The Changing Role of International Banking - Dissertation Example

 The Changing Role of International Banking in Development Finance The involvement of international banking systems to the financial development of developing countries have significantly changed over the past few years. This has led to the changing role of the international banking in development finance. This paper aims at proving and explaining the changing role of foreign banks in financial development of the developing countries. It clearly explains how the international banks have ventured into financial interaction with the developing countries and how this has resulted into economic benefits to the countries. It also explains the consequences that the involvement of international banking in the development of developing countries has caused. To support all this, the expansion and transformation of international activities in the developing countries have been outlined and explained in the paper as well. Contents Discussion 5 The Expansion and Transformation of International Banking Activity in Developing Countries 5 Economic Benefits of International Banking 8 Presence of International Banks has led to Improved Access to better Financial Services 8 Presence of International Banks have led to Improved Efficiency of Domestic Financial-Systems 9 The Presence of Foreign Banks has Helped in Easing the Constraints Faced by Domestic Credit levied on Manufacturing Firms 10 Macroeconomic Consequences caused by the Presence of International Banks in the Developing Countries 11 Presence of Foreign Banks has Led to the Weakening of the Monetary Policy Transmission 12 The Presence of Foreign Banks have Led to Increased Creation of Domestic Credit in the Developing Countries 12 Conclusion 13 References 14 Introduction Over the past few years, international banking industry has undergone significant changes that have triggered a shift in the way they relate with the developing worlds. Countries of the developing world have also faced rapid transformation in their financial sectors, a kind of growth which has been associated with economic growth which includes financial liberation. The changes that have been registered both in the international banks and the developing world have led to the formation of newer dynamics of parties engagement also coupled with fresh locus of the concerned mutual interest. These developments, unlike before when they were only restricted to the availability of trade credit with impromptu financing sovereigns, now extends well beyond this to define the changing role of the international banks in development finance. The international banking industry, through its penetrating operations and services in the developing countries, has now extended its services offered to the developing countries with the realization of efficient operating infrastructure, local agencies and smaller branches which have now grown to form part of the local banking industries of the developing countries. The international banking industry now performs series of financial transactions with the local banks in the developing world. They provide, to many industries and companies, a reliable gateway through which organizations, sovereigns, banks and other financial institutions perform foreign exchange and related derivatives, transfer funds, borrow money and invest their profits. The new role played by the international banks to the developing countries have created financial instability in the developing countries with their over reliance on the international banks. This calls for a redefinition of the policies guarding the relationships between the international banking industry and the local banks of the developing countries. Even though the coordination of policy of late has majorly focuses on the liquidity provision collaboration, financial scholars, participants of the market and policy makers have the need to focus on the long-term reevaluation and assessment that concerns the stringency that the financial regulation faces and the effects of asset markets to the stability and independence of the financial industry. The aim of this dissertation is to show the increasing importance of the international banking activity and specifically for the development finance on the developing countries while focusing on the economic benefits and the consequences of the increasing presence of the international banks in the developing countries. The main message that this dissertation aims at showing is that the increasing relationship between the developing countries and the developing worlds have resulted in great and significant economic benefits to the developing countries. These benefits have, over the past, been evident in terms of the improvement in efficiency of the banking systems, better and improved financial services and also increased ease of access to capital from the international banks; that the involvement of the international banks in the financial affairs of the developing countries has significantly increased over the past; the increased presence of international banks in developing countries have exposed the countries to various macroeconomic risks; there is need to incorporate both macroeconomic and general financial regulatory measures and regulations to govern the investment of foreign bodies as this brings more benefits; Needless to say, this paper will provide a basis for the economic benefits brought by the international banking system on developing countries as well as the consequences that comes along with this. This information can therefore be used to develop measures and regulatory actions that generally control the involvement of the foreign banks in the affairs of the developing countries and thus provide a better platform where both parties can benefit. Discussion The Expansion and Transformation of International Banking Activity in Developing Countries Ever since the international banking industry ventured in the developing countries, there has been a lot of transformation regarding the way and extent to which they operate. Their involvement in activities in the developing countries has, over the past, rapidly increased. Presently, the international banks play a major role in the development of the economy of the developing countries. Their already expanded territory of operation now directly affects the economic transformation of the developing countries. The international banking has greatly expanded their activities in the developing countries mainly because of their adoption and integration of the developing countries to the financial world through the provision of foreign direct investment (FDI) flows and this has resulted into a rise in demands com for the services relating to international banking, technological advancement and global automation and adoption of fair regulatory reforms. These reforms have given the developing countries a better platform to engage more in financial business with the international banks. The penetrative activities of the international banking industry have led to several changes to the international banking activities that are directed to the developing countries: a) A rapid change from the cross-border to now local market delivery of various financial services b) The widespread growth in the lending exposure c) Great foreign investment by the international investments and adoption of local affiliates The investment schemes of the international banks have increased the demand of international banking services by the developing countries. This has led to increased interaction between the international community and the developing countries. The result of this is that the position of the developing countries on the international financial platform has shifted by a great deal. International banks have therefore increased both their local activities in the developing countries as well as the international financial relationships with the countries. This has majorly been influenced by the diversification of risk as well as lavish asset growth. Figure 1: Showing Statistics of Claims of International Bank on Developing Countries Source: Bank for International Settlements (BIS) The Graph shows the foreign assets of banks that reports to the Bank of International Settlements (BIS) GDP represented in the graph is the aggregate GDP for the developing countries. Foreign banks have opened up business opportunities for the developing countries and made it easier for the countries to engage with them. This they have ensured by even engaging in local businesses and financial investments and transaction activities in the developing countries. One thing that the international banks have maintained is their use of their foreign currency. This they have maintained despite their significant increase in their involvement in the local financial market. Moreover, they have maintained the use of their foreign currency even with the affiliate networks that they have developed to help them reach the local market and achieve local participation. These activities by the foreign banks have made the developing countries invest as well in the international markets and engage more in the international financial affairs. The foreign banks have responded positively to this by opening their doors for international lending and grants by the local citizens. This has not only given them the exposure they need on the developing countries but also the benefit of profits that come along this. There are nowadays increased claims of international banks on developing countries, unlike before when the involvement of developing countries with international banking community only focused on a considerable area of business and financial relationship. Figure 2: Showing the Outstanding International Claims given by Regions, 3rd Quarter, 2007 Source: Bank for International Settlements: Calculations of World Bank Staff Europe and Central Asia dominates most parts of the developing countries with their cross-border financial relationship and asset investments. They have ventured more into financial involvement with the developing countries. As is the overall trend, this they have achieved through the setup of local affiliates in the developing countries and providing suitable financial regulations governing the way they relate and perform their cross financial transactions. These include cross border loans including loans offered by foreign banks affiliates and other offices to the developing countries. The extra involvement and financial interaction with the developing countries have created a better international exposure on the developing countries and made it easier to obtain international loans, grants, borrow assets as well as make international investment. East Asia and Pacific with Latin America and the Caribbean have also increased their international and cross-border involvement with the developing countries. Having 20% claims on developing countries make them only a level down from Europe and Central Asia which have the lead in the development finance of the developing countries. Figure 3: Showing the Percentage Composition of International Banks on Developing Countries based on Nationality of Banks Reporting to the Bank of International Settlements Source: Bank for International Settlements: Calculations of World Bank Staff As reflected by the regional financial claims projection, the composition of foreign banks on the developing countries by nationality is as shown in the figure. European banks have faced the greatest shift in the roles that their banks play in development finance in the developing countries. These banks have used various financial processes and activities to reach out to the developing countries. United States is also one of the combinations of states which have increased its participation with the developing countries. Banks of the United States now offer financial assistance to the developing countries and increasing their overall financial claims on the countries. Exposures dominated by foreign banks and financial institutions are basically funded using international currencies in the international markets. For this reason, they are usually controlled by the global movements of the interbank conditions and rates. Despite this, there are still an increasing number of borrowers from the developing countries. These borrowers, about 77% of them, are the holders of the majority of the international debts and the debts are usually in foreign currencies making them vulnerable to financial rates fluctuations. Economic Benefits of International Banking The involvement of international banks in the financial development of the developing countries has significantly increased over time. This has come along with several benefits to the developing countries. There have been substantial gains and benefits that the developing countries have gained from their increased involvement with the foreign banks. The amount of benefits that have been brought about by the international banks characteristics, their policy as well as that of the developing country and as well the provided institutional and regulatory environment provided by the host developing country. The presence of international banks in the developing countries has led to the improvement of financial management in the banks of the developing countries, it has ease the constraints of credit on the firms in the developing countries and generally leading to the rapid development and growth of the banking system of the developing countries. Presence of International Banks has led to Improved Access to better Financial Services The developed countries usually have the advanced banking technology, full teams of skilled personnel and ability to make use of opportunities of scale in their usual operational systems. This has enabled them provide high quality and sophisticated services at reduced costs than those of the banks in developing countries. These put them at the forefront of providing services to the clients in the developing countries who would rather go for reduced costs and better services than stay loyal to the local banks. This is evidenced as in the case of the document written by Arnold, Javorcik and Mattoo which explains that banks in the Czech Republic were the very first banks to fully implement the use of ATMs and other remote banking systems in a bid to improve their customer service (2007). They also opened up their branches for easy loan awarding to the local citizens. According to Garber, international banks are able to provide better loans, grants and new financial products like structured notes with little effort (2000). According to Levine, the international banks have also reduced the costs of their financial products and services as seen in the reduction of credit letters fees in the country Turkey in accordance to the set-up of new financial rules and regulations (2001). People like Wooldridge among others goes ahead to insist that the involvement of international banking industry in the developing countries have awarded the developing countries with a better platform for development in terms of financial securities and market derivatives. The international banks have also led to the improvement of the financial systems through adoption of better rules and regulations which include the financial supervision. Presence of International Banks have led to Improved Efficiency of Domestic Financial-Systems Foreign banks are generally efficient in their financial operations. This has been adopted by the developing countries which now also practice efficient banking systems. The domestic banks now attempt to adopt the modern technologies used by the international banks and their error-free banking systems. Again, the presence of the foreign banks to the local markets of the developing countries has triggered competition with the local banks. The competition has been stiff such that the efficiency of the banking services and their timeliness is what now brings the difference. Because of this competition, local banks are now advancing their banking systems, improving them and installing new technologies to their usual operations. The installation of advanced banking systems has greatly improved the efficiency of the domestic financial systems. According to Gelos and Roldos, the presence of the international banks has led to better competition which has seen the ralisation of improved financial services and products like loan acquisition (2004). Figure 4: Cost of Overhead to Total Assets Ratio in Selected Regions based on Entry of Foreign Banks (1998-2005) Source: Bank for International Settlements: Calculations of World Bank Staff There are several characteristics of international banks that affect their overall efficiency in the developing countries. These characteristics include the origin and general efficiency of the primary bank, their motive of venturing in the developing countries, their mode of entry into the local market and finally the market share held by the international banks. These are in accordance with Berger, 2008 and Sturm and Williams, 2005). The overall cost of overhead to total asset ratio is minimum in the developing countries and highest in the Sub-Saharan Africa due to the discussed factors. The Presence of Foreign Banks has Helped in Easing the Constraints Faced by Domestic Credit levied on Manufacturing Firms Figure 5: Showing the Actual Effects of Lending by Foreign banks Source: Bank for International Settlements: Calculations of World Bank Staff The increasing investment by the international banking industry in developing countries have created more credit sources and made their acquisition process easier and simpler. The involvement of international banks has also led to availability of improved technology, better risk diversification opportunities and also favorable financial regulations and laws. The competition brought about international banks has forced the local banks to adjust their credit attainment procedures and regulations as a way of attracting more investors and customers. According to Giannetti and Ongena, there has been increased and improved access to credit in the developing countries due to the presence of the foreign banks. Macroeconomic Consequences caused by the Presence of International Banks in the Developing Countries Despite the many economic benefits that the presence of international banks has brought to the developing countries, there is also concern as to the growing macroeconomic consequences that have emerged over the past. These consequences have affected the economy of the developing countries negatively. Presence of Foreign Banks has Led to the Weakening of the Monetary Policy Transmission Monetary policy has, in the past, created significant impact on the macroeconomic management criteria in many developing countries’ economies. Foreign banks’ presence by no doubt affects the transmission of monetary policy. Figure 6: Showing the lending and average money market rates in up to 22 countries (1995-2007) Source: Bank for International Settlements: Calculations of World Bank Staff The figure clearly shows the transformation that the lending rates and the average money market have undergone using a simple sample of 22 developing-countries. The drop in the average lending rates is as a result of the economic success of the countries towards inflation lowering. Despite this fact, there still exists an averagely high correlation coefficient. Several financial market analysts say that the availability of international banks in the developing countries is harmful to the monetary transmission of the given country in that the international banks are less-responsive towards domestic monetary policy-impulses. This they say is because the foreign banks have a wider access to greater amounts of funds from external sources where the monetary policies do not have authority and governance. The Presence of Foreign Banks have Led to Increased Creation of Domestic Credit in the Developing Countries Several countries have benefitted from financial credit expansion by a great deal. However, several other countries have also had their credit growth growing more than their deposit growth which is not very advantageous to the countries. Developing countries like Romania and Ukraine have over borrowed finances from the international market and invested more using the funds from the vulnerable foreign markets. Due to the accessibility of funds from foreign banks, many developing countries have gone deeper into debts and loans which have been borrowed from the international banks. This has been evident with the rise of average-ratio of private-credit to the GDP in these countries to 25% from 10%. Several econometric analyses that have been done by financial experts also indicate that there is direct relationship between the rise of private credit and the presence of the international banks in the developing countries. Conclusion The role once played by the international banking in the development finance of the developing countries has by no doubt changed over the past few years. There has been rapid expansion and transformation of international banking activities in developing countries which has seen the realization of rapid change from cross-border to local market delivery of various financial systems, widespread growth in lending exposure and great foreign investment by the international investments and adoption of local affiliates. There are also several economic benefits that the presence of international banks has brought to the developing countries. These include improved access to better financial services, improved efficiency of domestic financial system and the ease of the constraints faced by the credit levied on manufacturing firm. Despite these benefits, the involvement of the international banks has also brought many macroeconomic consequences to the developing countries. These have been eminent in the weakening of the monetary policy transmission and the increased creation of domestic credit. All these benefits and consequences have resulted as a result of the involvement of international banks in the financial activities of the developing countries and thus the changing role of international banking in development finance. References Arnold, Jens, Beata Javorcik, and Aaditya Mattoo. 2007. “Does Services Liberalization Benefit Manufactur- ing Firms? Evidence from the Czech Republic.” Policy Research Working Paper 4109, World Bank, Washington, DC. 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