7.      INTERNATIONAL COMMERCIAL BANKING   

 

Commercial banks principally provide savings or deposit facilities from which they advance loans and credit to government, corporate entities or smaller and medium sized businesses and households or individuals. These activities tend to be more country based as the banks are dependent on underlying deposit volumes or access to local money markets. Most commercial banks will fund their activities with a proportion of wholesale lending of between 20 and 35%. Many of the institutions that suffered the most difficulties during the global financial crisis, such as Northern Rock and RBS, had considerably larger dependent on short-term wholesale borrowing. Commercial banking can nevertheless still be profitable even on a cross-border basis. Commercial banks manage their payment systems which includes providing cross-border payment facilities for clients in addition to other lending, investment or insurance sales services.

 

(1)    Banking and Banks

 

Apart from the core activities of deposit taking and loan making, commercial banks may also offer a broad range of other financial services, dependent on legislation or tradition of different jurisdictions, at both retail and wholesale levels. Retail banking aims at servicing the general public and small businesses, while wholesale banking is mainly conducted in inter-bank market, with a relatively small number of high-value transactions involved.

 

The range of activities commercial banks may conduct varies from country to country. In some countries, such as US and UK, commercial banks are, either legally or traditionally, separated from investment banks or merchant banks, whose business is mainly concerned with securities underwriting and other related activities. Other countries, especially those in European continent, maintain the pattern of universal banks, which can conduct not only deposit taking and lending, but also securities underwriting as well as a wide range of other activities, such as insurance, asset management and corporate advisory services, etc. Despite of this difference, universal banking is increasingly becoming the international norm, following the deregulation activities and relaxation or removal of legal barriers to it.

 

(2)    International Banking

 

International banking, which means servicing the international requirements of clients such as importers, exporters, or foreign travellers at home and abroad, was originally conducted by commercial banks through establishing ‘correspondent’ relationships with a set of banks overseas. As correspondents, the banks act as each other’s local agent. This form of correspondent relationship still remains one option for banks nowadays that envisages the international operation. With the international economy more integrating, however, commercial banks have established their own presence in overseas markets, that is, multinational banking, which takes a variety of forms, including subsidiary (a separate legal entity), branch (wholly owned by parent banks), agency (similar to branch, but not able to accept local deposits), representative office ( as a point of contact only), or consortium bank (jointly owned by several banks).

 

(3)    Development of International Banking

 

International banking expanded quickly scope and scale during the 1960s with the overseas expansion of many banking groups especially from the US.  The large US banks wish to support their domestic corporate clients and multilateral corporations through the provision of a wide range of services through the establishment of overseas branches and subsidiaries. Many large US banks also moved to London to become involved in the expanding Eurodollar markets. International lending continued to grow during the 1970s and early 1980s with the recycling of funds from oil exporting countries and the rise in borrowing by Western and emerging market economies. An over commitment in these markets led to the international debt crisis beginning in 1982 lead to a slowdown in lending activity following the organised rescheduling or re-structurings that had to take place many under the Paris Club or Rome Club. European and Japanese banks were also closely involved in the expansion of the Eurodollar markets and were subsequently followed by the largest Chinese banks which became among the largest operators in the world.

 

(4)    International Commercial Bank Activities

 

International commercial banks were mainly engaged in trade finance, currency trading and foreign lending.  historically. They were closely involved in the growing Eurodollar market activities which developed in 1960s and 1970s, including specifically syndicated lending and interbank transactions. Commercial banks are the always been dominant players in the international project finance market which has provided funding for many large infrastructure projects across the world. Since 1980s and 1990s, they have also developed a number of further services and innovative products involving alternative sources of financing, global money market operations, global custody and global private banking and wealth management.

 

 

 

(5)    International Banking Regulation 

 

Banking has traditionally been more tightly regulated than most other industries due to its key role to the economy as a whole. Growing concern with regard to the stability of the international financial system has led to a number of multilateral initiatives being taken forward since the early 1970s and 1980s. Most of this work in the banking area has been taken forward by the Basel Committee on Banking Supervision which was established at the offices of the Bank for International Settlements (BIS) in Basel, Switzerland in 1974. The Basel Committee has produced a number of papers in the supervisory and regulatory areas.  These have included its international capital standards originally developed under its first Capital Accord in 1988 (Basel I) has extended in 2004 (Basel II) and then further amended in 2010 (Basel III). The Committee has also issued a number of sets of regulatory principles in core areas following the global financial crisis including on bank governance, remuneration, cross-border resolution, supervisory college supervision and wider macro-prudential oversight.

 

The Committee had originally worked on and agreeing a series of principles governing the supervision of internationally active banks on a cross-border basis.  These provided for the allocation of supervisory functions between the parent and host authorities and for the exchange of information, co-operation and coordination procedures between all of the separate sets of national authorities involved. These were initially set out in a 1975 First Concordat following the crises with Franklin National in the US and Bankhaus Herstatt in Germany in summer 1974. A Revised Concordat was produced in 1983 after the closure of Banco Ambrosiano and disagreement between the Italian and Luxembourg authorities as to its supervision. A separate Information Supplement was issued in 1990 and strengthened Minimum Standards in 1992 after the closure of BCCI. A further Report on the Implementation of the Minimum Standards was produced in 1996.

 

Bank capital has traditionally always been dealt with at the national or country level. Capital provides a buffer against losses which protects the solvency of banks and their individual stability as well as the stability of the markets as a whole which could otherwise be damaged through depositor ‘runs’ or contagion. Following expansion of international banking during the 1960s and 1970s, the authorities recognised that capital levels had fallen to historic lows especially following the Third World debt crisis in the early 1980s. This had been referred to in a number of statements by the Basel Committee.

 

While it had not been possible to agree common standards and the Committee level initially, the US and UK authorities produced a Bilateral Capital Accord in 1986 which was presented to the Committee for consideration with the threat of applying the new rules in New York and London in the absence of further global common standards. The Committee subsequently produced a first Capital Accord in July 1988, which established the minimum 8% of capital to risk adjusted assets ratio which became the de facto global base level.

 

 A separate set of standards for capital for securities activities of international banks was agreed under a Market Risk Amendment in 1996.  The Basel Committee had attempted to work with the International Organisation for Securities Commissions (IOSCO) although this had failed and the Committee proceeded to produce its own standards generally following the EU provisions set out in the Capital Adequacy Directive (CAD) which was adopted with the Investment Services Directive (ISD) in 1993. The Basel I capital requirements for banks were implemented in the EU under the Own Finds Directive (OFD) and Solvency Ratio Directive (SRD) in 1989, with their Second Banking Directive (SBD) in 1989. All of these provisions were subsequently consolidated in the Banking Consolidation Directive (BCD) 2000 which was revised (recast) in 2006 under a separate Capital Requirements Directive (CRD) to give effect to Basel II. This will be further amended to implement Basel III under a further CRD within the EU June 2011.

 

While Basel I was accepted as a common principal global standard for capital adequacy, it was strongly criticised from an early stage for its simplicity and for failing to take into account many of the underlying risks that banks were assuming and to keep up with financial innovation in the markets. The committee had also been unable to retain any common global liquidity standards. The original Basel I measures will extended under Basel II to include three mutually reinforcing pillars with  a minimum capital requirement (pillar 1), a formal supervisory review process  (pillar 2) and strengthened market discipline through market disclosure (pillar 3).

 

Basel II pillar 1 retains the original definition of regulatory capital with the minimum required ratio of 8% of all this is made more risk sensitive by using the ratings provided for government and corporate borrowers by internationally recognised Credit Rating Agencies (CRAs). Larger banks may alternatively use their own internal grades of risk or order were ratings under either a Foundation or Advanced Internal Ratings Based (IRB) approach subject to strict rules. The requirements for capital for securities activities in the trading book are retained in pillar 1 with a new operational risk charge also being provided for.

 

Pillar 2 of Basel II provides for a formal supervisory oversight procedure to confirm that banks have established necessary systems to identify, measure, monitor and control the overall risks they face and maintain capital accordingly. National authorities must ensure that banks are able to assess their capital adequacy positions relative to their overall risks and take appropriate actions in response to those assessments where they are found to be inadequate. A range of remedial actions may be applied to banks were the thing to do so, such as strengthening risk management, improving internal controls, or increasing regulatory capital requirements.

 

Pillar 3 support or complements pillars 1 and 2 by strengthening market discipline market discipline through the disclosure of mandatory and supplemental information by banks on their capital positions. This is intended to allow market participants to assess key aspects about a particular bank’s risk profile and level of capitalization and capital support.

 

The Basel Committee consulted on the revision of its Basel II requirements during 2008-2209 following a global financial crisis, with a final set of Basel III amendments being produced and agreed in December 2010. It is principally operate by increasing cord minimum tier one capital (essentially paid-up share capital and retained earnings) from 2% (a quarter of 8%) to 4 1/2 % with an additional ‘Conservation Buffer’ of 2 ½ % which takes core tier 1capital to 7%. This is to be supported by a further discretionary ‘Counter-cyclical Buffer’ of between 1-2 1/2% by national authorities in times of expanding ‘boom’ market conditions to allow banks to build up the capital reserves in the event of a downturn in the markets. This is to be further supported by a further ‘Systemic Risk Buffer’ of between 1-2% for the largest banking group's to reflect their additional systemic risk and potential liability to the national support.

 

The Committee has agreed a separate set of common global requirements for liquidity with a Liquidity Cover Ratio (LCR) and Net Stable Funding Ratio (NSFR) with an additional leverage ratio of 3% of core tier 1 capital.  These then supplement the strengthened capital measures within a new set of short-term funding liquidity requirements and a total debt ceiling under the then new leverage requirement. The leverage position of a number of banks and investment firms immediately before the crisis had risen to over 40% which was strongly criticised as this made their continued viability particularly difficult in the event of the significant trading losses suffered unstructured products and with the loss of funding in the interbank credit markets.

 

These financial reserve requirements have also been further supplemented by a series of principles being produced by the Basel Committee in such areas as bank governance, remuneration, cross-border resolution, the establishment of a supervisory college for all large banking groups (made up of official representatives from all of the countries they operate in) and the conduct of wider full financial macroprudential oversight to identify any build of risk across the financial system or economy as a whole.   

.