Module Name: Global Issues for the Financial Professional

[PAM100]

SRN: 190231662

Coursework Assignment 2

Final Word Count: 3993

 Table of Contents

Particulars Page No

Introduction 3-3

Banking Regulations: their need and supervision 4-4

Brief history of banking regulations: The Basel Accords 4-5

The current regulation regime with Basel II and Basel III 5-9

Strategies to maximise return from lending products 10-12

Conflicts that arise due to the different objectives of the regulators

13-15
and banks

Conclusion 15-16

Reference 16-18

pg. 2
Introduction:

There are evidently many papers that explore the current regulations that banks operate in.

This paper will do this no differently. On reading, we will briefly accustom ourselves as to

why bank are different from other organizations from the economy point of view and as to

why they need to be closely regulated. Banking regulations have generally been the most

regulated section in the economy and are developing with time. This paper intends to set

about looking at the current regulations and how it affects the overall banking performance.

This paper extends the topic with various scenarios and evidence and hopes to sets its own

perspective on the various regulations that banks need to supposedly operate under. Basel II

was implemented at a much later date in comparison to its announcement. Henceforth, even

though Basel III has been adopted by a few nations, majority of them still operate under

Basel II and thus this paper identifies and focuses on Basel II as the current regulatory

regime. Although implications and supervisions of these rules and regulations are a costs to

banks and also have impact on the profits efficiency. This paper acknowledges different

strategies, how amidst all these rigid regulation, how banks can increase their return and

profit efficiency. The paper intends to do so by discussing on the various strategies that banks

can implement and attend their required returns. After the in-depth discussion of the banking

regulations and how banks can maximise their returns operating under it, there will also

discussion on the potential conflict between the two i.e. banking regulations and bank’s

objective to maximise return; and how these can be improved. On the basis of the evidence

which will be provided, the paper will conclude on its viewpoint with all relevant

justification.

Without any further delay, let us dive in deep into the topic.

pg. 3
Banking Regulations: their need and supervision

In comparison to the different section of the financial system, banks are unique. For example,

in a country like Bangladesh the garments industry is a key player in the country’s economy.

If one company manufacturing ready-made garments goes bankrupt, it will only affect the

investors and the employees, but its competitors – the other garments manufacture will

benefit from this as it creates added market place for them. This does not fabricate a gaping

hole in the economy, and in some cases such extension may even be positive.

But financial institutions are contradicting in this scenario. The collapse of a solitary bank

can have calamitous results as it will prompt a ripple effect, coming full circle in a

foundational failure. Henceforth, the negative façade justifies why regulations are required

for financial institutions. Regulations are designed by the regulatory agencies and supervision

is the enforcement of these regulations.

Traditionally, banks have been the most regulated section in the financial system and here are

a few reasons why it is viewed as important to direct banks. Left to their own gadgets, banks

tend to over-burden themselves, go out on a limb and fall flat. As bankers have little to no

downside, but enjoy high upside which in turn has a motivating force for them to go out on a

limb than are wanted by their customers, their investors or other stakeholders. It is this

externality that has regularly been the fundamental inspiration for regulating banks.

Brief history of banking regulations: The Basel Accords

Banks traditionally did not trade outside the states or a country, but in today’s world of

finance it has crossed borders and has globalised. For banks to operate in an international

regulatory regime, the Basel Committee was set up by the national bank Governors of the

Group of Ten countries (G10 Countries) towards the finish of 1974 in the result of genuine

pg. 4
aggravations in international financial and banking markets (prominently after the collapse of

Bankhaus Herstatt in West Germany). The Committee, headquartered at the Bank for

International Settlements in Basel, was built up to upgrade monetary steadiness by improving

the nature of banking supervision around the world, and to fill in as a discussion for standard

collaboration between its part nations on banking supervisory issues.

Before beginning we should get the lexicon importance of standards "An acknowledged

standard or a method for carrying on or accomplishing things that a great many people concur

with” In straightforward words, we can say that a standard acknowledged by the worldwide

financial framework is the Basel Accords. Now the question emerges as to whose models

banks need to pursue? Why it is expected to pursue? Which benchmarks to pursue? This is

where the Basel Committee comes to place. The Basel I was introduced in the late 1980’s

focussing primarily on the credit risk which was revised in the mid 1990’s and was called

Basel II but its implementation was delayed to 2008, indicating that it was already out of

date. But it had overcome the flaws that was Basel I. This paper focuses on these regulations

that are implemented by the Basel Committee.

The current regulation regime with Basel II and Basel III:

Basel I mainly focussed on the credit risk of banks i.e. to maintain minimum capital which

was at a fixed rate of 8%. The safety and adequacy destinations for the financial system

cannot be accomplished exclusively through minimum capital requirement. The Committee

underlines that the New Accord comprises of three commonly strengthening pillars –

minimum capital requirement, supervisory audit and market discipline. Taken together, the

three pillars add to a more elevated level of safety and sufficiency in the financial framework.

The Committee perceives with extreme duty with regards to overseeing threats and

pg. 5
guaranteeing that capital is held at a level predictable with a bank's risk profile stays with that

bank's administration.

The first pillar manages the progressing upkeep of regulatory capital that is required to

defend against the three significant parts of risks that a bank faces - Credit Risk, Operational

Risk, and Market Risk. As Basel II uses the Standardised and the Internal Ratings Based

(IRB) methodology for the calculation of credit and operational risk respectively which will

return helps banks to maintain a lower capital requirement. This evidently leads to lower

costs for the banks. As the Basel accords also takes into account of the economic risk, this

automatically results in easy disbursement of loans. It likewise changes the manner in which

credit risk is overseen by banks since it will ensure that banks have adequate funding to

confront the operational risk. The other advantage to banks is the advancement of better risk

appraisals framework, prompting an edge over different banks, by concentrating on just those

objective fragments, markets and clients who have high risk and exceptional yield ratio.

The subsequent second pillar: the supervisory audit manages the board of different risks

looked by banks, for example, precise risk, risk identified with technique, notoriety, liquidity

and legitimate issues. It gives banks to check and re-examine their Risk Management System

by building up their very own risk the executives’ procedures to oversee and deal with their

dangers. Supervisors have doled out the errand of assessing and checking on the capital

prerequisite of manages on account concerning the different risks looked by them.

The third pillar: Market discipline revolves around the revelation of different significant data

of banks which encourages advertise members to consider perspectives like risk introduction,

procedures of risk appraisal and capital ampleness kept up by banks. Market order means to

share this indispensable data of banks which is utilized to survey bank execution by market

pg. 6
members like speculators, clients, financial specialists and investigators, different banks and

rating organizations.

Basically, all the three pillars of Basel II standards centres on to give more noteworthy

soundness in the financial framework by guaranteeing satisfactory cash-flow, to oversee risks

looked by banks, exploring the risk administered by Supervisors and sharing the huge data

by method for market revelation.

Basel II system builds the instability of the capital requirement for better of any developing

country. This is on the grounds that the risk assessment procedure and access is less in a

developing nation contrasted with a developed country, where it is effectively tried. In

accordance to Basel II accords, less risk assessment requires increasingly capital sufficiency

to alleviate the risk which may emerge from the benefits. This additionally implies the

operational risk necessity may increment and subsequently the general capital prerequisite of

the bank will be more. This may go about as an obstacle to execute Basel II standards in

certain countries. Numerous nations over the world executed Basel I standards, yet they had

kept up a marginally higher capital than the base necessity of 8%. According to second

mainstay of audit process, supervisor agencies centre on improving the inner risk the board of

banks so they can change to IRB approach, as opposed to actualizing standard methodology

of estimating risk, as other contender banks. In addition, the administrators who are

responsible for review and audit of Basel II norms in banks should plan to check the

adequacy of capital, size, household capital markets, accessibility and exposure of data, level

of estimating and observing the arrangement of loans and losses.

In today’s competitive financial market, central banks are relied upon to be the grapple of

strength and toss a life saver if there should be a rise in occurrence of financial risk. Central

pg. 7
banks are not by any means the only foundations that manage budgetary organizations. States

have made devoted directors to administer insurance agencies and security dealers.

After the effect of the 2008 Global Financial Crisis on banks, Basel III was acquainted to

improve the banks' capacity to deal with stuns from financial pressure and fortify their

transparency and revelation, though Basel III have not been implemented in most countries

yet. The troubles experienced by certain banks during the financial crisis were because of

breaches in fundamental standards of liquidity risk management. The full scale prudential

parts of Basel III are generally cherished in the capital buffer. Both the buffer for example the

capital preservation buffer and the counter-repetitive buffer are planned to shield the financial

division from times of abundance credit development.

But Basel Accords is not the only regulation that needs to be followed. In the fallout of the

2008 Global Financial Crisis, and the disastrous size of administrative failures, much

consideration has been paid to the different frameworks of financial framework guideline at

present in power. Of the aggregate of financial regulations frameworks as of now being used,

"Twin Peaks" has accumulated the most intrigue, and increased across the board

acknowledgment. This strategy is exemplified by guideline by objectives. As the name

recommends, this system involves two controllers, whose objectives are, on the other hand,

fundamental security, and market conduct and customer protection. Examples incorporate

Australia, the Netherlands, Switzerland, Qatar and Spain. Italy, France, and the United States

have demonstrated an enthusiasm for embracing this strategy for financial guideline, the UK

has received "Twin Peaks", and South Africa is all around cutting edge towards selection.

Preferably at this point, a twin peaks model gives equivalent need to financial framework

security, through a different bank prudential controller, as it will market conduct and

customer insurance, through a different purchaser assurance and market direct controller. In

pg. 8
principle at this point, twin peaks expects to protect buyers as energetically as it does to

strengthen the financial system. In times of torment, twin peaks can, in principle, endure

failure of financial firms, given the firm isn't of systemic significance.

The other side of the coin also needs to be looked at before we move forward. The

impediment of executing Basel or any other standard, deals with investment and extra costs

for the banks. The banks so as to be risk aversive, offer more of its interest in government

securities like government bonds, instead of offering credits to small or individual business.

This has come about in adversely influencing the credit disbursement to farming and small

scale ventures

All in all, what does this change mean? One significant takeaway is that the hotly anticipated

"pendulum swing" is presently happening, but in an extremely estimated way. Another is that

fitting of firm supervision is back in style; both from a statutory point of view and in the

manner controllers direct their supervision. Despite the fact that these for the most part give

off an impression of being certain improvements, firms can exploit this moderate

administrative alleviation by keeping up sound risk structures and proceeding to grasp

apparatuses to align chance.

Despite what authoritative changes officials and controllers may make, banking associations

should keep on driving viability and efficiencies over their risks and compliance programs so

they can meet material laws, guidelines, and supervisory expectations.

Banks may differ from other companies in terms of systemic risk, but they too are profit

making organizations and want to maximise their return. But how can they do so in this

current regulation regime? What are the strategies that banks can implement?

pg. 9
Strategies to maximise return from lending products:

Perfect market theory holds that there is an immediate connection between risk and return:

the higher the risk related with an investment, the more prominent is the return on

investment. This is instinctive: when we pick investment that we believe are progressively

risk, we normally hope to be remunerated with more significant yields.

Regrettably, this is not the case here and needs to face accordingly with different strategies to

maximise our return on different investments. This paper discusses such strategies that can be

followed.

Investing in educating the loan officers:

The home loan industry is dynamic — rules change, disclosures requirement are refreshed,

new items become accessible. With regards to shutting down a loan, information is control. A

learned loan official is bound to pick up the certainty of a borrower. They won't pass up a

deal since they are new to a credit program. Also, productivity is picked up when a

borrower's application is submitted accurately and streams easily through the pipeline. New

exposures, extra guaranteeing, and extensive discussions with a borrower would end up in

disrupting the processing system. The time spent in preparing new credit officials is a wise

speculation. Anticipating mistakes and false impressions is substantially more productive —

and less expensive — than rectifying them.

Analysing the life time value of borrowers’ base:

In the financial business, one of the most noteworthy indicators of benefit is the lifetime

estimation of clients. The following is a chart demonstrating the arrival on value (ROE) on a

business loan. The diagram demonstrates the normal ROE on the loan with various loan

pg. 10
terms. Short term loans will in general be less beneficial due to the forthright expenses related

with sourcing, endorsing and booking a credit.

Chri

s Nichols (August 29, 2018) Important Things for Banks to Improve Commercial Customer

Profitability (online) Available from:https://csbcorrespondent.com/blog/3-important-things-

banks-improve-commercial-customer-profitability.[Accessed on 15 October 2019)

Be that as it may, the same loan turns out to be progressively beneficial after the sunk and

forthright expenses are brought about, and afterward income proceeds on autopilot. As the

loan turns out to be progressively prepared, the principal is likewise diminished

simultaneously the property as well as business is bound to appreciate. This makes a more

noteworthy guarantee pad later in the credit along these lines diminishing the risk for the

bank. Banks ought to make items and methodologies that stretch the normal existence of the

customer association with the bank. There are numerous approaches to do this – including,

business loan prepayment arrangements, assignable and assumable loan structures, treasury

management items, mobile banking. One great beginning stage is to rethink hesitance to

longer-term commitment terms. The normal existence of a five-year credit is just a few years,

well underneath the ideal ROE level as appeared in the chart above.

pg. 11
Commercial lenders as stakeholders:

To get the most incentive from loan specialists, banks must adjust the moneylenders'

objectives to the bank's objectives. Loan specialists ought to be incented with the objectives

that the bank is focusing on and the higher the accomplished objective for the bank, the

higher the motivating force for the moneylender. The bank's objectives might be founded on

income, productivity (estimated as profit for resources, return on value, or investor worth

included), or some other emotional objectives like help or relationship esteem. Whatever the

picked objectives may be, loan specialists must be redressed (either fiscally or something

else) to augment these objectives. When both the party’s objectives are aligned together, it

boosts the commercial profitability.

Expanding the window for historical credit analysis:

Most credit officials agree that the past can anticipate the future and that is the reason banks

investigate past financial system. Many researchers concur that chronicled information stays

a suitable method to estimate future execution. Notwithstanding, it is the place you take a

gander at the past that is the most crucial.

In current time, banks usually only look back at three financial years to analyse a borrower’s

performance. In contrast, this is actually does not show the true picture. The borrower’s

performance should be examined in the last recession. For example, how the borrower fared

in the Global Financial Crisis. If a borrower, performed well in that period he/she would be a

great credit today.

Strategies to maximise return will always conflict with the objectives of any regulations. This

is what happens when an unstoppable force meets an immovable object.

pg. 12
Conflicts that arise due to the different objectives of the regulators and banks:

The financial framework is exceptionally mind boggling, and specialists face numerous

difficulties in managing and administering finance. Poor guidelines can force pointless

expenses, make unreasonable impetuses, decrease straightforwardness and even increment

risks.

Endogenous risk is the risk created and strengthened inside the financial markets by the

association of market members, rather than exogenous risk which alludes to stuns that

originate from outside the financial framework.

Some prudential guidelines, particularly those tending to risk taking, can legitimately build

endogenous risk. This happens precisely on the grounds that the guidelines target avoiding

over the top risk taken by banks, accordingly anticipating huge misfortunes or even

insolvencies. This is once in a while alluded to as smoothing the road. Diminishing extreme

risk is a commendable objective yet can be hard to execute by and by, and guidelines

targeting containing risk taking may have the unreasonable outcome of really expanding

danger.

From a probability point of view risk is very hard to quantify. Along the line, banks have a

motivating force to under-report risk. If everything is perceived to be running smoothly, risk

is concluded to be low; this makes banks impetuses to go for more risk. Since all things

considered, if everything is sheltered, what is wrong in taking up a little more risk. The

problem here is risk taking is not promptly visible, it is only realised in a later date. For

instance, it was not a decision take which immediately resulted in the Global Financial Crisis,

rather it was due to decisions taken before in the low risk phase (2003-04) which resulted in

the crisis. In Layman’s term, smoothing the road is pro-cyclical, urging banks to go out on a

limb when things are great and too little risk when things are bad.

pg. 13
A specific issue emerges on account of the motivations of banking administrators. At the

point when the financial framework is working admirably without any feature collapse, the

administrators are probably not going to get a lot of credit while bankers and even legislators

whine about inordinate administrative weights on this profitable economic venture. In the

event that, at that point a major failure happens, the leader of the supervisory office may

confront sharp hearings in the country's parliament and be pilloried in the press. All things

considered, the chief had all the data about the bank however didn't follow up on it to

forestall disaster.

There is a threat that the motivating forces of supervisors are to anticipate fiasco no matter

what and, subsequently, for the supervisors to turn out to be also risk-averse. This implies the

motivating force issue of the manager is reverse to that of the investor.

Financial regulations change the conduct of banks, as a rule in a positive way; risk is

decreased and the framework turns out to be increasingly steady. In some unreasonable cases,

the result can be the inverse. This may happen in light of the fact that guidelines drive risky

ventures under the radar. The banks proceed as in the past, yet with less oversight. A case of

this is shadow banking.

The targets of banking regulations aren’t to guarantee that banks don't violate the law, rather

which they don’t carry on such that damages society, and help in financial advancement. This

implies there is a threat of a too much legalistic or standard way to deal with banking

guidelines, frequently alluded to as tick-the-box guidelines.

But behind every dark cloud is a silver lining. There is place for improvement and so that

both regulations and profit maximization are in a balance. "The rules-based approach"

includes building up itemized leads and applying them to individual cases. Then again, "the

principles-based approach" is where a few key standards are expressly expressed in order to

pg. 14
support wilful endeavours by financial institutions in accordance with such standards. It is

imperative to guarantee the viability of the whole financial regulation through an ideal mix of

these two approaches. We are available to dialog with pertinent gatherings as to discover how

to join these two approaches.

Another strategy would be by empowering intentional endeavours by financial institutions,

and putting more prominent accentuation on incentives for them. The methodology toward

progressively motivating force similarity and more noteworthy accentuation on intentional

endeavors has just been fused to a critical degree in the administrative structure, for example,

the Financial Inspection Rating System, Basel II and the Relationship Banking structure for

local banks. Deliberate endeavors of monetary foundations are winding up progressively

pivotal as the money related segment is moving into another stage, so we mean to give

ceaseless consideration to the adequacy of such systems.

Another improvement can be in the acknowledgment of the regions where potential dangers

exist in financial framework at the earliest and the compelling distribution of assets to these

regions in order to address such critical issues. So as to do this, it is important to screen

financial aspects and markets and to comprehend as precisely as conceivable, the systems and

activities of financial institutions, notwithstanding leading serious correspondences with

financial institutions and market members.

Conclusion:

The current system of regulating and supervising global financial markets is principally an

issue managed by national authorities. To a constrained degree guideline is orchestrated by

the Bank for International Settlements (and its Committee on Banking Supervision), the

International Organization of Securities Commissions, and the International Association of

Insurance Supervisors. The effect of universal controllers is constrained. Adoption of

pg. 15
internationally agreed regulation is wilful and national supervisors may cease from going

along in light of the fact that they accept that national conditions warrant an alternate

methodology. In addition, national supervisors are probably going to ensure national

interests; they are enticed to loosen up implementation of globally agreed principles if

dangers can be moved to different locales. Domestic financial markets and national

supervisors have a typical enthusiasm to cover the presentation of high risks.

This paper examines and portrays the comprehension of Basel II standards and its effect on

the banking System. The abridged learning centres around the positive and negative effect of

embracing Basel Accord on the banks in countries. It traces that despite the fact that there are

a couple of escape clauses in the Basel II system which has a few negative marks; however it

has far longer rundown of advantages which exceeds every one of the weaknesses and

straightforward procedures that banks can convey to promptly reinforce return, make

increasingly beneficial connections and diminish credit risk.

Henceforth, executions of Basel accords or any other system by banks in different countries

have brought about better execution of banks, benefiting all its stakeholders.

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Chris Nichols (29 August 2018) ‘3 Important Things for Banks to Improve Commercial

Customer Profitability’ [online] Available from: https://csbcorrespondent.com/blog/3-

important-things-banks-improve-commercial-customer-profitability [Accessed on 13 October

2019]

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pg. 17
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pg. 18