International Banking and Financial System Need Reform - Research Paper Example

Name: Roll No: Class: Teacher: Subject: May 06, 2008 University: Contents Contents 3 Introduction 5 Need for Financial Stability 6 Role of International Financial Bodies 7 Crisis in Banking Sector 9 Banking Sector- Backbone of Economy 10 Improvement in Regulatory Structure 11 Need of Autonomy 12 Reforms in Payment and Settlement System 13 Structural Reform and Economic Liberalization 15 Standards of Governance and Transparency in Reforms 17 Risk Management 18 Need of Reforms in Developing Countries 19 Conclusion and Recommendations 20 Introduction A dramatic growth in the global banking and financial sector has taken place in the recent past as well as the diversification of product and services provided by them, acting through different markets and exchanges. International banking system has developed from a non-significant sideline activity of some major financial institutions to a significant activity that now accounts for an important potion of the asset of different large banks. Similarly substantial changes have occurred in the insurance and securities markets. The value of transactions in bonds, derivative instruments and stocks involving parties located in different countries have increased dramatically in the last half of 1990s and early 2006s. As more transactions of financial nature involve specific transnational elements, the overall ability of banks to avoid precise and meticulous regulatory standards by transferring to poorly regulated authority and jurisdiction has become a major cause of concern. This is the reason why least international banking and financial regulation standards are needed to avoid developing regulatory gaps in the international banking and financial system. 1(Colgate, M. ‘Banks, retailers and their customers: a relationship marketing perspective’ 2005 16 (4) International Journal of Bank Marketing pp-23-33 But it is necessary that international standards should be responsive to market developments and as such should not hinder innovation or liquidity in financial markets. 2(Berlin, M. ‘On the probability and cost of relationship lending’ 2002 22 (6-8) Journal of Banking and Finance P-243 Therefore it is quite necessary to develop a specific level of competition among different jurisdictions to produce particular market-driven standards that also address the purpose of controlling systemic risk. Financial stability in the international banking and financial system is in fact a public good that countries search to promote in their entire regulatory policies. As such in this paper we attempt to study and investigate the need for reforms in the international banking and financial system. The study will focus on the current scenario prevailing in the international banking system and arguments will be developed if structural reforms as well as reforms in payment and settlement system and in other significant areas can improve the standards of governance and increase transparency, accuracy and trust on the international banking and financial system. Need for Financial Stability In promoting and developing financial stability in the international banking and financial system for the global economy, countries from international institutions to overcome the joint action complexities of managing financial and monetary risk in their own economies. In doing so, countries with a wider range of obstacles that also include transaction costs, which are substantially reduced by their working jointly through international banking system should coordinate and promote their policy objectives. The under-pricing of monetary and financial risk can ultimately lead to a systemic and universal financial crisis that can extend to the banking sectors and also the payment systems of many nations. It can also engulf the international economy and community in a macroeconomic shock. A primary purpose of the regulation of the international and banking system is to control particular systemic risk by developing the pricing of capital effectively as well as financial products. In the international financial markets, regulators are in a position to accomplish this by having approach to information from different other regulators and also by having the overall capability to coordinate the enforcement and implementation of regulatory standards at the international level. The international banking and financial system have in played a primary role in this field by reducing joint action costs for the purpose of promoting the main goal of financial stability. 3(Allred, A.T. ‘Service Quality at banks and credit unions: What do their customers say?’ 2006 18 International Journal of Bank Marketing P-33) Role of International Financial Bodies The Basel Committee, BIS committees, IAIS, IOSCO, and FATF are among the major international financial bodies that are established with the objective of promoting and ensuring financial stability through minimizing the negative effects of different types of financial risks. The informal and consensual approach of IOSCO, Basel Committee and IAIS in developing rules and nonbinding standards for regulating the international financial markets has been viewed as achievement in fostering coordination and cooperation among the regulators of developed and advanced economies. The application of such standards by the World Bank and the IMF and subsequently their incorporation into laws of European Union reveals their significance as international financial models and the requirement to coordinate regulatory and supervisory practice for the purpose of ensuring their equitable and efficient implementation to all countries. Almost three-fourths of the entire international economy has been hit by significant banking crisis in the recent past. As such continuous and effective reforms should be introduced and implemented in the international banking and financial system to address the main causes of the crisis. The best way for application of serious reforms in international banking and financial system, in industrial as well as developing countries, is to install specific standards. The aim of implementing standards is based on the need to introduce further effective reforms in the international banking and financial system. The reforms should focus on: Bringing increased transparency to excessive involvement/ownership of government in banking system. Better disclosure to public about financial conditions of the banks Strict implementation and compliance of international accounting standards. Upgrading internal controls of banks Raising capital of bank to levels commensurate with the unpredictable and volatile macroeconomic atmosphere in the countries. Protects against political pressures specifically for regulatory forbearance Subjecting central bank supervisory systems to global and international surveillance. 4(Branelly. L. Suburbs back plans for community banks. Courier Mail. 200. pp. 132-145) Crisis in Banking Sector Banking crisis aggravates economic downturns; savings are kept from flowing to productive use and sternly constrain the willingness of authorities to increase interest rates at domestic level. The banking crises, mostly in developing countries, pose continuous challenges to industrial countries as the weight of most of the developing countries in the international financial markets is increasing rapidly. Net private capital flows directed towards developing countries exceeded one trillion dollars in the decade of 1990. 5(Sathye, M. ‘Adoption of Internet banking by consumers: an empirical investigation’ 2006 17 (7) International Journal of Bank Marketing pp-211-212) As such most of the analysts anticipate these flows to increase in the current decade. They will mostly be driven by high rates of return, large opportunities specifically for risk diversification by the investors of industrial countries, the internationalization and globalization of production and the increasing liquidity and overall maturity of securities markets of developing countries. Current international banking agreements were primarily designed for the industrial countries. They are not comprehensive enough to dissuade banking crisis in developing countries. To avoid such grave crisis in future the international banking and financial system need reforms. The Basle Capital Adequacy Accord in 1988 suggests that international guidelines and standards can ultimately induce countries for making certain improvements that they would not in fact make on their own, either due to the considerations of competitiveness with other countries or firms or because unilateral and autonomous reforms are not much credible than those supervised by an international agency. Different other approaches to motivating reforms in international banking and financial system, both in industrial as well as developing countries, such as depending exclusively on technical assistance or market discipline is not promising. Banking Sector- Backbone of Economy Banking sector is in fact the backbone of any economy. It serves as the nerve center where almost all financial transactions flow. It not only facilitates greater efficiency but increases the potential and possibilities for excesses. As such there is a dire need for the formulation of effective strategies and innovative reforms to build a banking system that can successfully respond in an effective manner to the ever-altering global environment. Some of the experts, in the area of reforms for banking and financial system, identify two primary areas. These are regulatory framework of a system and the second is corporate culture. A main factor in the reform process is the assurance that the entire regulatory environment is in fact at par with the perceived risks. As such the prudential regulations should be strengthened in relation with coverage, enforcement and stringency. A more comprehensive and harmonized supervision system across global banking system is the need for greater effectiveness and scope. For the purpose of ensuring effective enforcement the independence and the capability of supervisory authorities should also be strengthened. 6(Fulcher D.G. ‘Bank Selection Decisions and Market Segmentation’ 2006 21 Journal of Marketing, pp-32 Improvement in Regulatory Structure Yet improvement in the regulatory structure cannot be undertaken exclusively in isolations from the other factors of the reform process. Weaknesses in the balance sheets of banks along with operating set of procedures must be remedied and identified to enable them in providing effective and better response to and also comply appropriately with the overall requirements of a stern regulatory regime. As banks are exclusively corporate entities, their corporate framework should also take place. In other words there is a need for continuous improvement in the underlying institutional and legal frameworks for operational and financial restructuring. The bottom line for such reforms is to avoid future crises, as mentioned above, by the advancement of risk management skill of banks and also the supervisory authorities. 7(Babbie, E The Practice of Social Research. Wadsworth Publishing Company. 2004, pp-254-55) The reforms in banking and financial system should allow a greater and enhanced role for almost all market forces like increases in bank capitalization, deregulation of interest rates and overall improvement in bank supervisions. As such a high level of market orientation in the banking and financial system along with regulatory framework can be continuously improved. 8(Barnes. E. ‘Closeness, Strength, and Satisfaction: Examining the Nature of Relationships between Providers of Financial Services and Their Retail Customer’. 1999 21 Psychology & Marketing pp.78-83) As far as corporate reforms are concerned there is also a need for significant steps to be undertaken in aligning risk management, regulatory and disclosure practices compatible with international norms. Disclosure statements specifically for financial statements, duly audited, should be consistent with the established international accounting standards. Certain guidelines should be established by the central banks of the nations across the world to govern the duties and responsibilities of the concerned Boards of Directors of the member banks to ensure efficient and prudent bank administration. Need of Autonomy More autonomy is also needed to oversee these reforms to increase the administrative and fiscal independence of the charters of central banks. The element of increased autonomy can enable it to implement improved and flexible policies that could result in increased stability in the entire macro-environment. It can, in turn, promote the enhanced market confidence and trust in the banking and financial system. In the international banking and financial system, there exist certain challenges for increasing globalization and sophistication in the financial environment. For this purpose, primary banking reforms should be prepared, submitted to the concerned central banks and ultimately implemented. These reforms can further align the prudential standards with global norms, intensify competition in the overall banking sector and ultimately strengthen the regulatory and supervisory capability of the central banks across the globe. 9(Narus, J.A.’A Model of Distributor Firm and Manufacturer Firm Working Partnership’ 2006 33 (4) Journal of Marketing P-54) Modern and technology based amendments in the banking sector can also enable the international banking and financial system to adapt to the up to date innovations in banking technology, for instance electronic banking. With the general increase in electronic commerce, international banking system should be made compatible with the increasing competition that is posed by alternative systems of payments like digicash and electronic shopping malls. During the process, the supervisory scope of central banks should also be widened. 10(Cowles, D. L. The Role of Trust in Customer Relationships: Asking the Right Questions. Management Decision 1999, P44) Reforms in Payment and Settlement System The reforms in the area of payment and settlement system, for example, should be upgraded to move exclusively into a real-time basis. 11(Dubelaar C Personal Information Privacy and Shopping Behavior on the Internet Journal of Asia Pacific Marketing 2003, p. 21) Up to date risk rating should be introduced in the entire banking system to facilitate and allow for early identification of complications and improve the overall credit risk management. It is pertinent to mention that structural reforms including banking reforms take considerable time to design and implement. Although the initial impact of reforms is not significant, the advantages are less apparent because they are intended to spread on long term. For this purpose the political courage is mostly needed to observe the process of reform through its conclusion. The cooperation and support of the legislature is vital in implementing reforms that are anticipated to influence the banking system generally and economy specifically. 12(Leuza, C.D. ‘Earnings Management and Investor Protection: An International Comparison’: (2003) 15 Journal of Financial Economics. 2003, pp-65-66) As far as enforcement of reforms is concerned, a primary factor is the level of autonomy of the supervisory authorities from different government agencies and also from other vested focus. This motivates the greater confidence particularly from the private sector which is considered as the most vital element determining the ultimate failure or success of the entire reform process. Local reforms in the banking system are also the significant determinants of the overall economic growth due to their robust impacts on the private sector development and the smoothness of cross-border trade and commerce. Reforms in the banking and financial system also give rise to some critical issues. As such the economies that address actively their behind-the-border issues seem to be extra resilient to complete economic shocks, accomplish greater macroeconomic stability and ultimately experience continuous productivity especially in the longer term. These domestic reforms should be complemented by global and regional initiatives. With the support of cross-border activity that is in fact expanding at a swift rate, a strong rule-based system along with effective partnerships is required. Due to many real barriers to cross-border activities exist in domestic structural systems and policies, extensive consultation is required on the implications of domestic and national policies. Perspectives of sharing policies and learning from other countries’ experience confronting similar concerns can also support in increasing domestic reform endeavors. 13(Amuzegar G. E Determinants of Continuity in Conventional Industrial Dyads Marketing Science 2003, pp-77-85) Structural Reform and Economic Liberalization The profile of structural reform as well as economic liberalization has been significantly increased in the recent years. The structural reforms must be promoted primarily in the under-mentioned areas: Competition policy Regulatory reform Corporate governance Public sector management and Strengthening legal and economic infrastructure Another major trend that necessitates more reforms in the international banking and financial system is the global demographic change that encompasses ever-changing patterns of international population growth, international movement of people and the population ageing. Most of the increase in population has come from the less developed countries, specifically Asia. This trend of increase in population is expected to continue in the next fifty years and the global population is also anticipated to reach around nine billion by 2050. A rise in the overall share of the working-age population, particularly in the developing nations, has the potential to enhance output growth and also enhance domestic returns on investment. However, exploiting these potential advantages depend heavily on the application of domestic financial and economic market policies and the much needed, improved reforms in the international banking and financial system. These policies and reforms can ultimately increase the efficiency of investment and the capability to manage risk. However, in both developing and developed countries the above mentioned demographic changes will influence the level of investment, savings and assets returns at the domestic level and also on the growth of cross-border trade, capital flows and migration at the global level. As such the reforms in international banking system should also focus on the demographic change for financial institutions, markets and systems. Better performing markets in the global economies are significant for helping deliver maintainable development in these countries. 14(Barnea, A. J. ‘Classificatory Smoothing of Income with Extraordinary Items’. (1999) 14 The Accounting Review P-20) The reforms in banking and financial system should aim to ensure that saving is allocated to the best available productive uses, effective international financial markets and the overall capital mobility they strive to foster will support the global economies that deal with changing demographic and also fund the development requirements of emerging countries. Standards of Governance and Transparency in Reforms Another major element that impacts the reforms in international banking and financial reforms is that minimum standards of governance and transparency should be in place to facilitate capital flow among nations. Even though there are some impediments to the functioning of international banking system that could be addresses. They include: different forms of limitations on investment; distortions from various subsidies and taxes; incomplete and poor data. 15(Jones, E. ‘Personal Selling in Financial Institutions. (2005) 55 (6) Journal of Business Research, pp-5 For ensuring effective reforms in place the factor of incomplete and poor data should be strongly focused to improve the availability and quality of data on investment, reserves, production, pricing and consumptions of resources including minerals and energy. The regulatory changes in the international banking and financial system have improved the overall access to financial markets. Some of the changes are liberalization of domestic stock markets and capital accounts- including through the stipulation of greater approach to foreign investors. 16(Combs, H. W ‘Preparing Retail Banking for a Competitive Environment’ (2002) 14 Review of Business, p45-46. The greatest strides that had been made in the international banking system are in the area of communication and information technologies. These attempts have lowered particularly the transactions costs. Information costs, in particular, have declined, supporting to reduce the overall asymmetry of information between foreign and local investors. This has also encouraged the increased diversification of investment. One issue raised in implementing reforms is to identify the level of underdevelopment of international banking system and how it has contributed to the present situation prevailing in the global market. The financial fragility could have caused domestic policymakers to track macroeconomic policies that are designed to maintain current accounts mostly in surplus and as such avoid dependence on foreign capital. The reforms in banking system aim to raise a clear concern in relation with the requirements for investment to maintain growth and further deterioration in poverty, mostly in developing economies. A major concern that affects banking reforms is the role played by financial flows while responding to the changes in demographics. Risk Management Risk management is also the major trend that plays a vital role in the reforms needed in banking and financial system. In fact risk management has always remained a significant part of banking and financial system. But with the passage of time, the main focus by regulators and industry on the procedures of sound risk management has strengthened. Accurate managing of risks is necessary for any efficient and stable banking and financial system. To help maximize and facilitate the potential benefits from the reforms and also to help minimize some of the probable risks- regulators, market participants, international and governments organizations should work jointly for strengthening the international banking and financial architecture: specifically through the harmonization of global standards and practices, along with improving the banking and financial supervision and soundness. 17 (Branelly L Suburbs back plans for community banks. Courier Mail 200 pp. 132-145) Need of Reforms in Developing Countries To much larger extent this cooperation is already present through main international bodies like the Financial Stability Forum, Bank for International Settlements and the International Monetary Fund. But there is a dire need to intensify this cooperation through effective reforms. The focus of economic activity and growth are continuously moving to developing from developed countries particularly from west to east. The developments are in fact set to encourage the increased capital flows to developing countries. For the purpose of facilitating such adjustments strong reforms are needed in the efficient international banking system particularly in emerging economies and enhanced integration into international markets. It is pertinent to mention that economies grow swiftly for a specific period by implementing new and effective reforms in international banking and financial system. A well functioning banking and financial system in fact perform a vital role while promoting economic stability and growth. 18(Joseph, M. ‘Service quality in the banking sector: the impact of technology on service delivery’. (2004) 17 (4) International Journal of Bank Marketing, P-10) It reduces transaction costs and facilitates individuals to ultimately achieve preferred consumption level, channel domestic as well as foreign savings specifically to finance the profitable investment opportunities and provide effective means to diversify and spread risk. Such reforms also sharpen incentives in firms to enhance efficiency and governance. Diversified banking and financial system ultimately provide channels to provide investment finance that serve as support system in the event that the entire banking system comes under pressure. Development of full range international banking system including derivative and capital markets enhances the overall capacity in managing risk. Conclusion and Recommendations The current need to reform of international banking and finance system is increasing the homogeneity in overall behavior, not successful in policy suggestions to take account of the specific inter-relationship between macro-economic performance and micro-economic risk taking, and is still trapped in the intellectual standpoint of the nation state. In such kind of circumstances the possible consequences are deemed with equanimity. 19(Anderson W. T. ‘Determinance versus Importance in Bank Selection Criteria: A Reply’ (2005) 41 Journal of Marketing P-67) As such a satisfactory response is needed to the economic losses that are imposed by the volatility of financial and banking system should be to move in a different direction. Banking reforms should search for increasing liquidity by improving heterogeneity and should endeavor to strengthen the forces of stabilizing convention, should also take complete account of the entire macro-economic measure for the purpose of reducing entire systemic risk. With the support of reforms in banking and financial system, the benefits of international financial architecture can be exploited, if there is a greater recognition of all possible risks imposed on community by personal risk-taking investors. This also means developing a powerful structure of international charges and rules links associated with risk taking investment. A powerful force that increases stabilizing tradition in global banking system has been the lender of last resort. There is not specific international lender of the last resort, and if it was there its presence could enhance stability. Reforms should also include and cover macro-economic concerns. This is specifically essential for developing countries as they should be allowed to replace controls of macro-economic. The reforms should make greater utilization of new tasks on extreme, unusual event and should be incorporated with a macro view. It should also be acknowledged that while pursuing all reforms in international banking and financial system effectively the domain of regulator should be similar to the domain of the market. 20(Frost, C.A. ‘Interdependencies in the Global Markets for Capital and Information; The Case of Smithklilne Beecham Plc. Accounting Horizons. 1996, pp-113-120) None of the normal tasks of authorization, surveillance, development of the policy and enforcement of the policy are presently performed in a rational manner in global banking market. While implementing reforms in international banking and financial system full cognizance is to be taken on the complete social costs of systemic risk, specifically in macro-economic impact. 21(Gambetta D Can we Trust? In Trust: Making and Breaking Cooperative Relations. New York. USA. 2005, P. 25) Steps should also be taken to reinforce steady power of convention. International banking and financial markets are today global and as such new reforms and their implementation should also be global in scope. On the basis of reforms, discussed throughout the paper, it would be possible to frame a regulatory structure that could maximize the overall social benefit of banking and financial systems for the entire global community. References Allred, A.T. ‘Service Quality at banks and credit unions’. What do their customers say? (2006) 18 International Journal of Bank Marketing Amuzegar. G. E. Determinants of Continuity in Conventional Industrial Dyads. Marketing Science. 2003 Anderson, W. T. ‘Determinance versus Importance in Bank Selection Criteria. A Reply’.(2005) 41 Journal of Marketing. Babbie, E. The Practice of Social Research. Wadsworth Publishing Company. 2004 Barnea, A. J. ‘Classificatory Smoothing of Income with Extraordinary Items’. (1999) 14 The Accounting Review Barnes. E. ‘Closeness, Strength, and Satisfaction: Examining the Nature of Relationships between Providers of Financial Services and Their Retail Customer’. (1999) 21 Psychology & Marketing Berlin, M. ‘On the probability and cost of relationship lending’. (2002) 22 (6-8) Journal of Banking and Finance Branelly. L. Suburbs back plans for community banks. Courier Mail. 2005 Colgate, M. ‘Banks, retailers and their customers: a relationship marketing perspective’. (2005) 16 (4) International Journal of Bank Marketing Colgate, M. ‘Switching barriers in consumer markets: an investigation of the financial services industry’ (2003) 11 Journal of Consumer Marketing Combs, H. W. ‘Preparing Retail Banking for a Competitive Environment’. (2002) 14 Review of Business Cowles. D. L. The Role of Trust in Customer Relationships: Asking the Right Questions. Management Decision. 1999 Dubelaar, C. ‘Personal Information Privacy and Shopping Behavior on the Internet’. (2003) 2 (1) Journal of Asia Pacific Marketing Frost, C.A. ‘Interdependencies in the Global Markets for Capital and Information’: The Case of Smithklilne Beecham Plc’.(1996) Accounting Horizons Fulcher, D.G. ‘Bank Selection Decisions and Market Segmentation’. (2006) 21 Journal of Marketing Gambetta, D. Can we Trust? In Trust: Making and Breaking Cooperative Relations. New York. USA. 2005 Joseph, M. ‘Service quality in the banking sector: the impact of technology on service delivery’. (2004) 17 (4) International Journal of Bank Marketing Jones, E. ‘Personal Selling in Financial Institutions’ (2005) 55 (6) Journal of Business Research Leuza, C.D. ‘Earnings Management and Investor Protection: An International Comparison:’(2003) 15 Journal of Financial Economics. Narus, J.A. ‘A Model of Distributor Firm and Manufacturer Firm Working Partnership’. (2006) 33 (4) Journal of Marketing Sathye, M. ‘Adoption of Internet banking by consumers: an empirical investigation’. (2006) 17 (7) International Journal of Bank Marketing Read More