Transcript Introduction

INTERNATIONAL MONETARY
AND
FINANCIAL ECONOMICS
International
Banking
Third Edition
Central Banks and Supranational
Financial Policymaking Institutions
Joseph P. Daniels
David D. VanHoose
Copyright © South-Western, a division of Thomson Learning. All rights reserved.
International Dimensions of Financial
Intermediation
• The financing of capital investment projects may be
direct or indirect.
• Direct Finance: When savers allocate some of their
wealth to the purchase of a bond issued by a
company, they effectively make a direct loan to the
company.
• Indirect Finance: When a banking firm pools
together the funds of deposit holders and purchases
a bond issued by a company, savers are indirectly
lending funds to the company.
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Indirect Finance Through Financial
Intermediation
Financial intermediaries
facilitate indirect financing by
issuing their own financial
instruments and using the funds
they obtain from savers to
finance capital investments of
businesses.
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The Role of Financial Intermediaries
• Savers may desire to direct funds through a
financial firm because of asymmetric
information.
• Asymmetric Information: Possession of
information by one party in a financial
transaction that is not available to the other
party.
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Asymmetric Information Problems
• Asymmetric information can lead to several
types of problems in financial markets such as:
• Adverse Selection: The potential for those who
desire funds for unworthy projects to be
among the most likely to want to borrow or to
issue debt instruments.
• Moral Hazard: The possibility that a borrower
might engage in more risky behavior after
receiving funds from a lender.
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Economies of Scale
• Financial intermediaries specialize in collecting
information and analyzing the risk of potential capital
investment projects. Hence, they may help reduce
asymmetric information problems.
• Economies of Scale: Another potential benefit and
reason for financial intermediaries to exists is that, by
pooling the funds of savers, and increasing the scale
of the total amount of savings managed by a single
entity, they may reduce the average costs of
managing savings.
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Financial Intermediation across
National Boundaries
• International Financial Diversification:
Holding financial instruments in various
countries to spread portfolio risks.
• World Index Fund: A portfolio of globally
issued financial instruments with yields that
historically have moved in offsetting
directions.
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Banking Around the Globe
• One dimension along which banking systems differ
concerns the extent to which banks are the
predominant means by which firms finance their
working capital needs.
• U.K. firms, for example, firms raise nearly 70 percent
of their funds through bank loans, while U.S. firms
raise fewer than 30 percent of their funds through
bank loans.
• Bank market structure, or the organization of loan and
deposit markets in which banks compete, is another
dimension along which banking systems differ.
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Universal Banking
• Universal banking is a feature that traditionally
distinguished national banking systems.
• Universal banking is an environment in which
banks face few if any restrictions on their
authority to offer full ranges of financial
services and to own equity share sin
corporations.
• There is now a convergence toward universal
banking among the advanced economies.
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Global Payment Systems
• Payment System: A term that broadly refers to the set
of mechanisms by which consumers, businesses,
governments, and financial institutions make
payments.
• Large-value wire transfer systems are payments
systems that permit electronic transmissions of large
volumes of funds.
• Fedwire is a large-value wire transfer systems
operated by the U.S. Federal Reserve.
• Clearing House Interbank Payments System is a
privately owned system that is primarily used for
foreign exchange and Eurocurrency transactions.
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Payment-System Risks
• Liquidity Risk is the risk of loss that may occur if a
payment is not received when due.
• Credit Risk is the risk of loss that could take place if
one party to an exchange does not honor the complete
terms of the exchange.
• Systemic Risk is the risk that some payment
institutions may not be able to meet the terms of
payment arrangements because of the failure of other
institutions to settle unrelated transactions.
• Herstatt Risk is liquidity, credit, and systemic risks
across international borders.
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Financial Instability and International
Financial Crises
• Financial instability is a situation in which a nation’s
financial sector is no longer able to allocate funds to
the most productive projects.
• Financial crisis is when an nation’s financial system
is unable to function and typically involves a banking
crisis, a currency crisis, and a foreign debt crisis.
• Speculative attack is a concerted effort by financialmarket speculators to induce abandonment of an
exchange-rate target that will yield them profits in
derivative markets.
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Estimated Exchange Market Pressure
Pressure on currency
values in foreign
exchange markets
during the 1990s
appear to have first
increased in
Thailand before
spreading to
Malaysia, Indonesia
and Korea.
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Bank Regulation and Capital Requirements
• Bank regulation and supervision is a fundamental part
of most nation’s strategies for reducing the potential
for financial instability and crisis. Typically,
regulation aims to limit bank failures, maintain bank
liquidity, and promoting an efficient financial system.
• Insolvency is a situation in which the value of a
bank’s assets falls below the value of its liabilities.
• A bank is illiquid if it has insufficient funds available
to meet the cash needs of its depositors.
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Deposit Insurance
National governments increasingly offer deposit insurance guarantees to promote
confidence in their countries’ banking systems. Hence, the number of
government systems has increased significantly since the 1960s.
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Bank Capital Requirements
• Risk-Based Capital Requirements are regulatory
capital standards that account for different risk factors
that distinguish bank’s assets.
• Under the Basel capital standards, developed at the
Bank for International Settlements, banks must
compute ratios of capital in in relation to their riskadjusted assets. This is a weighted-average of assets
in which the weights reflect regulator’s perception of
distinctive asset risks.
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Equity as a Percentage of Bank Assets
in the United States
U.S. bank equity ratios fell considerably between the midnineteenth and mid-twentieth centuries. Recently they have
risen slightly.
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Central Banks
• Considerable expansion of the number of central
banks occurred in the beginning of the latter part of
the nineteenth century and particularly during the
latter part of the twentieth century.
• The best place to begin an examination of the
functions of a central bank is with their balance
sheets.
• Two principle assets are holdings of domestic
government securities and foreign-currency
denominated securities and deposits. Two principle
liabilities are currency notes in circulation and bank
reserve deposits.
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Number of Central Banking Institutions
1670 - Present
The twentieth
century witnessed
considerable growth
in the number of
central banks.
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What Central Banks Do
• Central Banks as Government Banks: Central banks
may serve as government depositories and as fiscal
agents.
• Central Banks as Bankers’ Banks: Central banks
supervise and regulate the systems through which
individuals, businesses, and banks exchange
payments and promote confidence in the banking
system by acting as a lender of last resort.
• Central Banks as Monetary Policy Makers: Central
banks can bring about variations in interest rates,
thereby changing the volumes of money and credit.
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Central Banks as Monetary Policy Makers
• Central banks have access to a number of
policy instruments, or financial variables that
they can control in an effort to achieve policy
objectives.
• Traditionally these instruments are:
– Interest Rates on Central Bank Advances
– Open-Market Operations
– Reserve Requirements
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Supranational Financial Policymaking
Institutions
• International Monetary Fund (IMF): A multinational
organization that promotes international monetary
cooperation, exchange arrangements, and economic
growth. It provides temporary financial assistance to
nations experiencing balance-of-payments
difficulties.
• World Bank: A sister institution to the IMF that is
more narrowly specialized in making loans to
developing nations in an effort to promote their longterm development and growth.
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International Monetary Fund
• Currently has over 180 member nations.
• A quota subscription is required when joining.
these are a pool of funds that IMF managers
can use for loans to member nations.
• Conditionality is a set of limitations on the
range of allowable actions of a government
that is receiving IMF loans.
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Growth in IMF Membership
The number of
member nations in
the International
Monetary Fund is
now about six times
larger than it was
when the
organization was
founded.
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IMF Quota Subscriptions
The quota
subscription of each
member nation,
which is
denominated in
SDRs, depends on
the nation’s real
national income. A
country’s quota
subscription
determines its voting
share within the IMF
and how much it is
able to borrow under
standard IMF credit
arrangements.
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The World Bank
• Narrowly specialized, making loans to about 100
developing nations.
• In contrast to the IMF, the World Bank has always
specialized in long-term loans designed to spur longterm development and growth.
• Typically governments seek World Bank loans for
specific projects as opposed to supplementing their
overall budget.
• The wealthiest nations fund most of the World Bank’s
activities, though the Bank also raises funds in private
capital markets.
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