Banking Risk Management in a Globalizing Economy - Essay Example

Banking Risk Management in a Globalizing Economy Introduction Modern banking theories have it all when it comes to the reasons as to why banks diversify internationally. In international banking, among the important ideas to learn are the motivations of banks as to why they diversify internationally. Why do they go overseas? This is an essential question to address knowing that banks do business with foreign in the actual setting. However, with reference to the 2007-2009 global financial crisis, the risks of banking globalisation cannot simply be overlooked. The work at hand is divided into two parts. The first part talks about the motivations of banks to diversify internationally or their ability to do business with foreign. The second part discusses the linked risks to banking globalisation with reference to the 2007-2009 global financial crisis. Banks Diversify Internationally One of the obvious reasons as to why banks manage to go international in their operation is their ability to deal with risks. In the age of modern technological advancement, banking technology is becoming an integral component of the decision-making process (Hughes and Mester, 2008, p.1). Information is vital in the decision-making process (Timmerman et al., 2008, p.113). With sufficient information, there is an available tool that can aid to the decision-making activity. In the case of banks, especially those performing in the international setting, they evaluate and manage risks, by simply referring to their databases and online information, making them easily have access to problematic clients, and problems that are non-performance that require immediate attention. Banks are always on the go to measure risks (Angelopoulos and Mourdoukoutas, 2001, p.158). After all, risks are associated with their banking business activity. When banks started to employ diversification process in the global background, prior to initiating it, they have already calculated the level of risks facing them. However, the reason as to why they still go forward to investing their business in the global level is their ability to mitigate the presence of threats. The advancement of technology and their ability to adapt it in their entire working system are the mere advantages they have over the presence of varied risks. In other words, one of the reasons why banks go international in their operation is due to their capability to manage risks. They have vital aid that could support them in times of tough decision-making activity, allowing them to decide what is best for their clients and in their whole business operations. Banks are motivated to always go for a win-win situation, allowing them to work on with a less level of risks on their part. However, the tasks involved in managing global financial risks are tough, for there is a need to ensure hard work, patience and talent (Hyman, 2006, p.2). To address this, international banks may have necessarily employ commercial bank and investment banking relationships at some point, just to eliminate the possibility of the global financial risk to take its toll on them. This is to say that these banks are able to face the challenges in the global scenario, and they do not just simply employ technology, but their optimum business capacity for understanding the entire marketing process involved in their business operation. On the other hand, large banks are also taking excessive risks, but the good thing is that they are able to externalize their costs (Hoflich, 2012, p.31). This means that they can tap the government in order to bail out those lenders who might fail to address their financial obligations. It is therefore important on the part of the bank that when they go international and invest in a country, the policies prevailing in the government set up are vital for consideration. It is the government and its prevailing laws that can also have greater impact on the banks’ financial performance for future financial sustainability. The government is a support system that could ensure a free-flowing business operation of the bank, minimising the risks associated with international banking. Nevertheless, banks do not just simply go international to manage risks. Managing risks is just an important component of allowing them to address their main objective in their entire business. Multinational banks are keen enough to scan the world for investment opportunities so as to generate access to money and capital markets across the world (Damanpour, 1990, p.110). Not only that. Multinational banks are eager to look for diversification at the lowest possible marginal costs. They are always looking forward to favourable regulations aside from the consideration of specific local laws or the domestic economies. These are two of the most important points that one should consider as to why banks diversify internationally. Investment opportunities are among the keys to sustainable development of a certain business. That is why there is no enough reason to refute the idea that the banks that are diversifying in the international market are looking forward to investment opportunities. The only way for the banks to keep growing is when they continue spread their investment. Although there is associated risks with this, diversifying their investment has also remarkable advantages. There are many investors out there who are looking forward to the opportunity to diversify their investments. These investors believe that the diversification of their investment can help them reduce their risks and this will also allow them to choose broader choice of securities (Fatemi and Salvatore, 2012, p.108). The ultimate way to cater these investors is for the banks to go international and diversify their investment, because diversification on their part would mean opportunity to generate access to money and capital markets in the world. There is a sustainable advantage in this case. In the first place, they have the competitive advantage over their competitors, because they will have higher opportunity for liquidity. However, in order to guarantee higher opportunity for marginal profit for such level of liquidity, the banks should continue to diversify its investment, allowing them to cater the universal financial needs of the global market. Banks operating internationally are always looking forward to pursue lower capital and riskier lending (Schoenmaker, 2013). Lower capital is quite an advantage. For sure, it would always lead to lower marginal cost, ensuring higher financial gain in the future. However, aside from the fact that risks could be disadvantageous, international banks pursuing riskier lending are trying to capture the opportunities behind. Investing with lower capital is not that costly after all. The reason is straightforward. Banks are there to ensure higher level of investment in a wide range, especially those trying to diversify internationally. Lower capital is a substantial advantage. Riskier lending would mean access to capital and money markets. Liquidity issue is a clear consideration. The more liquid a bank is the better. Banks with more liquid assets have the opportunity to enjoy a lower optimum capital buffer (Stolz, 2007, p.33). Though liquidity may “entail inflationary potential” (Alexander et al., 1995, p.9), bank’s liquidity is a major concern of banks diversifying in an international scope. The more liquid a bank is the more it is of its privilege to cater to various financial needs. Although there is risks associated with it, banks are still eager to generate more access to capital and money markets and are focused on it. It is a sure thing that there are calculable risks on the process, but it does not mean that the bank should stop there. Those banks pursuing international interests are looking for various opportunities behind the risks. However, some banks nowadays are already enjoying the benefits linked to a “cushion liquidity position” (Kim and McKenzie, 2010, p.366). Some of them hold more cash or very low return assets as their ultimate liquid assets. Their ultimate point is they need to continue their international operation. It is therefore clear that in going global in scope, international banks are always looking forward to opportunities and risks. However, the bottom line is financial management, in order for them to sustain their international operation, which is something that many of them are very good at. Banks operating at the global setting are benefiting due to diversification. In particular, with diversification, returns could be “maximised for the least risk” (Bhid, 2009). In addition, Bhid further argues that the diversification of the bank is a substitute for due diligence. Knowing this point, many of them are encouraged to finally take the plunge into the international market. There is a sense of security in this way of thinking. For this reason, many international banks are compelled to take their stand to go with their global operation. In line with this, global international banks are taking the lead, and are continuously influencing the conventional approach of banking. They try to go for innovation. In that innovation, they find the global opportunity for them to have right access to both capital and money market. In this point of view, it seems global international banks are thinking much more of the opportunity they can incur in their global operation, rather than the associated risks that sooner or later may plague their entire operation. Banks going global, however, are not free from the associated risks of their global scope of operation. In fact, one of the real-case scenarios can be obtained in the 2007-2009 global financial crisis. The Risks of Banking Globalisation With reference to the 2007-2009 global financial crisis, one can evaluate the risks linked to banking globalisation. It is a common observation that commercial banks are allowed to be involved in risky investments. As experienced, the surging demand for mortgages that overlooked the quality of underwriting process resulted to the economic bubble, foreclosure of both the commercial and investment banks. The inception of new financial instruments that may just lead to lack of money control contributed to the financial crisis. According to Schwartz, many of these financial innovations are employed in the market without too much consideration of their relevant flaws, beforehand (Comert, 2013, p.154). The lower interest rate may just ignite the existing financial crisis. On the other hand, the global financial imbalances triggered the 2007-2009 financial crisis (Allen and Wilhelm, 1988). These are some of the important information that one could truly consider as substantial reasons behind the 2007-2009 financial crisis. However, Schwartz argued that the real financial crisis takes place when the central bank is not able to act as lender-of-last-resort, which means that the common things observed at present such as the turn down of equity stocks’ asset prices, “real estate, commodities, depreciation of exchange value of national currency, financial distress of a large non-financial firm” and so on are just “pseudo-financial crisis” (Oliver and Aldcroft, 2007, p.183). While Schwartz may have substantial point, it is however clear banks may play a crucial role in the financial crisis. In the 2007-2009 global financial crisis, experts have many things to say about it particularly on the theoretical reasons behind it. However, some of them may quite believe the idea that there are risks associated with the financial innovations created by global banks in the international capital and money market. For others, there are perils with the diversification of commercial banking, particularly in the event of expansion that goes further than the traditional way of lending. In particular, mortgages in the US that went beyond the appropriate underwriting process led to the economic bubble, leading further to the foreclosure of both the commercial and investment banks starting in 2007 to 2009 within the period of economic crisis. Although there might be some other reasons that are linked to this or even may have come first prior to it, it is clear that the financial institutions operating globally and with the implementation of modern financial techniques have contributed to the economic bubble. Economic crunch is a term used by economies that in one way or another should involved the financial institutions. Now the point is clear. There is peril associated with banking globalisation (Corporation Essvale, 2011, p.8). Diversification of investment is risky, but it is inevitable when there is a need to go for expansion in the first place. However, what seems clear is the thought that modern techniques may just only provide more harm than good at some point. Banks, especially those operating globally are supposed to be there to provide financial help, but there are prevailing techniques they employ that go beyond the traditional way, that according to Schwartz is practiced without too much understanding of their relevant flaws in the long run. In financial market, there is therefore danger in innovation (Fair, 1986, p.330; Great Britain Parliament, 2010, p.19). Such danger has been proven through the 2007-2009 financial crisis. The Obama administration has become so ignited by the thought of distribution of wealth, without thinking too much of the financial capability of an individual prior to becoming part of the new financial system (Zonis et al., 2011, p.12; Kenski, 2010, p.226). In the first place, the economic bubble was partly contributed by the government and its prevailing policies (Financial Crisis Inquiry Commission, 2011, p.458; Payson, 2014). Considering the point that global banks are relying on local policies in every country, these institutions are therefore not free from the danger linked to combined economic and political issues. Banking globalisation therefore has two important points to consider: its innovation and the unknown due to the prevailing policies that may just be changed from time to time. In this way, it is necessary to consider the point that global banking is risky at some point, and it is just a matter of how those involved with it should learn to take to understand the rule of the game. In the first place, as already stated earlier, banks are also looking forward to find opportunities behind threats. Although there is danger associated with it, it is also important to consider that there are also remarkable opportunities linked with it. In other words, the risks involved in banking globally may be a reality, but the point that its opportunities are even so real might be enticing from the point of view of the bank. Conclusion In a nutshell, the work at hand tries to explicate as to why international banks are motivated to diversify internationally or go overseas. This is an essential problem addressed in the paper. So in particular, with reference to the 2007-2009 global financial crisis the risks of banking globalisation are also taken into account. As shown, the work at hand is divided into two parts. As shown in the first part, the motivations of banks to diversify internationally or their ability to do business with foreign are elaborated. As shown in the second part, the linked risks to banking globalisation with reference to the 2007-2009 global financial crisis are considered. The point clearly states that there is peril or risks in diversification, especially on the part of banks reaching out the international capital and money market. In this case, it is necessary to consider the thought of understanding the risks and the opportunities involved in global banking. With reference to 2007-2009 financial crisis, there is to much to learn about global banking. Diversification of investment in this case may have been proven sophisticated, but it is also important to understand its potential implication in the long run. For this reason, there is enough point to take prior to understanding the imminent danger associated with financial innovation in the global context. In reality, this change has something to do much with the financial institutions and their prevailing modern financial techniques. References Alexander, W. 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