UGB322 International Banking

UGB 322 - International Banking
Nguyen Thi Kieu Anh - ID. 149078874/1

1

ASSIGNMENT COVER SHEET

UNIVERSITY OF SUNDERLAND
BA (HONS) BANKING AND FINANCE
Student ID: 149078874/1
Student Name: Nguyen Thi Kieu Anh
Module Code: UGB 322
Module Name / Title: International Banking
Centre / College: Banking Academy of Viet Nam
Due Date: 15th May 2015

Hand in Date: 15th May 2015

Assignment Title: Individual assignment

Students Signature: (you must sign this declaring that it is all your own work and all sources
of information have been referenced)
Nguyen Thi Kieu Anh


UGB 322 - International Banking
Nguyen Thi Kieu Anh - ID. 149078874/1

International Banking
UGB 322

Nguyen Thi Kieu Anh - ID:149078874/1
Submission date: 15th May 2015

Number of words: 3,300

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UGB 322 - International Banking
Nguyen Thi Kieu Anh - ID. 149078874/1

TABLE OF CONTENTS
Part A ........................................................................................................................................ 4
I. Introduction ........................................................................................................................... 4
II. Main Body ............................................................................................................................. 4
1. Income opportunities available to international banks ...................................................... 4
2. International banks operations in foreign markets to maximize shareholder value ........... 5
2.1 The reasons that banks move to abroad ....................................................................... 5
2.2 Organizational mechanisms for carrying on international banking ............................. 7
2.3 Shareholder value maximization.................................................................................. 7
2.4 Determinants of bank operations in international market ............................................ 8
III. Conclusion ........................................................................................................................... 9
IV. References.......................................................................................................................... 10
V. Appendices .......................................................................................................................... 11
Part B ...................................................................................................................................... 13
I. Introduction .......................................................................................................................... 13
II. Main body ........................................................................................................................... 13
1. The need for regulating international banks .................................................................... 13
2. Regulations applied to international banks ...................................................................... 14
3. Difficulties in regulating international banks .................................................................. 14

4. International banking regulation reform .......................................................................... 15
III. Conclusion ......................................................................................................................... 17
IV. References.......................................................................................................................... 17
V. Appendices .......................................................................................................................... 19

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UGB 322 - International Banking
Nguyen Thi Kieu Anh - ID. 149078874/1

Part A: Discuss the income opportunities available to international banks and critically
evaluate international banks operations in foreign markets to maximize shareholder
value
I. Introduction
International banking refers to banking services undertaken across borders (Hagendorff,
2010, p.16). By approaching various markets and offering wider range of financial
services, international banks have more chances to generate profit as well as maximise
shareholder value. In order to understand deeply about this, this study aims to discuss the
income opportunities available to international banks and evaluate international banks
operations in foreign markets to maximize shareholder value.
II. Main Body
1. Income opportunities available to international banks
In international environment, banks have four principal sources of revenues, namely net
interest income (from loans), net fees and commission income (income from setting up
deals, providing advice and services), net trading income (from currency and financial
instruments), and investment income (from associates or subsidiaries) (Fight, 2004, p.7).
An example is given from income statement of Barclays bank as follows:

Figure 1: Consolidated income statement of Barclays PLC (Barclays, 2010, p.187)



Net interest income (NII): NII is the difference between interest income and interest
expense: a primary indicator of a bank’s ability to generate profit on its primary
business (Fight, 2004, p.118).
Net interest income (NII) = Interest income - Interest expense
Interest income arises from the loans and represents the largest source of revenue.
International banks offer the loans to both domestic and international clients in a

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UGB 322 - International Banking
Nguyen Thi Kieu Anh - ID. 149078874/1

range of currencies and maturities. One of the special services of international
banking is syndicated lending. In a syndicated loan, two or more banks jointly lend to
a business with big amount of money, typically exceed £50 million, which would be
too risky to underwrite by a single lender (Hagendorff, 2010, p.29). Interest expense
usually involves the amount of money (interest) that banks paid to depositors for the
use of their money.


Net fees and commission income: Fees and commissions are an increasing important
source of income. International banks get the front-end fees for the arrangement of
syndicated loans and the fees on issuing letters of credit (L/C)1, documentary
collections (D/C)2 to avoid risk of non-payment between trading partners (importers
and exporters who engaging in international trade). They get the commission on
factoring that allows exporters sell their receivable to the bank (forfaiter) at a discount

to meet its present and immediate cash needs. Besides, there are many others fees and
commissions such as underwriting commissions, commissions on selling securities to
investors, mergers and acquisitions advice and so on (Fight, 2004, p.120).



Net trading income: It includes trading profits from the bank’s operations in
securities, investments, and sometimes treasury operations. The major part of trading
income is foreign exchange or FX trading (Derivatives for hedging, namely forwards,
futures, options, swaps), but can also include income from trading in bonds,
certificates of deposit, treasury bills, and other marketable securities (Fight, 2004,
pp.119-120).



Investment income: Interest and dividends earned on securities held as investments.
Income from associates is fairly common among European and Asian banks but less
so with US banks due to historical US banking restrictions on crossing state
boundaries and on investing in non-banking subsidiaries (Fight, 2004, p.120).

2. International banks operations in foreign markets to maximize shareholder value
2.1 The reasons that banks move to abroad
Banks move to abroad for a variety of reasons but the biggest motive is to seek growth or

1

A commitment by a bank on behalf of the buyer that payment will be made to the beneficiary (exporter)
provided that the terms and conditions have been met, as verified through the presentation of all required
documents (Mizan, 2011, p.247)
2

International bank acts as intermediaries between importer and exporter by stipulating the term and conditions
under which the importer gains title to the goods purchases (Hagendorff, 2010, p.46)

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UGB 322 - International Banking
Nguyen Thi Kieu Anh - ID. 149078874/1

profit. In fact, when domestic banking system is mature, competitive and overly
regulated, approaching new potential market can offer better opportunities for growth
than domestic market Indeed, there are some evidence shows that it is very difficult for
domestic banks as well as foreign banks can earn profit in such a market. For example,
Stijin Claessens, Asli Demirgiic-Kunt, and Harry Huizinga examined the behavior of
banks in eighty mature and emerging markets in the period of 1988 to 1995 to investigate
how profitability differed between foreign and domestic banks. The results showed that
foreign banks were found to have higher profitability than domestic banks in emerging
markets, while the opposite was true in mature markets (Litan et al., 2001, p.34). That is
also the reasons why banks have a tendency to move to developing countries more than
developed countries. By going international, banks can offer wider range of products and
services, access new customer base and benefit from their brand awareness, economies of
scale, and lower their risk through increased opportunities for diversification (G20, 2008,
p.262). Specifically, providing products and services in multiple countries reduce the
bank’s exposure to possible economic and political instability in a single country
(Acevedo, 2015). Financial liberalization and the globalization of finance are the second
motive for banks to move abroad. Before the 1990s, the liberalization and adoption of the
market economy that have occurred worldwide together with the globalization tendencies
have led to deregulations in the financial markets. One specific outcome is abolishing the
restrictions on the entrance of foreign banks into the local banking system. Thus in 1990s,
foreign banks have started to display their presence in the national economies (KÖSE,

2009). Competitive advantage is also an important factor in driving the decision of banks
from specific countries to enter specific countries. Competitive advantages mentioned are
managerial expertise, technological know-how, sizeable capital and superior products and
services, marketing techniques which will outweigh the costs associated with foreign
market entry (costs of adapting to new regulatory environment and different customer
demand) (Hagendorff, 2010, p.26). Last important motivation mentioned is ‘follow the
customer’. In order to prevent multinational corporations from soliciting these local or
other foreign competitors, banks are impelled to follow the client by moving abroad
themselves in order to defend their unique bank-client relationship (Wezel, 2004, p.7).
Further, multinational firms may face additional incentives to continue banking with their
home market institution in case they find it harder to borrow funds from local banks in
their host market (Hagendorff, 2010, p.28).

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UGB 322 - International Banking
Nguyen Thi Kieu Anh - ID. 149078874/1

2.2 Organizational mechanisms for carrying on international banking
When a bank decides to enter a foreign location, it needs to determine the form of
representation. Representative office, agency, brand and subsidiary are generally
available organizational forms for the bank. Each of them involves different level of
investment, as well as allows offering a different range of banking services. The
representative office is the most economical of overseas banking organizational forms. It
is relatively inexpensive to establish but these offices are not allowed to participate in the
typical banking activities (Blandón, 1998, p.2). Agency requires a higher investment and
provides advantages over representative offices in that they can conduct transactions but a
certain limit. A foreign branch overcome the demerits of the above two modes. They can
offer a full range of banking services, with restrictions on regards access to liquidity

provision in the event of distress. However, the branches are not separate entities from
their parent unit. The parent unit has a full control over the functioning of the branches so
the branches have access to the full support, credit rating and capital base of the parent
(Sharan, 2012, p.351). Bank subsidiary can engage in a full range of banking activities
but the main difference makes it relatively costly compared to branch is that it needs to be
capitalized separately from the parent bank (Hagendorff, 2010, p.24). Establishing
representation offices can protect shareholder wealth as it is more risk averse, involves
less sunk costs. However, in fact banks tend to establish branches and subsidiaries abroad
in expectation of increasing shareholder wealth. For instance, U.S banking organizations
conduct most of their international activities through foreign branches and subsidiaries, in
which they conduct an estimated 60 percent of their international business through
foreign branches (Houpt, 1999, p.601).
2.3 Shareholder value maximization
Shareholder value maximization implies that the ultimate goal of business is to enrich
shareholders by increasing returns in the form of dividends and/or capital appreciation
and banking industry is no exception (Hall, 2015). Going abroad is one of the strategic
plans helps banks increase shareholders wealth. However, in order to achieve such thing,
banks need to make wise investment. Each market, each country may have different
economic environment, different level of financial system structure and different social
characteristic, therefore, foreign banks seem to thoroughly consider and evaluate cost and
benefit of each market to find the market where the underlying conditions are favorable.
For example, although China’s CPI is really high and the inflation rate is higher than the

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UGB 322 - International Banking
Nguyen Thi Kieu Anh - ID. 149078874/1

actual saving interest as a result of the non-maturity economy. Foreign banks still choose

China because Chinese economic began to take off since China’s reform and opening-up.
Especially after 2001, China have join into WTO, Chinese economic construction is
further developed and the cooperation with foreign partners was getting closer and closer
through the keeping opening up on different industries. The foreign banks come to China
in order to retain the customer resources that are searching for overseas investment
opportunities. Another reason for foreign banks access is to strive for the enormous
market opportunities in China. There are a large number of wealthy residents
accompanies by Chinese economic development (refer to appendix 1) (Zhao, 2009, p.24).
Foreign banks also recognize the challenges they face in these markets, therefore, they
make more efforts to enable success by investing in technological innovation and in
people (EY, 2014, p.28). Citibank was the first foreign bank in China to launch the smart
banking model. Citi Smart Banking branch comes equipped with media walls, interactive
kiosks and work benches to enable customers to surf through information, learn about
products and services and conduct transactions within a few minutes (Citi, 2015). HSBC
focuses on training local talent into experts with both banking and international
experience which will become key human resources for HSBC in the future. Currently
they employ about 5,500 staff, around 98% of whom were recruited locally (HSBC,
2009). Besides, banks utilizes Eurocurrency market3 to reduce the cost of capital and
minimize the risk as this market can avoid strict regulations imposed on the banking
system such as interest rate ceilings and strict reserve requirements and most of the
lending in the Eurocurrency market takes the form of syndicated lending (Hagendorff,
2010, p.32).
2.4 Determinants of bank operations in international market
International bank operation is also affected by many risks. Due to the limitation of the
study purposes, this study only mentions about country risk, operational risk and market
risk.


Country risk is the probability that political, social and economic conditions in the
foreign country which will affect the commercial operations of the foreign bank.

Country risk events could include political unrest, increases in corruption
(Hagendorff, 2010, p.68). In order to mitigate country risk, banks need to capture

3

The Eurocurrency markets offer wholesale foreign exchange transactions (loans, deposits) involving residents
and non-resident

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UGB 322 - International Banking
Nguyen Thi Kieu Anh - ID. 149078874/1

changes of the market in each period to give appropriate strategy at the right time.
For example, Standard Bank Group employed internal rating models to assess and
manage its country risk exposures (refer to appendix 2) (Standard Bank, 2013, p.56).
Besides, banks should start operation with low risk products and services first until
they operate stably in host countries. Especially they can purchase political and
commercial risk insurance to be more safety.


Operational risk is defined at the risk of loss resulting from inadequate or failed
internal processes, people and systems or from external events (Hagendorff, 2010,
p.67). To anticipate, mitigate and control operational risk, bank should have a system
of policies and establish a consistent framework for monitoring, assessing and
communicating risks. Citi bank has established a “Manager’s Control Assessment”
program to help managers self-assess key operational risks and controls and identify
and address weaknesses in the design or effectiveness of internal controls (Citigroup,
2013, p.119).



Market risk is the risk of losses overtime due to a number of risk factors such as
changes in interest rates, currencies, and equities. It can be understood as a form of
trading risk. Even banks which are completely focused on lending activities may be
exposed to market risk. If a particular bank has lent heavily to hedge funds (its
business engage in investing a wide range of market instruments such as stocks or
derivative securities), the bank becomes indirectly exposed to market risk because
those loans may not be repaid if the prices of the stocks or derivative securities held
by hedge funds decline substantially (Hagendorff, 2010, p.66). Commonly, banks
measure their exposure to market risk by applying the value-at risk (VaR) method. If
a bank determines that its exposure to market risk is excessive, it can reduce its
involvement in the activities that cause the high exposure. For example, it could
reduce the amount of transactions in which it serves as guarantor for its clients or
reduce its investment in foreign debt securities that are subject to adverse events in a
specific region. Alternatively, it could attempt to take some trading positions to
offset some of its exposure to market risk by selling some of its securities that are
heavily exposed to market risk (Madura, 2008, pp.537-538).

III. Conclusion
Through the analysis above, it is obvious that international bank can generate a lot of
profit and each bank has its own way to penetrate and maximize shareholder value in

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UGB 322 - International Banking
Nguyen Thi Kieu Anh - ID. 149078874/1

international environment. However, all banks face many risks that require bank give out
methods and solutions to manage the business operations for the purposes of existing in
fierce competitive market.
IV. References
Acevedo, L. (2015) Why Do Companies Go International?. Available at:
(Accessed: 26
April 2015).
Barclays (2010) Financial Statements. Available at:
(Accessed:
25 April 2015).
Blandón, J.G. (1998) 'The Choice of the Form of Representation in Multinational
Banking: Evidence from Spain', Economics Working Paper 271 , pp.1-17.
Citigroup (2015) Citi’s Smart Banking named Service Channel Innovation by IDC
Financial Insights. Available at:
(Accessed: 27 April 2015).
Citigroup (2013) Annual Report 2013. Available at:
(Accessed: 29 April
2015).
Claessens, S. and Horen, N. V. (2008) 'Location Decisions of foreign banks and
institutional competitive advantage', DNB Working Paper No.172, pp.1-32.
EY (2014) Banking in emerging markets: Investing for success. Available at:
(Accessed: 27 April 2015).
Fight, A. (2004) Understanding International Bank Risk. England: John Wiley & Sons
Ltd.
G20 (2008) Competition in the Financial Sector. Available at:
(Accessed: 26 April 2015).
Hagendorff, J. (2010) International Banking UGB 322. United Kingdom: University of
Sunderland.
Hall, R. (2015) Assignment Revision, [Lecture to International Banking UGB322].
University of Sunderland.

Houpt, J.V. (1999) International Activities of U.S. Banks and in U.S. Banking Markets.
Federal Reserve Bulletin, pp.599-614.
HSBC (2009) HSBC Bank (China) Company Limited. Available at:
/>Jan09.pdf (Accessed: 27 April 2015).

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UGB 322 - International Banking
Nguyen Thi Kieu Anh - ID. 149078874/1

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KÖSE, A. (2009) Foreign bank presence and domestic bank performance in Turkish
banking system. Available at: (Accessed: 26 April 2015).
Litan, R. E., Masson, P. and Pomerleano, M. (2001) Open Doors: Foreign Participation
in Financial Systems in Developing Countries. Washington, D.C.: Brookings Institution
Press.
Madura, J. (2008) Financial Institutions and Markets. USA: Thomson Higher Education.
Mizan, A.N.K. (2011) Factoring: a Better Alternative of International Trade Payment
methods. ASA University Review, 5(2), pp.247-64.
Naaborg, I.J. (2007) Foreign bank entry and performance. The Netherlands: Eburon
Academic Publishers.
Sharan, V. (2012) International Financial Management. New Delhi: PHI Learning
Private Limited.
Standard Bank (2013) Risk and capital management report and annual financial
statements 2013. Available at:
/>(Accessed: 29 April 2015).
Wezel, T. (2004) 'Foreign Bank Entry into Emerging Economies: An Empirical
Assessment of the Determinants and Risks Predicated on German FDI Data', Discussion

Paper Series 1: Studies of the Economic Research Centre.
Zhao, L. (2009) The motivation and impact on the foreign banks entrance in China.
Master thesis: Lund University.
V. Appendices
Appendix 1

Figure 1: China’s GBP growth from 1997 to 2007

Figure 2: China’s FDI growth from 1997 to 2007

Figures above showed that both of China’s GDP and FDI have dramatically increased
especially after 2001 that China entered into WTO (Zhao, 2009, pp.25-26).


UGB 322 - International Banking
Nguyen Thi Kieu Anh - ID. 149078874/1

Appendix 2

Figure 3: Country risk exposure by region and risk grade

The model inputs are continuously updated to reflect economic and political changes in
countries. The model outputs are international risk grades that are calibrates to a country
risk grade (CR) from CR01 to CR25. Countries rated CR08 and higher, referred to as
medium- and high-risk countries, are subject to increased analysis and monitoring
(Standard Bank, 2013, p.56).

Figure 4: Top five medium- and high-risk country risk

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UGB 322 - International Banking
Nguyen Thi Kieu Anh - ID. 149078874/1

Part B: Critically discuss the challenges regulators face when regulating international
banks
I. Introduction
International finance has changed dramatically over the past two decades as all nations
eliminated barriers to cross-border capital flows and opened their domestic markets to
foreign financial institutions (Oatley, 2001, p.36). These changes lead to the emergence
and growth of international banking. Banking no longer be regarded as traditional financial
intermediaries (take deposits and make loans), having become intermingled with other
financial activities, including securities business. Such thing poses formidable problems
for bank regulatory authorities who have to cope not only with a riskier banking system,
but a banking system whose scope is wide (Dale, 1994, p.1). This study will discuss the
challenges regulators face when regulating international banks.
II. Main body
1. The need for regulating international banks
Of all the financial institutions, banks are heavily regulated especially international banks
which operate cross border and hold a prominent share of the banking market in many
countries. Similar to banks, international banks is also regulated for two main reasons: to
protect customers and to ensure the soundness and stability of the financial system. Indeed,
after the financial crisis over the years, it is concluded that there are two features of
banking system that motivate for the entry of regulation: information asymmetry and
systemic risk. Asymmetric information results in adverse selection and moral hazard
problem. In the context of banking system, asymmetric information occurs between
depositors and banks. Depositors are unable to define the bank holding their deposit is
good or bad bank until they cannot withdraw cash on demand. It causes adverse selection
as customers have little choices and have high demand in holding deposits as means of

payment. Besides, as key player in payment system, banks have incentives to use
mobilizing funds from customers to invest in risky assets to earn profits, which so-called
moral hazard. On the other hand, banks also can be the victims of asymmetric information.
Borrowers have better information about level of risks they engaged when borrowing
money from banks. It is difficult for banks to appraise the investment project of customers
when they intended to hide the risky action. The presence of asymmetric information
lessens confidence of public in banking system. It should be noted that keeping customer
confidence in banking system is important more than ever. Banks operates mainly based

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UGB 322 - International Banking
Nguyen Thi Kieu Anh - ID. 149078874/1

on deposits from individuals and institutions to make loan. If depositors doubts about the
health of bank holding their money, they may rush to withdraw cash from the bank. A
“wholesale run” occurs leading to risk of illiquid and poses a threat to international
banking firms or even collapse in the worst case (Howells and Bain, 2007, p.362). The
failure of one bank causes a loss of confidence in banking in general, creates bad debts for
other banks and widespread collapse (risk of contagion or systemic risk) as the result of
the interconnectedness of banking firms via wholesale money markets within national
banking sectors and for international banks across national banking sectors (Hagendorff,
2010, p.98).
2. Regulations applied to international banks
Regulation is both internal and external but principally focuses on two strategies:
prudential regulation and conduct of business regulation. Prudential regulation attempts to
minimize moral hazard. It analyses a bank’s balance sheet for risks such as concentration,
liquidity and capital adequacy. Conduct of business regulation attempts to minimize
asymmetric risk. It examines banks internal operations (products and services offered) and

industry operations (industry business practices such as short-term funding) to encourage
active participation in financial markets and reduce systemic risk (Hall, 2015).
3. Difficulties in regulating international banks
The global financial crisis has recalled the important of accounting in the banking
industry. This is because it influences the level of capital and the measurement and
disclosure of financial institution’s exposure. As yet, there is no single accounting
framework that is universally applied in all jurisdictions (Schwarz et al., 2014, p.5).
Basically, there are two main accounting frameworks in the world: Generally Accepted
Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).
GAAP is used principally in the United States, and IFRS is used in European Union and
many other countries (Logue, 2015). Having different rules under US GAAP and IFRS
will mean a lack of comparability for investors between the result of banks reporting under
the different frameworks, and increased costs of international banks that have to prepare
figures under both accounting frameworks. It is also a big challenge for regulators to
collect and produce information about banks, which helps them to monitor the safety and
soundness of the banking system (Auditandrisk, 2014). Another challenge for bank
regulators derived from the existence of off-balance sheet entities. Off-balance sheet
banking activities encompass a variety of items including certain loan commitments,

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UGB 322 - International Banking
Nguyen Thi Kieu Anh - ID. 149078874/1

certain letters of credit, and revolving underwriting facilities and derivative instruments
(swaps, futures, forwards, and option contracts) (FDIC, 2004). Such activities earn fee
income by transactions that are not recorded on a bank’s balance sheet (Hassan et al.,
1993, p.69). Because off-balance sheet assets and liabilities were not included in financial
statements, bank took leveraged positions that were hidden bank risk from regulators and

investors. Since regulators use the balance sheet as an anchor in their assessment of bank
risk, they fail to provide a clear picture of the financial health of banks. Especially banks’
off-balance sheet operations have grown rapidly in recent years, for example, in Germany
alone, the trading volume has risen by more than thirty times since 1986 (Bundesbank,
1998, p.65). As a result, the risks of off-balance sheet could lead to sudden liquidity
squeeze or surprise losses and cause of financial crisis in the worst case (Partnoy et al.,
2015).
Internal risk models have been increasingly used in the past years for ‘external purposes’:
communicating information about an institution’s risks to creditors, shareholders,
regulators, or rating agencies. The regulation of banks in particular relies heavily on
internal models to compute capital requirements more in line with a bank’s risk because
the most accurate information regarding risks is likely to reside within a bank’s own
internal risk measurement and management systems. However, the problem is that bank
reports an internal model to the regulator, who chooses a capital constraint depending on
the report so banks tend to hide information and understate its risk and lend more. It leads
to the conflict between regulators and banks. Therefore, bank regulators meet many
difficulties in setting credit risk capital requirements (Colliard, 2012, p.2). Last difficulty
mentioned is regulatory arbitrage. Cross-country differences in banking regulations may
encourage the flow of bank capital from markets that are heavily regulated to those
markets that are less regulated. This form of regulatory arbitrage suggests there may be a
destructive “race to the bottom” in global regulations which restricts domestic regulator’s
ability to limit bank risk-taking (Houston, 2012, p.1).
4. International banking regulation reform
The presence of national safety net regulations which encompasses deposit insurance
arrangements and the lender of last resort functions can prevent bank run and contagion
but it is not stable for international banks, as national authorities do not incorporate crossborder externalities in their decision making (Schoenmaker, 2013, p.65). Basel Accord is a
solution to the problem arising from the inadequacy of the safety net and considered as one

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UGB 322 - International Banking
Nguyen Thi Kieu Anh - ID. 149078874/1

of the first attempts for international banking regulation. Bank capital is a central element
in Basel Accord. It has two functions: is a cushion that helps to prevent bank failure and
reduce bank moral hazard (Fiordelisi, 2015). The first capital accord was issued in 1988 by
the Basel Committee on Banking Supervision. This system provided for the
implementation of a credit risk measurement framework with a minimum capital standard
of eight percent by end-1992. Since 1998, this framework has been progressively
introduced not only in G-104 countries but also in virtually all other countries with
internationally active banks (Howels, 2010, p.206). The initial proposal was viewed as
overly simple and crude. By attempting to apply a “one size to fits all” policy, the
Committee encouraged substantial arbitrage among risk classes by the banks, which
weakened the effectiveness of the regulations.
Because of this criticism, the Basel Committee began to work on a broader and more
sophisticated capital accord, Basel II (Hall and Kaufman, 2002, p.15). It is adopted in 2004
and stared to implement at the start of 2008 only by European banks. Basel II has three
pillars (the first deals with a banks’ core capital requirement associated with operational
risk - Pillar 1, the second allows for supervisor discretion to adjust this requirement to
allow for additional risk and particular circumstances - Pillar 2, and the third fosters
market discipline - Pillar 3) (ANU, 2015). However, the financial crisis of 2007 to 2009
has revealed many weaknesses in Basel II. Firstly it did not require banks to have
sufficient amount of capital. Secondly risk weights in standardized approach are heavily
dependent on credit rating, which were unreliable in the run-up of financial crisis. Thirdly,
Basel II demands that banks hold less capital when times are good and hold more capital
when times are bad thereby exacerbating credit cycles. Because probability of default and
expected losses for different classes of assets rises during bad times, Basel II may require
more capital at exactly the time when capital is most short. this has been a major concern
after 2007-2009 crisis, bank's capital balances eroded, as a result there was cut back on

lending, doing more harm to economy (Qureshi, 2015).
As a result of this limitation, the Basel committee continued to work on new accord, Basel
III. It is issued in 2010 with the stricter on what constitutes capital (additional capital
requirements like the conversion buffer and countercyclical buffer), introduces a minimum
leverage ratio and creates two new liquidity ratios (the short-term Liquidity Coverage

4

UK, US, Japan, Belgium, France, Germany, Italy, the Netherlands, Spain, Sweden, Switzerland

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Nguyen Thi Kieu Anh - ID. 149078874/1

Ratio - LCR and the longer-term Net Stable Funding Ratio - NSFR) (refer to appendix)
(Acharya, 2012, p.13). On the positive site, this newly toughened capital and liquidity
requirements should made global financial system safer. Unfortunately, enhanced safety
will come at a cost, since it is expensive for banks to hold extra capital and to be more
liquid. As a result, loans and other banking services will become more expensive and
harder to obtain and especially it reduce banks’ returns and increases problem of
regulatory arbitrage. The banking industry argues that Basel III will seriously harm the
economy. For example, the Institute of International Finance (IIF) calculated that the
economies of the US and Europe would be 3% smaller after five years than if Basel III
were not adopted (Elliott, 2010). At the same year 2010, US regulators have introduced the
Dodd-Frank Act focusing on limits on leverage, heightened capital standards, and the
restrictions on certain forms of risky trading (Webel, 2010). Similar to Basel III, DoddFrank Act also have some disadvantages like affecting the cost and availability of credit
and securities lending and borrowing activities, adding uncertainty and complexity to
financial sector as well as increasing regulatory burden especially on small banks, which

weakens its competitive with other financial institutions (Alqatawni, 2013, p.5). Currently,
UK and European regulators are focused on splitting Universial banks. Some respondents
favoured a split because they felt that the ‘too big to fail’ gurantee of universial banks
distorted the market; whilst others argued against a split, for a variety of reasons including
the impact on businesses needing access to a range of complex financial products as well
as basic services (Lovegrove and Rose, 2011).
III. Conclusion
Overall, the regulators face a lot of challenges when regulating international banks. Each
regulation imposed has its own advantages and disadvantages. Therefore, it requires bank
regulators modify and continue researching and capturing changes in international
financial market for the purposes of coming up with creative tools to monitor international
banks more effectively.
IV. References
Acharya, V.V. (2012) 'The Dodd-Frank Act and Basel III: Intentions, Unintended
Consequences, Transition Risks, and Lessons for India', Contemporary Banking in India,
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Alqatawni, T. (2013) The Impact of the Dodd-Frank Act on Small Banks. MPRA Paper
No. 51109.

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ANU (2015) The Structure of Basel II. Available at:
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2015).
Auditandrisk (2014) New standard will have "massive" effect on banks. Available at:
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Bundesbank (1998) Banks' internal management model and their prudential recognition.
Available at:
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2015).
Citi (2015) Citi’s Smart Banking named Service Channel Innovation by IDC Financial
Insights. Available at: />(Accessed: 27 April 2015).
Citigroup (2013) Annual Report 2013. Available at:
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2015).
Dale, R. (1994) Issues in International Banking Regulation: Global Policies for Global
Markets. University of Southampton.
Elliott, D.J. (2010) Basel III, the Banks, and the Economy. Available at:
(Accessed: 03 May
2015).
FDIC (2004) Off-balance sheet activities. Available at:
(Accessed: 01 May 2015).
Fiordelisi, F. (2015) Lecture 2: Bank Regulation and Supervision. Available at:
/>(Accessed: 02 May 2015).
Hagendorff, J. (2010) International Banking UGB 322. United Kingdom: University of
Sunderland.
Hall, M. J. B. and Kaufman, G. G. (2002) 'International banking regulation', Structural
Foundations of International Finance. Halifax, Nova Scotia, 2002.
Hall, R. (2015) Assignment Revision, [Lecture to International Banking UGB322].
University of Sunderland.
Hassan, M. K., Karels, G. V. and Peterson, M. O. (1993) 'Off-Balance Sheet Activities and
Bank Default-Risk Premia: A comparision of risk measures', Journal of Economics and
Finance, 17(3), pp.69-83.
Houston, J. F., Lin, C. and Ma, Y. (2012) Regulatory Arbitrage and International Bank
Flows. HKIMR Working Paper No.15/2012.
Howells, P. and Bain, K. (2007) Financial markets and institutions. 5th edn. London:

Longman.

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Howels, P. (2010) Financial Markets APC313. United Kingdom: University of
Sunderland.
KÖSE, A. (2009) Foreign bank presence and domestic bank performance in Turkish
banking system. Available at: (Accessed: 26 April 2015).
Logue, A.C. (2015) Comparing U.S. GAAP and IFRS Accounting Systems. Available at:
(Accessed: 01 May 2015).
Lovegrove, S. and Rose, N. (2011) Independent Commission on banking: the UK
approach to Glass-Steagall. Available at: (Accessed: 04 May 2015).
Oatley, T. (2001) 'The Dilemmas of International Financial Regulation Consequences of
the 1988 Basle Accord Should Concern Those Who Want More International Regulation
of Financial Institutions', Regulation Magazine, 23(4).
Partnoy, F. and Turner, L. E. (2015) Bring transparency to off-balance sheet accounting.
Available at: (Accessed: 01
May 2015).
Shah, S. (2014) Banking Fundamentals. Available at:
(Accessed: 03 May 2015).
Qureshi, M.U. (2015) Basel Accord: Working and Limitations. Available at:
(Accessed: 03 May 2015).
Schoenmaker, D. (2013) Governance of International Banking: The Financial Trilemma.
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Schwarz, C., Karakitsos, P., Merriman, N. and Studener, W. (2014) 'Why accounting
matters: A central bank perspective', ECB: Occasional Paper Series No.153 , pp.1-35.

Webel, B. (2010) The Dodd-Frank Wall Street Reform and Consumer Protection Act:
Issues and Summary. CRS Report for Congress.
V. Appendices

Figure 1: The comparison of Basel II and Basel III capital requirements (Hall, 2015)

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Figure 2: Differences between Basel II and Basel III requirements (Shah, 2014)

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