansur, 2003).

Terms & Concepts

Basel Committee on Banking Supervision: Organization committed to overseeing banking matters the world over.

Bank-Firm Relationships: “The close and continued interaction between a firm and a bank that may provide a lender with sufficient information about, and voice in, the firm’s affairs” (Peterson & Rajan, 1995).

Collections: An alternative to letters of credit, collections refer to shipping documents which allow customers to collect payments quickly and easily.

International Banking: Banking transactions crossing national boundaries.

International Banking Federation: A consortium of banking associations from Europe, the United States, Australia, and Canada charged with addressing financial service issues on a national and international level.

International Trade: The buying and selling of goods and services over international borders.

Letters of Credit (LOCs): Issued by a bank, letters of credit ensure that in a business transaction, the seller will receive payment; acts as a testament to the customer’s ability to pay.

Wire Transfers: Allow for the purchase, sell or transfer of any major world currency.

Bibliography

Baldwin, R., & Martin, P. (1999). Two waves of globalization: Superficial similarities, fundamental differences, in Horst Siebert (ed.), Globalization and Labor. Tubingen: Mohr Siebeck.

Botis, S. (2013). Mergers and acquisitions in the international banking sector. Bulletin of the Transilvania University of Brasov. Series V: Economic Sciences, 6, 119-126. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=90223615&site=ehost-live

Buch, C. (2005). Distance and international banking. Review of International Economics, 12, 787-804. Retrieved July 5, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=14741055&site=ehost-live

Cetorelli, N., & Goldberg, L. S. (2012). Banking globalization and monetary transmission. Journal of Finance, 67, 1811-1843. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=79958360&site=ehost-live

Dietz, M., Härle, P., & Nagy, T. (2013). A new trend line for global banking. Mckinsey Quarterly, , 18-19. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=87315647&site=ehost-live

Elyasiani, E., & Mansur, I. (2003). International spillover of risk and return among major banking institutions: A bivariate GARCH model. Journal of Accounting, Auditing & Finance, 18, 303-330. Retrieved July 5, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=9669216&site=ehost-live

Degryse, H., & Ongena, S. (2002). Bank-firm relationships and international banking markets. International Journal of the Economics of Business, 9, 401-417. Retrieved July 5, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=8797206&site=ehost-live

International banking federation established. (2004). Teller Vision, (1321), 5-6. Retrieved July 5, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=13214317&site=ehost-live

Nolle, D. (2003, June). Bank supervision in the U.S. and the G-10: Implications for Basel II. Retrieved July 5, 2007, from http://findarticles.com/p/articles/mi%5fm0ITW/is%5f9%5f85/ai%5fn14897313/pg%5f2

Petersen, M., & Rajan, R. (2002). Does distance still matter? The information revolution in small business lending. Journal of Finance, 57, 2533-2570.

Portes, R., & Rey, H. (2001). The determinants of cross-border equity flows. Center for International and Development Economics Research, University of California, Department of Economics, Berkeley, CA.

The world of international banking. (2003). Teller Sense, , 1-8. Retrieved July 5, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=9381161&site=ehost-live

Ortino, S. (2004). International and cross-border co-operation among banking supervisors: The role of the European central bank. European Business Law Review, 15, 715-734. Retrieved July 5, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=21282696&site=ehost-live

Suggested Reading

Comford, A. (2007). Trade, investment and competition in international banking. Journal of Banking Regulation, 8, 195-197.

Frierson, R. (2006, July 13). Orders issued under international banking act. Federal Reserve Bulletin, C128-C130. Retrieved July 5, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=24429375&site=ehost-live

Ingves, S., & Lind, G. (2007). Using international sound practices as a basis for banking reforms. Sveriges Riksbank Economic Review, , 5-20.