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Risk Analysis in International Banking & Capital Markets: Macro-economic Impacts & Payment, Study Guides, Projects, Research of Finance

A lecture script from a university course on international banking and capital markets, focusing on the topic of measuring and managing risk. The lecture covers various risks to financial markets, systems, and economies, including macro-economic impacts, external issues, monetary impacts, and payments performance. The document also emphasizes the importance of understanding the past as no guide to the future and the significance of trade in the development of international banking and capital markets.

Typology: Study Guides, Projects, Research

2010/2011

Uploaded on 09/11/2011

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International Banks & Capital Markets
Lecture 5: Measuring & managing risk
Monday 08 March
1. Introduction
In considering this topic we will seek to look at a number of risks to
nancial markets, systems and economies and how these impact on
international banking and nance. This list is not exhaustive, nor
exclusive, but takes the opportunity to look at some of the major
issues. These include:
Macro-economic impacts e.g. ination, scal instability and
balance of payment/current account dysfunctionalities
External issues e.g. foreign debt, foreign debt servicing and
FX reserves
Monetary impacts – e.g. exposure to FX risk
Payments performance critical issues about cash ow &
sustainability
I will try to associate each of these topics with a real life case study
scenario, but essentially we have to take a rm grip on the concept
that the past is absolutely no guide to the future. If it were, then we
would have no need for analysts and their like, nor indeed would we
need to employ fund managers; it would simply suce to have large
computers which replicated past indexed portfolios. We could
manage by employing statisticians and economic historians, who
together would provide all the data we needed. Regrettably this is
not the case, yesterday’s boom or bust is not tomorrow’s. The
lesson of 2007-2008 is that we don’t know what is round the corner,
although we can often have a pretty good guess that our rosy
perceptions of ever expanding growth and ever inating property
prices are really bizarre to say the least.
2. Returning to the analysis what is a bank or a
market?
At this point we need to return to our previous analysis – before we
started to look at specic instruments when we posed the
questions about the role and functionality of a bank or a market.
Economic historians will tell us that the origins of banks and of
capital markets can be found in the huge expansion of trade in cities
states such as Firenza, Venezia and the components of the
Hanseatic League (centred on Hamburg) in the late medieval era.
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International Banks & Capital Markets

Lecture 5: Measuring & managing risk

Monday 08 March

1. Introduction

In considering this topic we will seek to look at a number of risks to financial markets, systems and economies and how these impact on international banking and finance. This list is not exhaustive, nor exclusive, but takes the opportunity to look at some of the major issues. These include:

  • Macro-economic impacts – e.g. inflation, fiscal instability and balance of payment/current account dysfunctionalities
  • External issues – e.g. foreign debt, foreign debt servicing and FX reserves
  • Monetary impacts – e.g. exposure to FX risk
  • Payments performance – critical issues about cash flow & sustainability

I will try to associate each of these topics with a real life case study scenario, but essentially we have to take a firm grip on the concept that the past is absolutely no guide to the future. If it were, then we would have no need for analysts and their like, nor indeed would we need to employ fund managers; it would simply suffice to have large computers which replicated past indexed portfolios. We could manage by employing statisticians and economic historians, who together would provide all the data we needed. Regrettably this is not the case, yesterday’s boom or bust is not tomorrow’s. The lesson of 2007-2008 is that we don’t know what is round the corner, although we can often have a pretty good guess that our rosy perceptions of ever expanding growth and ever inflating property prices are really bizarre to say the least.

2. Returning to the analysis – what is a bank or a

market?

At this point we need to return to our previous analysis – before we started to look at specific instruments – when we posed the questions about the role and functionality of a bank or a market.

Economic historians will tell us that the origins of banks and of capital markets can be found in the huge expansion of trade in cities states such as Firenza, Venezia and the components of the Hanseatic League (centred on Hamburg) in the late medieval era.

The financing of trade with the east – spices, silk – and the west – wool, fish – sparked the creation of two types of entity.

TABLE 2.1:

ELEMENTS OF GDP

TABLE 2.2:

ELEMENTS OF THE BALANCE OF TRADE

3. Macro-economic impacts

Our first action is therefore to look at the effect of macro-economic impacts on the symbiotic relationship between business-trade- government and the financial markets in general.

The events of recent years have demonstrated very clearly that we cannot ignore the effect of such factors on banking/markets as interest rates, inflation and the rapid decline of real economic growth.

TABLE 3.1:

GROSS DOMESTIC PRODUCT

2009 QUARTERLY % CHANGE

Country Q1 Q2 Q3 Q Australia 0.8 0.7 0.3 0. Canada -1.8 -0.9 0.2 1. EU-27 -2.5 -0.2 0.3 0. Indonesia 1.1 1.3 1.5 1. Japan -3.2 1.3 0.0 1. USA -1.6 -0.2 0.6 1.

TABLE 3.2:

CONTRIBUTIONS TO GDP: PRIVATE

CONSUMPTION

2009 QUARTERLY % CHANGE

Country Q1 Q2 Q3 Q Australia 0.5 0.9 0.7 0. Canada -0.3 0.4 0.9 0. EU-27 -0.8 -0.2 -0.2 0. Indonesia 1.9 0.4 1.1 0. Japan -1.3 1.1 0.6 0. USA 0.2 -0.2 0.7 0.

TABLE 3.3:

CONTRIBUTIONS TO GDP: GOVERNMENT

CONSUMPTION

2009 QUARTERLY % CHANGE

Country Q1 Q2 Q3 Q

EU-27 -6.3%

Indonesia -2.6% Japan -9.5% USA -14.0%

4. The external economics environment

It is also important to assess the impact of the wider trade flows and related issues. Trade imbalances submit bankers and their customers to a range of pressures – they affect currency values, impact on credit ratings and drive interest rates.

TABLE 4.1:

NET TRADE BALANCE

2009 QUARTERLY AS % OF GDP

Country Q1 Q2 Q3 Q Australia 0.5 ± -0.4 -0. Canada 0.1 -0.2 -0.4 ± EU-27 -0.4 -0.1 ± ± Indonesia 1.1 1.4 0.9 1. Japan -0.2 0.3 0.3 0. USA -1.2 -1.1 -1.2 -1.

TABLE 4.2:

CURRENT ACCOUNT BALANCE

2009 FORECAST AS % OF GDP

Country 2009f Australia -3. Canada -1. EU-27 -1. Indonesia -1. Japan 3. USA -3.

TABLE 4.3:

REAL EFFECTIVE EXCHANGE RATE

OECD DATA 2009 BY QUARTER

Currency Q1 Q2 Q3 Q AUS 87.9 98.4 105.2 112. CAN 94.8 100.3 105.1 108. EUR 104.3 104.7 105.0 106. IDR 100.3 108.1 111.9 115. JPY 104.9 97.4 98.7 100. OECD definition: Real effective exchange rates take account of price level differences between trading partners. Movements in real effective exchange rates provide an indication of the evolution of a country’s aggregate external price competitiveness.

TABLE 4.4:

3-MONTH INTERBANK INTEREST RATE

2009 BY QUARTER

Country Q1 Q2 Q3 Q Australia 3.35 3.16 3.27 3. Canada 1.28 0.70 0.40 0. EU- eurozone

Indonesia 11.04 9.67 8.69 7. Japan 0.69 0.58 0.54 0. USA 1.08 0.62 0.30 0.

5. The risk environment for banks

This then leads on to an element that is crucially important to the role of banks in financing trade and also in the management of cash flows within enterprises. It is an element that also impacts strongly on the credibility of enterprises on a wider level – e.g. on the capital markets – as well as affecting the perceived value of banking institutions in terms of the potential problems that may exist in their lending to enterprises.

TABLE 5.1:

PAYMENT PERFORMANCE OF COMPANIES

As amount of outstanding invoice values paid by

importers to exporters

Country Prompt/< days

30 days + 60 days + 120 days +

Australia 60% 33% 17% 5% Canada 53% 46% 29% 18%

TABLE 5.2:

TERMS OF TRADE

Key issues affecting exporters and those financing

exports to this sample of countries

Country Time delay for bank transfers (months)

Terms of trade (instruments)*

Terms of payment (days)

Export Credit insurance

Australia 0-1 Sight Draft 30 days

Full cover Canada 0-1 Open Account

30 days

Full cover Indonesia 0-2 Letter of credit

30 days

Short Term only Japan 0-1 Sight Draft 30 – 90 days

Full cover USA 0-1 Open Account

30 days

Full cover

* TERMS OF TRADE INSTRUMENTS

Letter of Credit = a guarantee of payment to an exporter from the importer’s bank normally conditional on delivery of goods/services Sight deposit = a bank draft or bill payable on demand or presentation Open account = credit is extended without a note, bill or guarantee

6. FX risk – effects on companies, banks and

economies

TABLE 6:

FX risk – effects on companies, banks and

economies

SCENARIO 1 - DOMESTIC CURRENCY REVALUES (i.e.

strengthens)

+ Imports become cheaper

+ Import cover increases

+ Capital flow attraction – FX reserves improve

+ FDI becomes more attractive

+ Improved borrowing propensity

+ External debt servicing costs decrease

- Exports come under price competition

- Capital inflows lessen in value

weakens)

+ Exports become more competitive

+ Capital inflows increase in value

  • External debt servicing costs increase
  • Imports become dearer
  • Capital flow detraction – FX reserves decline
  • Import cover declines

7. The global financial system – what may go

wrong?

Next week, I will seek to address some further issues relating to the inherent risks in banking and in the operation of capital markets at an international level. This will include the topic of interest rate risk, which we had to abandon this week due to conditions in the lecture theatre.

I will then seek to define how in the very changed world we are now facing, the role of the regulator and of international governmental bodies may be shifting very decisively. Regulation based on principle and light touch has patently and very explosively failed; regulation based on rules – which implies a harder touch – may well be the direction in which we are heading.