The Reforms in the International Banking and Financial Sector - Literature review Example

International Banking

The reforms initiated in the financial sector globally are to facilitate economic reforms that would eventually bring forth the realization of a better banking environmental structure. Liberalization and deregulation of the banking sector are key to the reformation of the banking sector. For instance, liberalization intensifies competition in the industry through the creation of new market ventures for private and foreign banks (Festić, Kavkler & Repina, 2010). Alternatively, deregulation of the banking sector has led to the development of various business opportunities for those organizations involved in the banking industry thus facilitating the realization of organizational growth and development. This essay offers an assessment of the existing correlation between the risks associating to competition in the banking sector.

The interest rates' decline, as well as the reduction in lending margins, has brought forth different challenging conditions for banks especially those involved in the public sector. The occurrence of the banking crisis in this sense relates to the failure of various banking institutions in fulfilling their obligations as stipulated in their contract agreement with depositors, and the significant holders of the bank liabilities (Blundell-Wignall & Roulet, 2014). As such, the breach of settlement and service obligations to their depositors results to the declaration of bankruptcy, thus the liquidation of the bank (Chan & National Bureau of Economic Research, 2005). Financial crises require the development of monetary, fiscal policies, financial markets, and other banking management strategies so as to avoid the economic downturn and the collapse of the banking sector.

According to the research by Walter (2009) indicates that banking crises are brought forth by the complicated adoption of the new macroeconomic conditions top the various banking systems. Particularly, the liberalization of foreign relations, globalization of market systems, and the deregulation of the banking industry are the major factors that associate with the development of economic imbalances and macroeconomic instability thus negatively affecting the banking system. Also, Tröger (2015) attributes the decline of production levels and deteriorating solvency of borrowing institutions to the development of economic turmoil that eventually affects the banking industry. Regardless of various factors being influential on the impact that economic crisis has on the banking system, it is of importance to lay focus on the systemic risks that associate with banking activities.

According to Hutchison (2002), factor analysis of the risks in the banking sector indicates that financial banking institutions are exposed to risks relating to liquidity ratio, uncertainty regarding the stability of the domestic market, and fluctuating interest rates. However, the international competition for global market ventures as well as risks associated with credibility and uncertainty in the financial sector also have the significant effect on the financial operating capabilities of banking institutions. Notably, with economic reforms, countries gain the ability to strengthen financial institutions through enabling the development of markets as well as the integration of the banking system to new technological innovations (Fernandez-Bollo, 2013). However, the development of various market ventures calls forth for banking supervision to eliminate the issue regarding excessive competition in the sector. Extreme competition in the banking industry could be threatening to other banking institutions as it could result to solvency.

According to Walter (2009), the supervision of the banking sector concerning the control of the competition amongst the various players in the market is of great significance. In this case, failure to ensure proper supervision of the sector could hamper the necessary stability needed for quality operations in the industry. For instance, the liberalization of banking systems brings forth to the rise in competition for markets and finally eroding the valued franchise of an institution. Notably, the rising competition encourages banking institutions to pursue risk associated policies to maintain their profitability nature (Hutchison, 2002). Examples of risk associated policies that banks could undertake to keep their profit view are lowering capital levels and high credit risk loans.

The undertaking of such riskier policies in the banking sector leads to the increment of the possibility of high non-performing loans thus facilitating bankruptcy. However, with restrained competitive natures in the banking sector banks are encouraged to protect their franchise values through pursuing safer strategic policies thus facilitating the realization of a stable banking system (Hutchison, 2002). The support of the franchise value paradigm is essential in the banking sector in enabling the survival of banking institutions, especially during the economic crisis. Therefore, the attainment of the desired stability nature of the banking system entails the implementation of banking reform systems that focus on improving the levels of supervision, recovery and resolution arrangements as well as capital investments. The enhancement of control capabilities in the banking sector could be attained through the development of the prudent regulatory framework that is inclusive of the development of a Financial Policy Committee tasked with oversight of any emergence of risks in the financial sector.

Systemic risks infer the breakdown of entire systems rather than the failure of individual parts of that system. In the financial sector, systemic risks make reference to the cascading failure of the financial sector due to existing interlinkages within the system thus causing the economic downturn. As such, the primary focus of various policymakers is the issue of ensuring the limit of any arising build-up associated with systemic risks (Jones & Tsutsumi, 2009). Particularly, the development of systemic risks in the banking industry is characteristic of intensive clustering of financial failures. Besides, the Bank of International Settlements (BIS) associates systemic risk to the inability of participants in a commercial market to settle their contractual obligations leading to the rise in financial difficulties. As stated by Mohd-Sanusi and Rameli (2015), the risk is integral to all activities associating to political, economic, and social operations hence the uncertainty of events in the commercial banking industry. Due to the importance commercial banks have to the economy as well as the maintenance of continual social reproduction, it is a necessity for policymakers in the financial sector to ensure proper management of the systemic risk.

Systemic risks were evidently profound during the global financial crisis whereby the decline in economic standards brought forth systemic effects on the global financial systems. To ensure proper sustainability of the financial sector, there is the need for the development of new theoretical approach measures to address management practices necessary to avoid systemic risks (Jones & Tsutsumi, 2009). In reference to systemic risks, Hutchison (2002) emphasizes that the ability to predict, to prevent, and managing systemic risk is a necessity for the realization of normal functioning of the financial sector as well as economic growth and development.

Banking panics and instability of a banking system could be attributable to an institutional source of the systemic risk due to the following reasons; the financial intermediaries model of banking that entail the fact that banking institutions convert short-term liabilities to loans based on long term basis thus the assumption that account holders need not withdraw their funds (Jones & Tsutsumi, 2009). However, fearing for the safety of their deposited money, depositors would tend to recover their cash deposits upon economic panic situations regarding the banking sector thus making the above assumption invalid in such cases (Chan and National Bureau of Economic Research, 2005). The second assumption refers to banking panic whereby information about the occurrence of an economic downturn makes individuals initiate the withdrawal of their cash deposits.

With globalization and internationalization of business operations, the development of an increase in competition for the market is brought forth by the growth in organizations involved in the offering’s market. In this sense, the increase in competition results to the erosion of the banking policies such as the limitation of risk-taking measures so as to ensure quasi-monopoly granted by government charters (Walter, 2009). Therefore, the erosion of such rents and charter values would eventually lead to intensified ban-risk taking capabilities as well as financial instability.

Unhealthy competition in the banking industry is characteristic of strategies undertaken by various banking institutions to ensure that they cope with the rising competition, especially from foreign banking organizations. Mainly, localized banking organizations develop the need to seek more funding from international organizations or the central bank regardless of the interest rates that the loan could accrue (Mohd-Sanusi, Rameli, Omar & Ozawa, 2015). Besides, such organizations could partake in high-risk opportunities with the desire to ensure they attain their normal profitability nature in spite of the existence of a healthy market competition (Evanoff et al. 2009). Under the provisions of the dynamic optimization model, the decrease in a banks’ market power results in the development of an incentive to engage in riskier policies as means to increase the franchise value (Festic, Kavkler and Repina, 2011).

According to Jones and Tsutsumi (2009 p.56), the dynamic model of moral hazard indicates that competition could attribute to the development of prudent banking behaviour whereby the banking institutions increase their gambling incentives using capital requirements control rates. Through the research, Fernandez (2013) views the existing relations between deregulation of the banking sector with the increase in loan losses, while Chan (2005) brought forth the realization that liberalization through interstate branching facilitated the increase in competition in the banking sector and thus reducing the profitability enjoyed by the various players in the sector. Focusing on new market entrants, it is evident that an increase in loan market competition could result in increased loan losses attributable to the winner’s curse arising from a high degree of asymmetric information.

However, competition in the banking industry is of significance to business operations as banking services provide diverse financial products to choose from at a suitable rate of return. Alternatively, rebuilding a mutual understanding and trust between banking institutions and their corresponding clients is of importance in enabling the creation of a healthy and competitive banking industry. According to Blundell and Roulet (2014), the realization of a healthy competitive business environment in the financial sector could be attainable through imposing strategies and policies that restrict excessive entry of participants to the banking industry. Additionally, the government intervention could be a necessity to curb the occurrence of malpractices in the sector regarding undertaking high-risk banking policies thus endangering the stability of the banking sector.

The understanding of the systemic risk entails various key elements associating to the banking industry. An endogenous risk, for example, infers risk creation within a financial system due to a devastating economic event outside the industry. Conversely, amplification mechanisms, which relate to systemic risk as well refers to the trigger that initiates the outbreak of the systemic crises. The small trigger event is amplified by the existing linkages in a financial system. Finally, the policy responses relate to the regulations formulated by policymakers that could aid in the reduction of the drastic economic effects brought forth by the systemic risk (Evanoff et al. 2009).

White (2014) reiterates that the crystallization effects of the systemic risk are economically detrimental thus governments need to mitigate the impacts and prevent the occurrence of another financial crisis in the system. Nonetheless, regulations could as well bring forth the creation of systemic risk by facilitating the change in the manner at which private corporations behave. The development of new regulatory policies could as well cause the development of pervasive incentives and thus impacting some parts of the financial system (Tröger, 2015). As such, it is necessary that policymakers put a lot of consideration on the financial system as an entire unit before initiating a financial regulation policy as a crisis response measure.

During the past financial crisis situations especially that experienced in 2008, systemic liquidity risk has been the epicenter. In this sense, central banks and other government agencies need to stress the significance of developing a macro-prudential system aimed at reducing the systemic liquidity risk (Tröger, 2015). Therefore, policy makers could ensure a succinct regulation of the banking sector through the development of several policies such as prudential regulation and other tools such as monetary policies to allow the maintenance of a proper financial stability.

Additionally, the creation of an oversight control committee would enable the policymakers to ensure close monitoring of settlement and payment systems in the state. Notably, it is also a necessity for the policymakers to ensure the regulation of the critical activities such as business management in the financial sector, thus ensuring financial scandals and frauds associated with misappropriation of funds does not shock the banking industry. Finally, ensuring the proper attainment of stability in the financial sector depends on the policymakers’ ability to eliminate instability factors that associate with systemic risk thus enabling the maintenance of the desirable economic system.