Why has the growth in international banking continued despite a reduction in regulatory constraints?

Content

Abbreviations

1. Introduction

2. The Transformation of International Finance

3. Third-Market Trading
3.1. EuroDollar Market

4. Why Growth Continued
4.1. Globalisation
4.2. Technological Changes
4.5. Financial Innovation
4.4. Deregulation

5. Recent Changes in Regulation

6. Future Markets insuring Continuative Growth

7. Compendium

Bibliography

Appendices

Abbreviations

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1. Introduction

Financial liberalization has caused a jump in volatility and risk in the past.

Examples are: the 1994-1995 Mexican peso crisis and the 1997 Asian crisis. Due to international interdependencies the Asian crisis i.e. dragged down the Russian and Brazilian economy. Both crises resulted from inadequately monitored large-scale flows of private, short-term capital (Bank for International Settlements 1998).

Furthermore the opening of national capital markets in many countries led into financial sector crisis. Cost of such crisis can reach 3 per cent to 25 per cent of GDP.

The United States Savings and Loan crisis cost the world’s strongest economy 3 per cent of GDP. Japanese loan crises cost the economy an immeasurable amount of money, the absolute loss in smaller countries can even be bigger. Recent cases include i.e. Venezuela, 18 per cent; Bulgaria, 14 per cent; Mexico, 12-15 per cent; Hungary, 10 per cent. Other cases of even weaker economies like Argentina, Chile and Côte d’Ivoire have experienced costs of over 25 per cent of GDP in their crises (Goldstein, Turner 1996). Another trend was recognizable 20 years ago, due to deregulation the banks noticed increasing competition followed by lower margins. That is why many banks started to bank global. Not only to stay into the increasing competition had they followed their global going customers on foreign markets. Owing to the increasing need to hatch back the rising risks of dealing in foreign currencies, the volume of derivatives trading increased enormously. Many “rough traders” have seen their way to easy, quick money. One of them was Nick Leeson of Bearings ruining his company on the SIMEX exchange in Singapore. Due to this globalisation of banking, technological change and an increasing range of financial instruments and products the banking sector continued growing.

2. The Transformation of International Finance

Many companies stared to use their experience on domestic markets to go global and to gain economies of scale in the second half of the last century. Examples for this trend are i.e. MercedesBenz becoming Daimler-Chrysler and later acquiring MitsubishiMotors to gain retail channels in Asia.

The problem for their financial partners at this time was that they, in many cases, were not that experienced enough to become fullservice financial firms. As seen in the experience of many commercial and merchant Banks.

The growing scale of cross border banking forced the transformation of in the complex set of national controls on foreign currency transactions and regulations.

During the second half of the last century banks recognized a major changed set of economic circumstances. The 1970s and early 1980s brought record rates of inflation, record levels of interest rates, and the worst recession since the 1930s. Conversely, one of the key factors for banks to go over seas was the increasing saturation of their domestic markets. These economic factors collided with the more aggressive, more risk exposed posture of the banking industry coming into the 1970s. The result was a grater number of bank failures and increased concern about the soundness and safety of the banking system. During the 1960s, the trend was toward a relaxation of the regulatory constraints on the banking industry imposed in the aftermath of the depression experience of the 1930s. This changed in 1970s, toward more emphasis on the need for stricter supervision of banks and bank activities in the light of the problems of financial markets and the economy. Concern about the soundness of banks and thrift institutions conflicts with the general trend toward deregulation in the financial system and the economy (Horvitz, Ward 1983)

3. Third-Market Trading

An economic analysis of off-board trading of New York Stock Exchange (NYSE) -listed stocks shows that high commission rates were an incentive for third-market trading (Hamilton 1987). Even if this problem has been recognised by the Securities and Exchange Commission (SEC) and the Congress, what forced to deregulate all exchange commissions after May 1st, 1975 the impact on reducing off-board trading did not occur. In his 1987 paper Hamilton discusses some more reasons fostering off-bard-trading: Such as better circumstances for block trading, satellite risk and the rules of the NYSE.

Another problem according to Pilbeam (2005) is the overall competitiveness financial firms around the world are acting in.

Therefore markets are especially keen to avoid heavy-handed regulations which can drive businesses away to other markets that adopt a more light-handed approach. This is one of the lessons of the development of the Eurodollar market where US regulations clearly stimulated the development of the market. "Many investors are not bothered whether an issue is global or not as long as it is liquid, so there is not so much incentive for borrowers to go through the costly procedure of getting SEC registration," says John Fleming, global head of syndicate at Credit Suisse First Boston.

3.1. EuroDollar Market

Eurodollars are deposits in US Dollars at banks headquartered outside the United States, or in foreign branches of banks headquartered within the United States. There is absolutely nothing "European" about Eurodollar deposits; a US dollar-denominated deposit in Singapore or Delhi would also be Eurodollar deposits. The deposits normally are very large and mostly involve deposits placed by one financial institution with another. Therefore, the Eurodollar rate shows quite accurately bank's cost of funds. Maturities are ranging from one day to six months; there is some very light trading that may run out as far as five years.

Even if being paid on deposits booked elsewhere in the world, the Eurodollar rate is driven primarily by the American economy. This is because it represents an interest rate paid on US dollar- denominated deposits. When the Fed tightens (or is expected to tighten, within the lifetime of the deposit) the Eurodollar rate goes up, and when the Fed eases (or is expected to ease) the Eurodollar rate goes down.

"Asian investors and central banks have started to buy the sector again," says Tom Ineke, head of syndicate at UBS Warburg. "Many people thought that the Eurodollar market was going to die in 2001 and the year before, but last year saw decent issuance and we have seen some very keenly priced transactions go very well." Due to renewed participation by institutional accounts, the Eurodollar market became fertile ground for frequent issuers such as the European Investment Bank, Kreditanstalt für Wiederaufbau, the Inter American Development Bank and the World Bank (Richards 2003).

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