5.4 LOAN AND SECONDARY MARKET The Loan Market Association (LMA) is the trade body for the Europe, Middle East and Africa (EMEA) syndicated loan market and was founded in December 1996 by banks operating in that market. Its aim is to encourage liquidity in both the primary and secondary loan markets by promoting efficiency and transparency, as well as by developing standards of documentation and codes of market practice, which are widely used and adopted. Membership of the LMA currently stands at over 650, covering 60+ nationalities, and consists of banks, non-bank lenders, borrowers, law firms, rating agencies and service providers. The LMA has gained substantial recognition in the market and has expanded its activities to include all aspects of the primary and secondary syndicated loan markets. It sees its overall mission as acting as the authoritative voice of the EMEA loan market vis à vis lenders, borrowers, regulators and other interested parties. Syndicated loans started as a way of allowing lenders to lend large sums of money to a single borrower, where the sums involved went far beyond the credit appetite of a single lender. Origination and syndication of the transaction take place in the primary market; it is where lenders lend directly to borrowers, with loans syndicated before the loan is made, or shortly thereafter. Following completion of the transaction, the loan becomes \"free to trade\", subject to the terms and conditions contained in the primary documentation. The secondary loan market refers to the sale and distribution of syndicated loans by lenders in the original syndicate or by subsequent purchasers of the loan. The secondary loan market has aided the growth of the syndicated loan market by opening the market to a wide variety of types of institution, including, amongst others, insurance companies, pension funds and hedge funds, fuelling an increase of liquidity within the primary and secondary markets. The secondary loan market is also an essential tool that lenders use to manage their loan portfolios. The purpose of this guide is to provide an introductory overview of the secondary loan market. Amongst other things, this guide shall provide a target timeline for a typical secondary loan market transaction, including a brief explanation of the documentation which may be entered into by the parties; description of the parties active in the secondary loan market; and description of the common methods used by lenders to transfer syndicated loan participations. The secondary loan market is a private market and data with regard to depth and liquidity is limited. There is no single data source to determine the actual volume of loans traded. Data which is available is collated on a contributor basis, via third party service providers, and reflects in the main only those transactions concluded on an intermediated basis, i.e., those trades which have passed through trading desks, rather than those traded directly between seller and buyer without the involvement of one of the banks contributing to the data 101 CU IDOL SELF LEARNING MATERIAL (SLM)
collation exercise. A 12-year overview of reported volumes, for the years 2004 to 2017, is given below. Given the limitations as described, the expectation would be that actual traded volumes are somewhat higher. Up to the mid-1990s, participation in the secondary loan market in Europe was dominated by a small number of US houses, predominantly investment banks, specialist debt traders and vulture funds, with activity focused on the distressed market. However, from the mid-1990s onwards, institutional investors and other non-bank financial institutions increasingly looked to the secondary loan market to invest their money. Today's secondary loan market is utilized by a diverse and vast number of participants, including investment banks, commercial banks, hedge funds, pension funds, private equity funds and specialist loan brokers, each looking to transact in par, near par and distressed debt. In the distressed market, the diversification and growth in the number of participants follows from the diversification and growth in the number of participants in the leveraged finance market generally. In addition, government agencies, such as the Irish National Asset Management Agency (NAMA), were set up to buy non-performing debt as a result of the 2007-2009 financial crisis. Although there are no statutory or conceptual barriers to a borrower, or its associated companies, buying back its own debt, there may be practical or commercial difficulties in it doing so. We will not explore the possibility of borrower-buy backs in this guide. Par value or near par value loans are traded at or very near to their face value. These are loans that the market considers to be extremely likely to be repaid on time and in full. The secondary loan market in par debt is particularly useful for lenders that wish to change the focus of their lending portfolio by concentrating on, or diversifying away from, particular borrowers, countries or types of business. The purchase of debt may also be used to build a relationship with specific borrowers or particular lenders in a syndicate, especially if the buyer was unable to participate in the original syndication. Distressed debt refers to loans that are unlikely to be repaid in full because the borrower is either in a form of insolvency process or in severe financial distress. Distressed debt typically trades at a significant discount to face value. A buyer will take a view on the likelihood that either a portion of the debt will be repaid as part of the insolvency settlement or that the borrower will recover and the loan will eventually be repaid in full. In some cases, the buyer will buy enough debt to secure influence in the borrower's insolvency or restructuring process, perhaps ultimately assuming control of the borrower. In the latter case, the buyer will make its investment decision based also on its ability to rescue an insolvent or distressed company. Most secured loans traded in the secondary loan market will be syndicated loans that are part of multilateral financing structures, which will often include a security trust arrangement.4 In a syndicated loan, which is documented under English law, a security trustee is typically 102 CU IDOL SELF LEARNING MATERIAL (SLM)
appointed to hold security on trust for all the lenders from time to time. The incoming lenders take the benefit of the security on completion of the trade without any need for any amendments to the security documents or additional registration, as the security itself remains untouched. The use of a security trust arrangement avoids the need for the security to be assigned or for new security to be taken when a loan is transferred. New security would trigger a new registration requirement and, in the event of insolvency, this fresh security would be particularly susceptible to challenge during any hardening periods. In most cases, once a transfer occurs in accordance with the provisions of the facility agreement, the incoming lender becomes a Finance Party and as such, a beneficiary of the security. However, in some cases, the incoming lender may also be required to accede to a security trust deed and/or intercreditor agreement to ensure that they also agree to be bound by the terms of those documents. The form of the accession is usually contained in a schedule to the security trust deed and/or intercreditor agreement. Note that where there are non-English Obligors and/or there is security which is not governed by English law, the security trust arrangement may not be recognised in the relevant jurisdictions. This can be problematic for transfers of the loan and related security. Novation is the only way in which a lender can effectively 'transfer' all its rights and obligations under the facility agreement. The process of transfer by novation effectively cancels the existing lender's obligations and rights under the loan, while the new lender assumes identical new rights and obligations in its place. The contractual relationship between the transferring lender and the parties to the facility agreement ceases and the new lender enters into a direct relationship with the borrower, the agent and the other lenders. At the time the new lender becomes a party to the facility agreement the loan could be fully drawn, particularly if it is a term loan facility. However, particularly in the case of a revolving credit facility, the new lender could be assuming obligations to advance monies to the borrower. All of the parties to the original syndicated facility agreement, including the borrower, need to consent to the novation. The documentation required to affect a novation of a participation in a syndicated loan depends on the provisions in the facility agreement. However, most facility agreements (including the LMA recommended form) contain comprehensive novation provisions in which all parties (including the borrower) agree that, provided the other conditions to any transfer by novation set out in the facility agreement are complied with, they consent to the novation. Most transfers by novation are affected by the execution of a transfer certificate.5 the form of Transfer Certificate is usually attached as a schedule to the facility agreement. Under a funded participation the existing lender (the grantor) and the participant enter into a contract providing that, in return for the participant paying the grantor an amount equal to all 103 CU IDOL SELF LEARNING MATERIAL (SLM)
or part of the principal amount loaned by the grantor to the borrower, the grantor will pay the participant an amount equal to all or the relevant share of principal and interest received by the grantor from the borrower in respect of that amount. In a funded participation, the participant agrees that its deposit will be serviced (in terms of payment of interest) and repaid only when the borrower services and repays the loan from the grantor. The funded participation agreement must ensure that the grantor is put in funds in time to meet the borrower's demands for drawdown. Therefore, the participant takes a double credit risk, that of the borrower failing to pay and of the grantor failing to pay. The secondary loan market has aided the growth of the syndicated loan market by opening the market to a wide variety of types of institution, fuelling an increase the syndicated loan market by opening the market to a wide variety of types of institution, fuelling an increase of liquidity within the primary and secondary markets. The secondary loan market is also an essential tool that lenders use to manage their loan portfolios. The aim of this is to provide an overview of the role of the secondary market in the syndicated loan market, identifying, amongst other things, participants active in the secondary loan market, the types of debt available, a typical anatomy of a trade and the different transfer mechanisms. 5.5 SUMMARY We specify a model that identifies the factors that determine whether a loan is likely to be syndicated and, if so, to what extent. Our dependent variable, loan is likely to be syndicated and, if so, to what extent. Our dependent variable, the percentage of a particular loan that is syndicated, is somewhat similar to that of Gorton and Pennachi, who examine the proportion of a loan that is sold. Their sample consisted strictly of loans sold, however. Our sample includes non-syndicated loans, which assume a value of zero. The proportion of a loan that will be syndicated depends generally on the agent’s underlying motives for selling and on the scope of the agency problems associated with syndication. Accordingly, variables that reflect potential information asymmetries are a critical part of the model, as are variables that represent potential solutions 12 to these problems. Some of the latter variables may be captured in certain characteristics of the individual loan, although some loan attributes—such as loan size—may be related to the underlying motivations for syndication. Similarly, certain characteristics of the agent bank may affect the syndication potential of a given loan, either as a mechanism for resolving agency problems or as a reflection of the underlying motives for syndications. Pennachi demonstrates how agency problems limit loan sales in the sense that a seller’s ability to market loans depends on the buyer’s perception of the seller’s incentive to monitor. 104 CU IDOL SELF LEARNING MATERIAL (SLM)
Pennachi argues that when the benefits to monitoring are negligible, a loan can be sold in its entirety. Greenbaum and Thakur demonstrate formally that, under certain conditions, banks will sell or securitize higher-quality assets and retain lower quality loans on their balance sheets. Mester presents evidence suggesting that it is less costly for a bank to monitor a loan that it has originated compared to a loan that it has purchased. The implication of this research is that loans that involve information which is “transparent” have higher syndication potential than loans involving “opaque” information. We employ several different measures of the quality of the information available in a specific loan transaction, including the existence of a public credit rating, whether the borrower is a publicly-listed firm, and the annual sales of the borrower in the year the loan closed. We argue that information is likely to be more transparent when the borrower has a credit rating or is a listed firm or when the borrower is large. Increased transparency in turn raises the likelihood that a larger sales). Increased transparency in turn raises the likelihood that a larger proportion of a particular loan can be syndicated. Certain characteristics of the loan itself may affect the agent bank’s capacity to syndicate either because the characteristic serves to attenuate agency costs or because it influences the perceived value to the buyer for nonagency related reasons. The maturity and the status of the loan with respect to collateral are two such characteristics. A number of potential channels exist that might affect a loan’s syndication potential and the likely impacts are not unidirectional. If there is significant potential for the lead/agent bank to exploit the syndicate members, then keeping loan maturity short could serve to minimize such a prospect. Short-term loans involve less opportunity for the agent bank to shirk, for example, and short maturities are likely to involve frequent requests for renewals, which triggers more frequent monitoring of the borrower and the agent by the syndicate members. Gorton and Pennachi argue that “banks are less likely to shirk in information production or covenant monitoring” when selling loan “strips,” which are short-term segments of longer-term loans. The reason is that the selling bank intends to resell the strip on the date it matures to avoid having to fund it. These arguments suggest that lengthening a loan’s maturity would reduce its potential for successful syndication. On the other hand, frequent renewals also increase the overall monitoring costs for the set of syndicate banks. Diamond demonstrates how the avoidance of 14 duplicative monitoring costs helps provide a rationale for the existence of financial intermediaries. Syndication results in duplicative monitoring by its very nature. Since the majority of syndicated loans involve variable-rate pricing, which minimizes interest rate risk, syndicate members 105 CU IDOL SELF LEARNING MATERIAL (SLM)
might prefer longer-term claims on the borrower’s cash flows to avoid “excessive” monitoring costs. 5.6 KEYWORDS Certificate of Manufacture – A statement, sometimes notarized, by a producer who is usually also the seller of merchandise that manufacture has been completed and that goods are at the disposal of the buyer. Certificate of Origin – A document issued by the exporter certifying the place of origin of the merchandise to be exported. The information contained in this document is needed primarily to comply with tariff laws that may extend more favourable treatment for products from certain countries. Chain – A method of calculating cross rates. For example, if a foreign-exchange trader knows the exchange rate for euros against U.S. dollars and for Mexican pesos against U.S. dollars, the chain makes possible the calculation of the cross rates for euros against Mexican pesos. Documents Against Acceptance (D/A) – Instructions given by an exporter to a bank that the documents attached to a draft for collection are deliverable to the drawee only against their acceptance of the draft. Documents Against Payment (D/P) – Instructions given by an exporter to their bank that the documents attached to a draft for collection are deliverable to the drawee only against their payment of the draft. 5.7 LEARNING ACTIVITY 1. Create a survey on Loan and Secondary Market. ___________________________________________________________________________ ___________________________________________________________________________ 2. Create a session on Syndication Process and Main Actors. ___________________________________________________________________________ ___________________________________________________________________________ 5.8 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. What are Personal Loans? 106 CU IDOL SELF LEARNING MATERIAL (SLM)
2. What is Credit Card Loans? 3. Define Syndication Process? 4. Define Payday Loans? 5. What do you mean by Home Renovation Loan? Long Questions 1. Illustrate the Syndication Process and Main Actors. 2. Illustrate the Types of Loan. 3. Explain the concept of Personal Loans. 4. Explain the concept of Loan and Secondary Market. 5. Examine the concept of Home Renovation Loan. B. Multiple Choice Questions 1. Which of the following is a reason to hedge a portfolio? a. To increase the probability of gains b. To limit exposure to risk. c. To profit from capital gains when interest rates fall. d. All of these 2. What does happen by hedging risk for a long position is accomplished? a. Taking another long position. b. Taking additional long and short positions in equal amounts. c. Taking a neutral position d. Taking a short position. 3. What happens by hedging risk for a short position is accomplished? a. Taking a long position. b. Taking another short position. c. Taking additional long and short positions in equal amounts. d. Taking a neutral position. 4. What does a contract require the investor to buy securities on a future date is called? a. Short contract. b. Long contract. c. Hedge 107 CU IDOL SELF LEARNING MATERIAL (SLM)
d. Cross 5. What is a long contract requiring from the investor? a. Sell securities in the future. b. Buy securities in the future c. Hedge in the future d. Close out his position in the future Answers 1-b, 2-d, 3-a, 4-b, 5-b 5.9 REFERENCES References book Berger, Allen and Gregory Udell, 1990, Collateral, loan quality, and bank risk, Journal of Monetary Economics. Berger, Allen and Gregory Udell, 1993, Securitization, risk, and the liquidity problem in banking, in Michael Klausner and Lawrence White, Eds.: Structural Change in Banking (Irwin Publishing). Berger, Allen and Gregory Udell, 1995, Relationship lending and lines of credit in small-firm finance, Journal of Business. Textbook references Booth, James and Richard Smith, 1986, Capital raising, underwriting, and the certification hypothesis, Journal of Financial Economics. Carey, Mark, Stephen Prowse, John Rea, and Gregory Udell, 1993, The economics of private placements: a new look, Financial Markets, Institutions, and Instruments 2. Cole, Rebel, 1998, The importance of relationships to the availability of credit, Journal of Banking and Finance. Website https://corporatefinanceinstitute.com/resources/knowledge/credit/loan-analysis/ https://study.com/academy/lesson/what-is-a-loan-definition-types-advantages- disadvantages.html https://en.wikipedia.org/wiki/Loan 108 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT 6 – INTERNATIONAL BANKING AND DEVELOPMENT STRUCTURE 6.0 Learning Objectives 6.1 Introduction 6.2 Bank Lending in Emerging Economies 6.3 Microfinance 6.4 Bank Lending and Sustainability 6.5 International Monetary System (IMF) 6.6 World Bank 6.7 IDB 6.8 WTO 6.9 UNCTAD 6.10 Summary 6.11 Keywords 6.12 Learning Activity 6.13 Unit End Questions 6.14 References 6.0 LEARNING OBJECTIVES After studying this unit, you will be able to: Illustrate the concept of International Monetary System Explain the concept of Bank Lending and Sustainability Illustrate the concept of Bank Lending in Emerging Economies 6.1 INTRODUCTION At the Bretton Woods Conference in 1944 it was decided to establish a new monetary order that would expand international trade, promote international capital flows and contribute to monetary stability. The IMF and the World Bank were borne out of this Conference of the end of World War II. The World Bank was established to help the restoration of economies disrupted by War by facilitating the investment of capital for productive purposes and to 109 CU IDOL SELF LEARNING MATERIAL (SLM)
promote the long-range balanced growth of international trade. On the other hand, the IMF is primarily a supervisory institution for coordinating the efforts of member countries to achieve greater cooperation in the formulation of economic policies. It helps to promote exchange stability and orderly exchange relations among its member countries. It is in this context that the present chapter reviews the purpose and working of some of the international financial institutions and the contributions made by them in promoting economic and social progress in developing countries by helping raise standards of living and productivity to the point of which development becomes self-sustaining. One major source of financing is international non-profit agencies. There are several regional development banks such as the Asian Development Bank, the African Development Bank and Fund and the Caribbean Development Bank. The primary purpose of these agencies is to finance productive development projects or to promote economic development in a particular region. The Inter-American Development Bank, for example, has the principal purpose of accelerating the economic development of its Latin American member countries. In general, both public and private entities are eligible to borrow money from such agencies as long as private funds are not available at reasonable rates and terms. Although the interest rate can vary from agency to agency, these loan rates are very attractive and very much in demand. Of all the international financial organisations, the most familiar is the World Bank, formally known as the International Bank for Reconstruction and Development (IBRD). The World Bank has two affiliates that are legally and financially distinct entities, the International Development Association (IDA) and the International Finance Corporation (IFC). Exhibit 1 provides a comparison among IBRD, IDA and IFC in terms of their objectives, member countries, lending terms, lending qualifications as well as other details. All three organisations have the same central goals: to promote economic and social progress in poor or developing countries by helping raise standards of living and productivity to the point at which development becomes self-sustaining. Toward this common objective, the World Bank, IDA and IFC have three interrelated functions and these are to lend funds, to provide advice and to serve as a catalyst in order to stimulate investments by others. In the process, financial resources are channelled from developed countries to the developing world with the hope that developing countries, through this assistance, will progress to a level that will permit them, in turn, to contribute to the development process of other less fortunate countries. Japan is a prime example of a country that has come full circle. From being a borrower, Japan is now a major lender to these three organisations. South Korea is moving in a direction similar to that of Japan nearly a quarter of a century ago. The World Bank group is a multinational financial institution established at the end of World War II (1944) to help provide long-term capital for the reconstruction and development of member countries. The group is important to multinational corporations because it provides much of the planning and financing for economic development projects involving billions of 110 CU IDOL SELF LEARNING MATERIAL (SLM)
dollars for which private businesses can act as contractors and suppliers of goods and engineering related services. The IBRD was set up in 1945 along with the IMF to aid in rebuilding the world economy. It was owned by the governments of 151 countries and its capital is subscribed by those governments; it provides funds to borrowers by borrowing funds in the world capital markets, from the proceeds of loan repayments as well as retained earnings. At its funding, the bank’s major objective was to serve as an international financing facility to function in reconstruction and development. With Marshall Plan providing the impetus for European reconstruction, the Bank was able to turn its efforts towards the developing countries. Generally, the IBRD lends money to a government for the purpose of developing that country’s economic infrastructure such as roads and power generating facilities. Funds are directed towards developing countries at more advanced stages of economic and social growth. Also, funds are lent only to members of the IMF, usually when private capital is unavailable at reasonable terms. Loans generally have a grace period of five years and are repayable over a period of fifteen or fewer years. The projects receiving IBRD assistance usually require importing heavy industrial equipment and this provides an export market roar many US goods. Generally, bank loans are made to cover only import needs in foreign convertible currencies and must be repaid in those currencies at long-term rates. The government assisted in formulating and implementing an effective and comprehensive strategy for the development of new industrial free zones and the expansion of existing ones; reducing unemployment, increasing foreign-exchange earnings and strengthening backward linkages with the domestic economy; alleviating scarcity in term financing; and improving the capacity of institutions involved in financing, regulating and promoting free zones. The World Bank lays special operational emphasis on environmental and women’s issues. Given that the Bank’s primary mission is to support the quality of life of people in developing member countries, it is easy to see why environmental and women’s issues are receiving increasing attention. On the environmental side, it is the Bank’s concern that its development funds are used by the recipient countries in an environmentally responsible way. Internal concerns, as well as pressure by external groups, are responsible for significant research and projects relating to the environment. The women’s issues category, specifically known as Women in Development (WID) is part of a larger emphasis on human resources. The importance of improving human capital and improving the welfare of families is perceived as a key aspect of development. The WID initiative was established in 1988 and it is oriented to increasing women’s productivity and income. Bank lending for women’s issues is most pronounced in education, population, health and nutrition and agriculture. The IDA was formed in 1960 as a part of the World Bank Group to provide financial support to LDCs on a more liberal basis than could be offered by the IBRD. The IDA has 137 member countries, although all members of the IBRD are free to join the IDA. IDA’s funds come from subscriptions from its developed members and from the earnings of the IBRD. 111 CU IDOL SELF LEARNING MATERIAL (SLM)
Credit terms usually are extended to 40 to 50 years with no interest. Repayment begins after a ten-year grace period and can be paid in the local currency, as long as it is convertible. Loans are made only to the poorest countries in the world, those with an annual per capita gross national product of $480 or less. More than 40 countries are eligible for IDA financing. An example of an IDA project is a $8.3 million loan to Tanzania approved in 1989 to implement the first stage in the longer-term process of rehabilitating the country’s agricultural research system Financing is expected from several countries as well as other multilateral lending institutions. Although the IDA’s resources are separate from the IBRD, it has no separate staff. Loans are made for similar projects as those carried out by IBRD, but at easier and more favourable credit terms. As mentioned earlier, World Bank/IDA assistance historically has been for developing infrastructure. The present emphasis seems to be on helping the masses of poor people in the developing countries become more productive and take an active part in the development process. Greater emphasis is being placed on improving urban living conditions and increasing productivity of small industries. The IFC was established in 1956. There are 133 countries that are members of the IFC and it is legally and financially separate from the IBRD, although IBRD provides some administrative and other services to the IFC. The IFC’s main responsibilities are to provide risk capital in the form of equity and long-term loans for productive private enterprises in association with private investors and management; To encourage the development of local capital markets by carrying out standby and underwriting arrangements; and to stimulate the international flow of capital by providing financial and technical assistance to privately controlled finance companies. Loans are made to private firms in the developing member countries and are usually for a period of seven to twelve years. The key feature of the IFC is that its loans are made to private enterprises and its investments are made in conjunction with private business. In addition to funds contributed by IFC, funds are also contributed to the same projects by local and foreign investors. IFC investments are for the establishment ne1x enterprises as well as for the expansion and modernization of existing ones. They cover a wide range of projects such as steel, textile production, mining, manufacturing, machinery production, food processing, tourism and local development finance companies. Some projects are locally owned, whereas others are joint ventures between investors in developing and developed countries. In a few cases, joint ventures are formed between investors of two or more developing countries. The IFC has also been instrumental in helping to develop emerging capital markets 6.2 BANK LENDING IN EMERGING ECONOMIES The global financial crisis shook the foundations of international banking and finance and put the international banking system under intense stress. Many financial markets became dysfunctional, and many international banks went bankrupt. Although the crisis originated in advanced economies, it quickly moved to emerging market economies (EMEs), particularly 112 CU IDOL SELF LEARNING MATERIAL (SLM)
in the aftermath of the collapse of Lehman Brothers. Cross-border bank lending proved to be one of the major financial channels through which stresses in the international financial system were transmitted to individual EMEs. This examines cross-border bank lending during the crisis. It also aims to understand the role played by international banks and hopes to provide lessons for thinking about economic policy. Cross-border lending to EMEs declined steeply during the crisis. Economies and banks relying on wholesale funding were hit especially hard. This decline raises many questions for policymakers – perhaps the most important one concerns the drivers of the decline. Although the decline in cross-border lending is necessarily linked to the international banks which provide those loans, a careful look suggests a more nuanced picture of their role. In particular, even though international lending fell substantially during the crisis, there was a slight increase in domestic currency loans provided by international banks to local affiliates. Based on consolidated claims of BIS reporting banks, Graph 1 contrasts international claims and the local claims of their affiliates in local currency. The heterogeneity of international banks may reveal further nuances. As the example of Mexico suggests, centralized international banks were perhaps more likely to respond to local market disturbances and limit lending than decentralized ones. There is also considerable geographic heterogeneity. Different regions have experienced very different economic developments, which as an important demand factor – could explain some of the outcomes. For instance, financial flows to China have stabilized faster than in the rest of emerging Asia. However, it seems that there are some common factors across regions which are not fully explained by economic fundamentals. For instance, financial flows have reversed sharply both in booming China and in emerging Europe. This could potentially be explained by supply factors. The second section of this examines the supply and demand factors in cross-border lending, and finds that supply factors were the main drivers in the fall in cross-border bank lending to emerging markets. The demand for cross-border bank lending also declined, but it played a much smaller role. This contrasts with a much more balanced impact prior to the crisis. The section examines further, more detailed, evidence from some particularly affected countries. Certain well-performing economies, such as China or India, faced a withdrawal of cross-border lending which was unexplained by credit demand factors. Nevertheless, supply effects were not uniformly negative: for instance, parent banks seem to have supported banking operations in Hungary during the financial crisis. This heterogeneity in experiences suggests that a nuanced view might be appropriate for assessing the role of international banks before and during the global financial crisis. The remainder of the paper is organised as follows: the third section examines the types of cross-border lending and the most affected sectors. The fourth section documents the available evidence on lending conditions. The fifth section examines the role of parent banks and the final section concludes with implications for the future. The changing role and organization of international banks seems to be a major factor in cross-border bank lending. Three main stylized facts regarding the changes in international 113 CU IDOL SELF LEARNING MATERIAL (SLM)
banking appear to have been relevant for cross-border lending to emerging markets in the last two decades. First, foreign banks became major players in the domestic financial markets of most emerging markets. By the end of 2008, total bank lending of foreign banks and their affiliates exceeded US$ 1,500 billion in emerging Asia, US$ 900 billion in emerging Europe and US$ 800 billion in Latin America. Second, the expansion of international banks mainly took the form of increased domestic currency lending by local affiliates, especially in Latin America. This implies that cross-border bank lending became relatively less important in those regions. In essence, many of those subsidiaries operate almost as local banks – with foreign ownership. Furthermore, currency mismatches were also limited in those regions. Finally, domestic currency lending by local affiliates suggests that when thinking about the role of international banks aside from cross-border lending, a wider context also needs to be considered. However, somewhat exceptionally, emerging Europe remained largely reliant on cross border lending. Such reliance, especially on cross-border wholesale funding, exposed the banking sector to the risks of sudden stops. The risks were exacerbated by foreign currency loans creating currency mismatches. However, foreign bank participation needs to be evaluated by assessing long-term impacts, as focusing solely on the crisis period could be misleading. For instance, the Magyar Nemzeti Bank notes that increasing foreign bank presence together with bank privatization improved the functioning of the banking sector in Hungary. Third, two distinct models of international banking have emerged, creating substantial heterogeneity in cross-border bank lending and bank behaviour. On the one hand, some international banks centralized liquidity management, capital structure and lending decisions (e.g., Deutsche Bank and UBS), linking emerging market activities more closely to the aggregate lending decisions of the bank. On the other hand, some banks decentralized these activities, managing liquidity separately (BBVA and HSBC). Of course, there are many dimensions to the structure of international banking, and the broad characterization referred to above could be further refined for policy purposes. The structure of international banking could have been important in the crisis. Preliminary evidence from Mexico suggests that decentralized banks provided more stable lending during the crisis.3 Bank Negara Malaysia also notes that requiring foreign banks to be locally incorporated and committing capital locally limited any contagion effects. Hence, it is possible that distressed centralized banks could not provide adequate lending to relatively robust emerging markets. However, in other cases, centralized banks might have been able to provide support for severely distressed markets by quickly reallocating liquidity. The decline in cross-border lending to emerging markets coincided on the one hand with falling export demand (and, in many cases, sharply falling domestic output) and, on the other hand, with severe stress experienced by internationally active banks. Thus, it seems obvious that both demand and supply factors played a role. This section aims to assess these impacts and examine which effect was stronger during the financial turmoil. It finds that supply factors seem to have played a larger role in determining cross-border bank lending. First, a 114 CU IDOL SELF LEARNING MATERIAL (SLM)
panel regression framework is used on BIS data to disentangle demand and supply factors in cross-border bank lending. Second, further investigations are undertaken to examine the roles of demand and supply using alternative measures. The analysis uses a panel regression framework that incorporates a global supply factor and country-specific demand factors. The dataset covers quarterly data from 21 emerging market countries between early 1995 and the third quarter of 2009: Argentina, Brazil, Chile, China, the Czech Republic, Hong Kong SAR, Hungary, India, Indonesia, Israel, Korea, Malaysia, Mexico, Peru, the Philippines, Poland, Russia, Singapore, South Africa, Thailand and Turkey. Currency-adjusted locational claims are used as the dependent variable. The advantage of using BIS locational statistics is that they measure cross-border lending exactly,i.e., consistently with the principles underlying national accounts and balance of payment statistics. By contrast, the consolidated statistics measure international claims, which also include local claims in foreign currency besides cross-border lending. These local claims in foreign currency are not directly relevant for balance of payment financing, and might therefore bias the results. They are also substantial in many emerging economies, so any bias might be non-trivial. Furthermore, changes in locational claims are also available in currency-adjusted form, which is not the case for consolidated data. However, using locational data also involves trade-offs. Most importantly, it only allows global supply factors to be identified. In contrast to consolidated data, the locational statistics do not permit researchers to exploit information in the variation across lender countries due to the presence of financial centres, such as London, which intermediate bank lending. These intermediated claims show up twice in the locational data: first, between the original lender’s country and the financial centre, and second, between the financial centre and the end destination. Since it is not possible to track flows from their origin to their destination, bilateral flows cannot be explained by demand and supply factors of the two countries involved. The analysis uses the normalized quarterly volatility of the S&P 500 financial index for the global supply factor. Volatility tends to be high in periods of stress, which is in turn negatively related to credit supply. Higher volatility also implies that it is more difficult for banks to raise additional capital, which also limits credit supply. A further advantage is that volatility is computed from stock prices, which are based on large trading volumes and have a long track record. The most important demand factor in the analysis is quarterly GDP. This follows straightforwardly from the standard credit equation: higher levels of output require more credit, including more cross-border lending. Takats shows the robustness of the above demand and supply specification. The impact of country-specific demand factors and a global supply factor on cross-border lending is estimated in a panel regression. The benchmark model estimates demand and supply factors jointly. All coefficients have the right sign and are statistically significant. The size of coefficients also seems plausible: a 1% increase in output is associated with an increase in cross-border bank lending of around 0.2%. However, the demand and supply factors are correlated, which calls for the standalone “demand only” and “supply only” estimates. By omitting the other variable, these standalone models force 115 CU IDOL SELF LEARNING MATERIAL (SLM)
their respective coefficients to assume the full effect of correlation between the two variables. They therefore provide upper bounds for the demand and supply effects, respectively. The relative proximity of the standalone and the respective benchmark coefficients suggests that the correlation does not substantially affect the magnitude of the estimates. 6.3 MICROFINANCE This book is an outcome of my research and teaching experience of around one decade of the field of microfinance experience of around one decade of the field of microfinance and rural banking in Sri Lanka and the knowledge gathered by attending various local and international seminars, meetings, conferences, discussions and trainings for many years. Further, my interest of studying and reviewing of relevant research studies in the field of microfinance and rural financing motivated me to disseminate the insight that I have gathered for interested and needy people. The key objective of this book is to provide basic and essential knowledge needed by people who are involved in various ways in the field of microfinance and those who working and managing Microfinance Institutions (MFIs), bankers, university lecturers, students, investors, professional and development practitioners in this field. The concept of microfinance is just not only providing financial facilities, it essentially includes ethical and moral values and social responsibility to eliminate worldwide poverty as a noble mission. The original strategy of microfinance was non-profit oriented and anticipated eliminating poverty. In the present day more and more financial intermediaries are entering into the microfinance sector due to globalization, popularity of the concept and market competition. Some of the intermediaries enter this market with the motive of profit earning for their viability and sustainability, while meeting their social responsibility and serving the vulnerable women their social responsibility and serving the vulnerable women and poor in the society. The surveys conducted in the field of microfinance and banking in the past three decades in many developing countries show that the size of informal financial markets which is larger than formal markets. Consequently, the contribution by the informal sector for the fulfilling of financial requirements of poor has to be recognized as well. The contribution of MFIs is more important for the development of this sector, and the channels of microfinance, approaches of microfinance, fundamentals of microfinance, modern banking and microfinance systems, micro credit and microfinance are illustrated in this book. As a fundamental of microfinance, it has to operate and ensure viability and sustainability in an increasingly competitive environment by focusing on the service delivery with exceptional customer service. The correct market strategies and the role of microfinance to eliminate poverty and economic development have to be included in the process. Chapter two and three has discussed literature on microfinance activities and operations in various countries and regions in recent past. Chapter two has illustrated global microfinance scene and emerging lessons in greater details. Chapter three mainly has discussed the microfinance intervention process in Sri Lanka. Most of these currently available studies both international and local, are basically limited in analysing the impact of microfinance intervention on poverty and empowerment of 116 CU IDOL SELF LEARNING MATERIAL (SLM)
women clients but not the other aspects of microfinance such as approaches of microfinance, institutional strategies and impact of microfinance on poverty, and socioeconomic and political vulnerability reduction of low-income groups, particularly women. Access to financial services has long been recognized as an important means of improving income generation opportunities and overall living conditions among poor households. As an approach, microfinance appeared as a strategy to address the institutionalized exclusion of the poor from formal financial systems. As a tool for poverty reduction microfinance is based on the premise that improved access to credit by the poor is crucial to improve the returns to economic activities; it expands self-employment and promotes business and entrepreneurial activities; it allows incomes to grow and provides a “safety net” to the poor who are vulnerable to income fluctuations. Chapter four of this book is dedicated to the approaches and models of microfinance in Sri Lanka and the world. Approaches of microfinance, aspects of outreach, poverty, microfinance and economic well-being, and women empowerment and social capital are the main theoretical and conceptual parts of the chapter. Over the past three decades, MFIs have adopted innovative ways of providing services to poor entrepreneurs, especially in developing countries. Mainly two main approaches can be identified. In terms of the first approach that is portrayed as the Minimalist Approach the MFIs offer only financial services in the form of credit. These MFIs are unwilling to provide non-financial services due to multiple reasons ranging from high administrative costs to high transaction costs. On the other hand, MFIs that follow Credit-plus Approach provide other services in addition to financial services. These non-financial services may include skill development, training, educational activities, marketing assistance, supply of inputs and business development services1. According to them, the provision of credit alone will not guarantee that the receivers of credit use scarce capital in productive manner so that the recovery of loans is capital in productive manner so that the recovery of loans is not ensured. It is interesting to note that these services are increasingly being recognized as an important component of microfinance intermediation as they are associated with the viability and sustainability of the enterprise. Moreover, it is believed that the viability and sustainability of enterprises will in turn ensure financial viability and sustainability of the relevant MFIs. Even though this is not a direct financial service, it is part of the financial package offered by a financial institution and should be kept in mind when outreach of financial intermediation is studied. Under these broader two main approaches there are lots of microfinance models operating in the field. The most popular microfinance models are Grameen Bank (Bangladesh) model, Self-Group (SHG – India) model, and MFIs model and NGOs. All over the world microfinance models are replicated by one another in search of best practices and working models. In the process of replication, the authorities should deeply understand ‘what microfinance strategy is’, and the lending models of MFIs vary substantially depending on the characteristics of target groups, environment of the country, local rules and regulations and organizational philosophies. Once the products (credit, savings, insurance, remittances, leasing, housing and pawning) and services are provided to the poor it is important to assess the socioeconomic 117 CU IDOL SELF LEARNING MATERIAL (SLM)
impact and further improve the system. The impact assessment of post evaluation can identify the factors affecting creating poverty and vulnerability, and such factors would help in formulating strategies, which can address poverty reduction. The widely used impact assessment methods are randomized such as training on business and financial management, accounts/book keeping. pre-test post-test evaluation method, quasi-experimental design method, ex-post comparison of project and non-equivalent control group method, and rapid assessment exposit impact evaluations method. The main issue with these impact evaluation methods is the operation cost, time and man power. Some impacts which can be identified are increase of household’s income, accumulated assets, number who crossed the poverty line, reduced socioeconomic vulnerability, empowerment of women, reduced isolation, find basic needs, and savings provided for the safety of the poor, etc. Understanding the operational process and impacts of MFIs and their impacts on living standards of households is essential for the analysis of issues that affect the demand for and supply of microfinance. Therefore, Chapter five and six of this book attempts to evaluate the nature and patterns of activities, current status, and services provided by SEEDS and TCCSs in the Kandy District with reference to minimalist and credit-plus approaches. The analysis of the current status as presented here is a subjective one, based on the perceptions of the MFIs interviewed and the secondary data gathered from relevant institutions. The demand side analysis, Chapter six discusses impacts of microfinance on household income and overall living conditions. Further, it analyses the extent to which households have utilized financial services, and explore the disparities between TCCSs and SEEDS, gender and income groups with special attention on minimalist and credit plus approaches. The family/household is considered as the centre of this analysis. The reason is that small enterprises in rural economies are closely linked with the family/household. Microfinance can be defined as the provision of a broad range of financial services such as deposits, credits, broad range of financial services such as deposits, credits, payment services to the poor and low-income households and their microenterprises. The discourse on microfinance traverses several fields and interconnects with issues of economic globalization and neoliberal policies, strategies for poverty and vulnerability reduction, and pathways for women’s empowerment. Its credibility has grown over the last few decades, including international legitimation of it as a tool for addressing poverty and socio-economic vulnerability. The Microcredit Summit held in Washington DC in 1997, recognized it as a “miracle tool” for poverty reduction. It focused on four themes – reaching the poorest, the empowerment of women, building self-sufficient financial institutions and ensuring a positive and measurable impact on the lives of clients and their families. A vast empirical and theoretical literature on poverty reduction and microfinance exists as microfinance is considered to be an entry point in a wider strategy for enlarging poor’s lively-hood options. However, the existing evidence on the impact of microfinance on poverty and vulnerability reduction of poor is ambiguous. While some research work suggests that access to microfinance has the potential to reduce suggests that access to microfinance has the potential 118 CU IDOL SELF LEARNING MATERIAL (SLM)
to reduce poverty significantly, others argue that microfinance has a minimal impact on poverty reduction. Comparative study of Vanuatu and El Salvador, Daley-Harris and Zimmerman showed that when microfinance is used to meet day-to-day consumption it can lead to debt for the borrowers. MFIs be they a bank, a cooperative, a credit union, and NGO or some other form of non-bank financial intermediary, NGO or some other form of non-bank financial intermediary, seek to provide clients or low-income households with a range of money management and banking services. Microfinance appeared as a strategy to address the institutionalized exclusion of the poor, especially women, from formal financial systems. Microfinance as a tool for poverty and vulnerability reduction is based on the premise that improved access to credit by the poor is crucial to improve the returns to economic activities; it expands self-employment and promotes business and entrepreneurial activities; it allows incomes to grow and provides a “safety net” to the poor who are vulnerable to income fluctuations. Innovative financial services such as especially credit and savings are expected to break the vicious cycle of poverty. According to Younus a virtuous circle can be established: “low income, credit, investment, more income, more credit, more investment, and more income”. Most governments in LDCs have tried to improve their finance management because they believe that economic development is inhibited due to people in rural sector being too poor, lack of capital and high interest rates when they borrow from the informal money market. Commercial Banks are generally urban biased. They serve mainly urban/sub urban elite groups. And also, commercial banks probably target the business sector. As microfinance has become recognized as a valuable tool for increasing the livelihoods and reducing vulnerability, many World Bank project planners have become eager to include microfinance components in social funds and other multisectoral projects. One of the recent studies has revealed that Sri Lankan financial market is essentially a microfinance market with over 80 percent of households having total borrowings below Rs. 100,0001. With the objective of fulfilling these below Rs. 100,0001. With the objective of fulfilling these small credit requirements various approaches and programs have been advocated on the role of microfinance in poverty and vulnerability reduction. All these programs are aimed at providing access to credit for poor people at affordable interest rates. In addition to the government, a wide range of semiformal institutions, private institutions such as non- governmental organizations (NGOs) and some social institutions are also working in the sector. However, the achievements have been inadequate, especially in terms of reaching the small entrepreneurs. The main reason is that these programs include terms and conditions that are not favourable to the rural poor. Among these conditions are the collateral requirements from the institutions that made the loan beyond the reach of the poor. Other problems associated with the programs are lack of program planning, clear-cut policy directives, small loan amount, inappropriate training and coordination among banks and line agencies. Having being driven from the formal credit markets due to these stringent conditions, poor 119 CU IDOL SELF LEARNING MATERIAL (SLM)
entrepreneurs’ resort to borrowing from informal sources. This may affect the rating of formal sector financial services for micro-entrepreneurs. This study describes recent developments of microfinance intervention process at the global level in general and Sri Lanka, in particular. It also examines how and to what extent microfinance intervention can contribute to improvement of households’ income generation opportunities, overall living conditions and reduce poverty and vulnerability. To study the different approaches of microfinance intervention and their 1 Ministry of Finance and Planning and GTZ. 6.4 BANK LENDING AND SUSTAINABILITY Adequate financial markets are core to sustainable development. To make the right capital allocation decision, return on investment should incorporate the social and environmental (E&S) allocation decision, return on investment should incorporate the social and environmental (E&S) variables impacting, negatively or positively, such investment. The allocation of resources, the identification of risks and opportunities and the pricing of financial assets and liabilities must reflect these impacts. This values-based capital allocation relies on sound corporate governance structures that guide the decision-making process towards sustainability objectives. Such objectives imply that the use of natural capital must be done while still preserving the stock of capital, and assuring that all generations live off the income-flow of such stock. At the same time financial markets should further engage in growth and redistribution models to create wealth for and inclusion of the bottom of the pyramid Long-term financial sustainability is then aligned with environmental sustainability and social inclusion. In this sense, given their financial intermediation role, banks and other financial intermediaries (FIs), are able to catalyse, promote and influence social change. Such influence can be exercised through their direct and indirect sustainability footprint. Banks intermediation role and high capillarity shapes their sustainability footprint. Banks have numerous stakeholders (employees, clients, regulators, shareholders, etc.), wide geographic and industry coverage, maintain multiple layers of inter-relation with the communities they serve, have a large employee base and are users of multiple buildings throughout their branch networks. Furthermore, many are global players with influence and impact throughout the globe. This capacity to have impact across industries, businesses, geographic locations, governments and society as a whole, provides for a fundamental opportunity and a social responsibility to foster the required transformation of current business models. The type of social change needed to achieve this essential reconciliation between financial intermediation and sustainability is a renewed infrastructure for doing business. One that incorporates as fiduciary objectives, in addition to traditional financial and economic values, the E&S values at the core of sustainable development. This evolving business infrastructure is shaping into different models that aim to differentiate from “business as usual”. Business models that range from creating new legal corporate structures such as B Corporations 1 Four billion people living on less than US$2 per day. 5, to ones that look at going-back to the roots of capitalism as opposed to its degradation into a “crony capitalism”. One that does not fully 120 CU IDOL SELF LEARNING MATERIAL (SLM)
serve the social inclusion and respect to the environment at the levels required to foster long- term sustainable development. The discussion has evolved around the need to identify new models of economic growth, social transformation, consumption patterns and innovation trends that foster the healthy growth of business at sustainable levels and the wellbeing of society and the planet. Bill George in the foreword of Conscious Capitalism states: “I chose business because I believe that well-run, values-centred businesses can contribute to humankind in more tangible ways than any other organization in society”. The idea being that the challenge is about improving the existing capitalist model so that society can enhance its successes and overcome its limitations or failures. This challenge is of particular relevance for the LAC region where different economic models coexist at different stages of development. There are a variety of economic models in the region, some of which cannot be fully defined as being capitalist models in any of its conventional forms of -laissez-faire capitalism, welfare capitalism, or state capitalism. These economies, similar to some other emerging economies worldwide, are yet to fully develop sound property-rights structures, have to strengthen their financial markets, have to facilitate that means of production are primarily controlled by private entities, and continue to face important challenges/limitations in their capital and labour markets. The region has a mixed track-record of economic growth, economic reforms and market liberalization, state participation/control and trade openness. Yet the existing array of models faces the challenges of sustainability, social inclusion and income inequality. Capitalism, with its virtues and faults has led to an era of prosperity. Prosperity that has benefited many, by allowing a significant part of the world population to step out of extreme poverty, that has created jobs, that has fuelled and been fuelled by the innovation of free enterprises and democratic societies. Two hundred years ago 85% of the population lived in extreme poverty compared to the current 16% life expectancy has increased to 65yrs from 45yrs in 1950, and over 50% of the people live in democratic governments. Yet there is no doubt that these and other achievements have come with a high cost to the environment, and that inequality and low social inclusion persists in many regions. Yet the proposed premise is that capitalism continues to be the best system available and that together with democratic governments are able 6 to best serve the objectives of long-term sustainable growth, environmental care and social inclusion. Is a system that needs to improve and focus on value generation (economic, social and environmental value) facing the sustainability challenge and becoming part of the solution. Sound financial markets are a necessary component of the improvement of the economic system. FIs have the capacity to finance the growth of values-centred businesses that promote social inclusion and respect for the environment. For this the guiding practices of capital allocation and pricing are fundamental to the creation of adequate conditions to foster the sustainable business model. Yet capital raising efforts by sustainable businesses still face important limitations either by not being able to access capital at terms that reflect their sustainability and social inclusion efforts, and/or by not accessing a wider investor’s base. Anecdotic evidence indicates that even in those cases where FIs partnered with International Finance Institutions (IFIs) to 121 CU IDOL SELF LEARNING MATERIAL (SLM)
implement sustainable models, the investor base did not necessarily price-in this value proposition. Thus, it did not necessarily reflect in better financial terms and conditions. This pricing-in should reflect the good practices resulting from: the inclusion of risk-mitigation measures linked to the financing provided by FIs (i.e.: E&S systems that fully reflect the risks associated to the different levels of financing from working capital to capital expansion and IPOs, and the financing of “good social causes” like clean energy, climate change mitigation measures or financial inclusion of the BOP, for example. Although there is an increasing investment community that incorporates sustainability and social inclusion practices at the core of their investment decision making, it still represents a small percentage of the international community (WEF, 2013). This growing investment community is guided by somewhat different principles, although all are based on the inclusion of environmental and/or social parameters in the investment decision making process. To some, investment decisions are based on the application of “exclusion or negative list of activities” to avoid working with companies/industries that harm society or the environment. Others guide their investment decisions by selecting companies that actively pursue and measure the benefit to society and/or the environment of their business activities (i.e.: Impact Investors). It is important to highlight that impact investors do not only look for those companies that “do good”, but those are rigorous in the measurement and monitoring of such positive impact. According to WEF impact investors manage approximately US$40 billion of cumulative capital committed2. A more general term, Socially Responsible Investment (SRI) or any known similar definitions; ethical investment, green investment, triple-bottom line investment, or sustainable investment have as commonality that of being guided by long-term value creation. That is, a value creation that refers not only to financial or economic value, but to the broader values of inclusion, sustainability and fairness. Similarly, to the role of IFIs, the role of SRI investors is at the same time important and limited. A key challenge is to mainstream the view and practice that the cost of capital and therefore its allocation should also be guided by the common principles of the internalization of the social and economic externalities of the economic activities they finance In this sense, the objective is to mainstream this internalization of externalities so that the tens of trillions dollars mobilized by mainstream investors (asset managers, pension funds, money market funds, etc.) are directed to shifting current economic models towards those that are sustainable and socially inclusive (WEF, 2013). ESG variables continue to have a limited impact in SRI strategies, with Asia and Europe leading the market, but with the core of the market having little or no integration of ESG factors in their investment strategies. The development of such way of doing business is a complex and dynamic process that faces important challenges and potential setbacks. While many aspects have been present in different societies at different times, the implementation of a comprehensive approach incorporating sustainability variables into banking business models is still to be fully formulated. incorporating sustainability variables into banking business models is still to be fully formulated. There are several important sustainability initiatives for the financial sector 122 CU IDOL SELF LEARNING MATERIAL (SLM)
to guide its activities. Among those worth listing is UNEP FI, Equator Principles, the Carbon Disclosure Project and Enhanced Analytics Initiative, Principles for Responsible Investment (PRI), the Carbon Principles and Climate Wise. Years of working with FIs in LAC have provided many different opportunities to assess this concept and its practice across the region. While many institutions are in fact taking important steps towards a “better banking model”, there is still much more to do. As discussed later, the region has benefited from the active role IFIs to foster sustainability and social inclusion objectives in banking. IFIs and FIs have worked towards the enhancement of sustainable banking practices to encompass more transparent corporate governance structures, stronger risk assessment and mitigation methodologies, the development of green products and downscaling strategies. At the same time, FIs in the region are actively participating in one or more of the sustainability initiatives such as Equator Principles or UNEP FI. To have impact, the proposed way of doing business must be developed in a way that reinforces competitive advantage and allows for reaching the required scale to affect social change. Some examples of what is being done in LAC can be found in the Inter-American Development Bank (IDB)’s beyond Banking initiative. A key aspect of FIs challenge is well captured by Porter and Kramer shared value framework. According to them, companies continue to see value creation through the prism of short-term profits, rather than on an economic value creation that also addresses the needs and challenges faced by society. This is presented as a contrasting approach to CSR initiatives, described as not being core to the business, philanthropic in nature and only as a limited response to the legitimacy crisis they face. When discussing this concept with bankers in the region, there is an array of reactions that fall everywhere along the spectrum, from true believers to those with high scepticism. At the same time, some express concerns regarding the fact that many of the sustainability parameters applied to banking are still being developed, especially in terms of determining the “true E&S costs and benefits” related to the economic activities they finance. This creates a genuine area of concern for an industry that is used to more exact forms of cost and benefits measurements. In turn, this opens the space for 9 many bankers to postpone any business change. Others do take the lead to move forward even in this environment of uncertainty as they look for better ways to measure newer qualitative and quantitative parameters. Likewise, the efforts made by FIs in terms of sustainability and social inclusion are also received by the public with an array of reactions. For many, it is only “green wash” and driven solely for improving public perception and not really responding to a genuine business transformation. Others perceive the change as incipient, maybe even erratic, but evolving in a positive direction. Regardless of where one stands in the opinion spectrum, much more still needs to be done. It is a systemic challenge that requires the commitment and active participation of many stakeholders. Shared value is presented as a fix to capitalism and one that is unavoidable. A fix of the substantive obstacles of continuing doing business as usual and to the overall negative image society has of private companies. A model that is no longer viable. Companies may lead processes of bridging back together businesses and society by diminishing their short-termism. By incorporating E&S 123 CU IDOL SELF LEARNING MATERIAL (SLM)
costs and benefits into the profitability function to develop new market ecosystems, and pursuing the inclusion of the BOP. Regardless of the view of the relevance of those that consider that shared value is neither new nor “fully cooked”. Or that it does not represent a real fix to capitalism as it is still based on Capitalism 2.0 instead of “Capitalism 3.0”. The merits of the core proposal stand: value has to be shared by all stakeholders not only shareholders. Value has to be broad and better distributed in our societies so that those who still live-in poverty can improve their living conditions. Value has to preserve the natural capital for generations to come and for the wellbeing of other species on earth, while simultaneously maintaining positive investment returns overtime. The sustainability challenge at stake requires revisiting some pillars of a capitalism driven by the short-term horizon, prevalence of shareholders value thinking above any other stakeholder, and value measured solely by financial returns. It requires a capitalist system that reconciles financial performance with progress of the whole. One that impacts positively the social and environmental spheres with a view on the future value of their economic activity, and not primarily on a net present value basis. In this scenario FIs face the “substantive” sustainability challenge and a “legitimacy crisis”. The aim is to act on incorporating in their core business models E&S variables that add value to the firm (long–term competitiveness) and to 10 society (transparent social and financial inclusion). FIs can direct their lending activities to foster sustainable development and in this way tackle their sustainability challenge and work towards reclaiming their social legitimacy. In their intermediation role they allocate capital across industries thus influencing the speed, direction and nature of economic growth and hence the social and environmental impacts. Yet short-termism does not affect just bankers. When considering public policy, the short-term view of many politicians and legislators affects the possibility of long-term decision-making. To aim for sustainability and social inclusion, a long-term view of economic, social and environmental issues is required. This does not only or primarily affect the private sector, but pertains to society as a whole. It has a key impact on public policy as all levels of government – federal, state and municipal- have to respond to short-term party and social interests. Yet some long- term public-goods issues, such as addressing climate change, have still moved forward, although slowly, even in situations where public policy has failed to do so. In this sense some states in the Unites States have moved forward more decisively climate change policies and actions, even when the Federal Government has kept behind the international climate change agenda. Although situations like this can create complications at the regulatory level due to overlapping and in some cases contradictory public policy and regulations, it reflects the fact that society is able to push forward social change from many directions, even in situations where high level government policy falls behind. There are of course several sustainability challenges relevant to the LAC region. In all these challenges, FIs have an important role to play both as contributor to the problem as well as potentially being part of the solution. A role that FIs should internalize at all levels of their core business, and incorporate in the financial products and services they offer. For example, the supply of financial products and services 124 CU IDOL SELF LEARNING MATERIAL (SLM)
can shape the agenda of public policies and interventions regarding climate change adaptation and mitigation. Although LAC has a relatively modest carbon footprint, it is significantly weighted to land use, energy and transportation. At the same time, LAC is particularly vulnerable to the effects of climate change due to its geographic location, population and infrastructure distribution, and natural resources dependency. Studies indicate that the combination of adaptation and mitigation measures would provide the best policy mix in terms of cost-benefit analysis for the region. They indicate that the cost of adaptation investment ($17-$27bn) represents one-sixth of the estimated costs of a rise in 11 temperatures of 2C over pre-industrial levels (approximately $100 billion annually by 2050) (IDB, 2013). FIs also have a role to play to uphold the sustainability of the natural capital of the region which crosses geographic boundaries and has global impact. The LAC region represents only 16% of the planet's land, yet it holds 40% of the world's biological diversity, more than 30% of the earth’s available freshwater, and almost 50% of the world’s tropical forests (IDB, 2012). The region´s environmental resources play a key role in the global hydrology cycle and climate control while representing the largest biological repository on earth. Understanding and wisely tapping LAC natural capital in a sustainable manner (where current generation uses its \"cashflow\" while protecting the \"capital stock\" for future generations) is a need that should be faced by both public and private sectors. At the same time, natural capital is relevant to key productive sectors -agribusiness, forestry, tourism-, to transversal needs -access to clean air and water-, and to assure the region's food security. FIs have the capacity to impact the direction of the economic growth, through its allocation of financial products and services in a manner that is aligned to the objective of a sustainable use of LAC's natural capital. Nonetheless a core sustainability challenge FIs in LAC face is to implement a sustainable downscaling strategy that guides its small and medium enterprises (SMEs3) lending activity. With the implementation of this type of downscaling strategy, FIs actively contribute to address its high level of inequality4while backing its sustainable development path. Yet the complexity of the task ahead responds to the multi-dimension of the challenge. Let’s think for example of the needs to have better transparency in the sources of capital that flow through the banking system. This requires that FIs implement comprehensive know-your customer policies that reflect international best practices so that institutions maintain a healthy correspondent-banking network. 6.5 INTERNATIONAL MONETARY SYSTEM (IMF) The global financial crisis of 2008-2009, the follow-on Great Recession and the euro area sovereign debt crisis have spurred renewed interest in reforming the international area sovereign debt crisis have spurred renewed interest in reforming the international monetary system (IMS). The deficiencies of the IMS - global imbalances, exchange rate misalignments, volatility, and high mobility and sudden stops in capital flows - are well known and these have been repeatedly exposed by systemic malfunctions in the form of repeated occurrences of financial crises with systemic spill overs. The marked volatility in financial markets since 125 CU IDOL SELF LEARNING MATERIAL (SLM)
May 2013, and the unforeseen impact on major emerging market economies, that resulted from a mere hint of tapering of unconventional monetary policy (UMP) by the US Federal Reserve, is yet another symptom of such deficiency. Yet in a fundamental sense, on account of its sheer complexity, pervasiveness and persistence, the North Atlantic financial crisis (NAFC) of 2008 and its global after-effects have brought these issues to a head. Increasing financial market integration and the interdependence of economies have provided a whole new dimension to the IMS, motivating the case for truly ambitious reform. Moreover, the drive for transformation has acquired a global political context, as reflected in the G20 deliberations. Reformers will, however, encounter inertia of governments and international organizations alike to embrace radical changes in the IMS, partly due to ideological concerns and vested interests, and partly due to network externalities associated with existing arrangements. It has also been argued that the NAFC of 2008-2009, despite its heavy costs, has not really jeopardized international monetary stability, and the IMS is not on the verge of collapse (International Monetary Fund [IMF], 2009c). What the crisis has shown, however, is that the imperfections of the IMS feed and facilitate developments and policies that are ultimately unsustainable and expose the system to risks and severe shocks, that are difficult to address effectively. The NAFC is yet to end, and the ultimate consequences of the UMP are not known. This attempts to evaluate the proposals on various facets of the IMS that are on the table, and to set out some responses that reflect an emerging and developing economy (EDE) standpoint in the debate. Clearly, at this stage, there is little consensus on these issues, as they sit uncomfortably on the trade-off between global governance and national sovereignty. “International monetary system” is often used interchangeably with terms such as “international monetary and financial system” and “international financial architecture.” “International Monetary and Financial system” as well as “International financial Architecture.” Since the nomenclature involves de jure/de facto jurisdiction, obligations and oversight concerning sovereign nations and multilateral bodies, it is important to be precise and specific. The objective of the IMS is to contribute to stable and high global growth, while fostering price and financial stability. The IMS comprises the set of official arrangements that regulate key dimensions of the balance of payments (IMF, 2009c; 2010a). It consists of four elements: exchange arrangements and exchange rates; international payments and transfers relating to current international transactions; international capital movements; and international reserves. The essential purpose of the IMS is to facilitate the exchange of goods, services and capital among countries. As outlined in the s of Agreement that established it, the IMF is required to exercise oversight of the IMS. The obligations of member countries are to direct economic and financial policies and to foster underlying economic and financial conditions desired to achieve orderly economic growth with reasonable price stability (“domestic stability”), avoid manipulation of the exchange rates and to follow compatible exchange rate policies. In 2007, the IMF sought to broaden the scope of surveillance from the narrow focus on exchange rates to the concept of “external stability” — “a balance of 126 CU IDOL SELF LEARNING MATERIAL (SLM)
payments position that does not, and is not likely to, give rise to disruptive exchange rate movements” (IMF, 2007) — but the focus on exchange rates as the main objective was retained. Thus, the IMF, as a multilateral institution, has a very specific mandate to ensure the stability and effective operation of the IMS. This is important in view of the areas in which the IMF has been seeking to amorphously expand its outreach and ambit poverty, climate change, inequality and financial supervision, to name a few. This mission creep is most evident in some of the new proposals to reform the IMF’s surveillance mandate, which warrant caution and vigilance, as they could collide with the principles of national sovereignty and specialization. The Fund views issues such as climate change, inequality and financial supervision as relevant since it needs to explore the fiscal and financial stability consequence of these trends, so that it can incorporate them in its strategic planning (IMF, 2013a). The IMS is not synonymous with the international financial system. Indeed, its founding fathers may have not intended it to be so. The IMF has no powers of oversight over the IMS beyond the broad appraisal of domestic policies and conditions that may encompass the financial sector. Since 2009, however, the IMF has made the Financial Sector Assessment Program (FSAP) (jointly owned with the World Bank) mandatory for 25 countries as part of its surveillance function. Finally, as demonstrated most starkly by the NAFC of 2008-2009, policies and conditions in systemically important countries can have huge negative externalities for the IMS at large, whether they are transmitted through the balance of payments, or through other channels, such as the confidence channel. The external effects of the policies and conditions of systemically important economies can erode the stability of IMS. The question that arises, however, is: whether it is feasible for the IMF to effectively 5 constrain these countries in exercising policies that have significant negative spill overs? The IMS has evolved continuously over the last century, reflecting ongoing changes in global economic realities and in economic thought. Throughout this whole period, there has been a continuous search for an effective nominal anchor. In the process, the binding rules that marked its passage through the gold standard and the Bretton Woods regimes have fallen by the wayside. The gold standard provided the anchor in the pre-World War I period: a period characterized by free capital flows and fixed exchange rates and, hence, no independent monetary policy. The interwar period was marked by confusion, which yielded to the Bretton Woods system of semi-fixed exchange rates and controlled capital flows that provided scope for an independent monetary policy. The collapse of the Bretton Woods system in the early 1970s led to the introduction of the prevailing system of floating exchange rates, free capital flows and independent monetary policy in the major advanced economies. Within this post- Bretton Woods framework, the monetary policy framework also transitioned from a monetary targeting regime in the 1970s and the 1980s to inflation targeting frameworks. Given the preference for open capital accounts, and the belief in efficient financial markets, financial sector regulation moved from an intrusive framework to a light-touch framework. However, given the recurrence and increased frequency of financial crises, the IMS appears to be caught in a bind analogous to the impossible trinity domestic stability versus external stability 127 CU IDOL SELF LEARNING MATERIAL (SLM)
versus global stability. The pursuit of sustained growth with price stability may not guarantee a balance of payments position that does not have disruptive effects on exchange rates; domestic and external stability cannot preclude threats to global stability. Neither can global stability assure domestic/external stability at the individual country level. The performance of the IMS in the post-Bretton Woods era has been mixed when evaluated against relevant metrics. Average global growth has tended to slow and has also become volatile, mainly due to recent developments in the advanced economies (AEs). On the other hand, in recent times, growth in the EDEs has tended to provide some stability to global growth. Inflation and its variability moderated globally in both the AEs and the EDEs. The period of the Great Moderation is generally believed to have begun with the taming of inflation in the early 1980s and extends up to 2007, when the global crisis struck. This is not discernible, however, in terms of decadal comparisons. While the variability of growth did come down in the 1990s relative to the preceding decade, it was still higher than in the 1970s. Analogously, the lowest variability in inflation seems to have been in the 1970s for the AEs and in the 2000s for the EDEs. This discussion, however, provides no information on causality; it is difficult to infer whether the post-Bretton Woods IMS is responsible for heightened instability, or whether it exists in a period of heightened volatility. 6.6 WORLD BANK The World Bank is a United Nations international financial institution that offers loans, advice, and an array of customized resources to more than 100 developing countries all around the world. The World Bank is a component of the World Bank Group, and the largest global development institution focuses exclusively on private sector ventures and projects in developing countries in partnership by financing investment, mobilizing capital in international financial markets, and providing advisory services as well as technical assistance to businesses and governments. Its institutional culture and approach to development have changed in parallel with the evolution of international development thinking over the past sixty years. This research aims to argue connection between the World Bank and development thinking. Through a review of the literature, this research attempts to clarify the ways in which the World Bank's institutional culture has both influenced and been influenced by the understanding of 'development'. The World Bank was established in 1944, and its purpose was to issue long-term loans to governments for reconstruction and economic development following the Second World War. It has since become an international development agency, aiming to promote prosperity and sustainable development. Over the course of more than 50 years, its institutional culture, approach to development and priorities have evolved from the rebuilding of infrastructure to reducing poverty and improving living conditions. New theories and economic models have deepened development paradigms and have influenced the Bank's development practices and strategies. This raises the following questions: How has the Bank been influenced by 128 CU IDOL SELF LEARNING MATERIAL (SLM)
development theories? In what ways has the Bank shaped international development thinking? In parallel with the evolution of its institutional culture, it has become the world's leading source of funds, ideas, and expertise for development. The Bank is centred around the goals of sustainability, ending extreme poverty and promoting shared prosperity. It raises funds for the International Development Association (IDA) through private financial markets and receives donations on a regular basis from its richer members. Becoming a major contributor to the World Bank's International Development Association gives a country added influence over its administration and development policies, and leverage over how money is spent in poor countries. The United States, as the largest grant donor in the most recent round, dominates and influences the Bank’s strategies and policies. In parallel with the evolution of its institutional culture, it has become the world's leading source of funds, ideas, and expertise for development. The Bank is centred around the goals of sustainability, ending extreme poverty and promoting shared prosperity. It raises funds for the International Development Association (IDA) through private financial markets and receives donations on a regular basis from its richer members. Becoming a major contributor to the World Bank's International Development Association gives a country added influence over its administration and development policies, and leverage over how money is spent in poor countries. The United States, as the largest grant donor in the most recent round, dominates and influences the Bank’s strategies and policies. There has been general criticism from other international development agendas (i.e., NGOs and governments) of the Bank’s poverty- related projects and policies. The fact that neoliberal policies and the so-called ‘Washington Consensus’ are implemented by the World Bank in developing countries has become controversial among borrower countries, in particular those in Latin America. Moreover, after the 1980s, the Bank’s policy towards environmental and sustainable development has increasingly been criticized by local NGOs and environmental organisations. In what ways does the World Bank respond to this kind of criticisms and campaigns against its projects and policies? In order to answer the above question, it is first necessary to analyse a mutual connection between the Bank and development thinking. It has three fundamental objectives: Firstly, to provide an analysis of the historical background of World Bank, the evolution of its organizational culture, its approach to development and relations with other development actors. Secondly, to investigate the ways in which the Bank’s institutional culture has been influenced by an understanding of development. Thirdly, to examine the Bank’s role in developing countries and its influence on development thinking. The World Bank is a United Nations International Institution, and a member of the United Nations Development Group. It makes leveraged loans and provides advice and research to developing nations to aid their economic advancement and for capital programs. It is one of the largest and most well-known development banks. Its loans and setting of policy conditions for developing countries makes the World Bank one of the most important development agencies globally. In order to explore the Bank’s role and influence in the understanding of development, it is important to analyse its historical background, structure 129 CU IDOL SELF LEARNING MATERIAL (SLM)
and changing perspective on development, and the evolution of its institutional culture over the past decades. 6.7 IDB The Islamic Development Bank Group (IDB Group) is a South- Group (IDB Group) is a South- South multilateral development finance institution established in pursuance of the Declaration of Intent issued by the Conference of Finance Ministers of Muslim Countries held in Jeddah in DhulQ’adah 1393H, corresponding to December 1973. The Inaugural Meeting of the Board of Governors took place in Rajab 1395H, corresponding to July 1975, and the Bank was formally opened on 15 Shawwal 1395H corresponding to 20 October 1975. The purpose of the Bank is to foster the economic development and social progress of member countries and Muslim communities individually and collectively in accordance with the principles of Shariah. The membership of IDB stands at 56 countries from four continents: Africa, Asia, Europe, and South America. To become a member of Asia, Europe, and South America. To become a member of IDB, a country must fulfil certain conditions. First, the country must become a member of the Organization of Islamic Cooperation (OIC); second, it should pay the first instalment of its minimum subscription to the Capital Stock of IDB; and third, accept such terms and conditions that may be decided by IDB Board of Governors. Objective: The objective of IDB is to foster economic development and social progress of its member countries and Muslim communities in non-member countries individually and collectively in accordance with the principles of Shariah. To fulfil this objective, it provides financial resources through different modes of financing to finance development activities in member countries as well as in Muslim communities in non-member countries. 6.8 WTO The World Trade Organization (WTO) is an intergovernmental organization that regulates and facilitates international trade between nations. Governments use the organization to establish, revise, and enforce the rules that govern international trade. It officially commenced operations on 1 January 1995, pursuant to the 1994 Marrakesh Agreement, thus replacing the General Agreement on Tariffs and Trade (GATT) that had been established in 1948. The WTO is the world's largest international economic organization, with 164 member states representing over 96% of global trade and global GDP. The WTO facilitates trade in goods, services and intellectual property among participating countries by providing a framework for negotiating trade agreements, which usually aim to reduce or eliminate tariffs, quotas, and other restrictions; these agreements are signed by representatives of member governments and ratified by their legislatures. The WTO also administers independent dispute resolution for enforcing participants' adherence to trade 130 CU IDOL SELF LEARNING MATERIAL (SLM)
agreements and resolving trade-related disputes. The organization prohibits discrimination between trading partners, but provides exceptions for environmental protection, national security, and other important goals. The WTO is headquartered in Geneva, Switzerland. Its top decision-making body is the Ministerial Conference, which is composed of all member states and usually convenes biannually; consensus is emphasized in all decisions. Day-to-day functions are handled by the General Council, made up of representatives from all members. A Secretariat of over 600 personnel, led by the Director-General and four deputies, provides administrative, professional, and technical services. The WTO's annual budget is roughly 220 million USD, which is contributed by members based on their proportion of international trade. Studies show the WTO has boosted trade and reduced trade barriers. It has also influenced trade agreement generally; a 2017 analysis found that the vast majority of preferential trade agreements (PTAs) up to that point explicitly reference the WTO, with substantial portions of text copied from WTO agreements. Goal 10 of the United Nations Sustainable Development Goals also referenced WTO agreements as instruments of reducing inequality. However, critics contend that the benefits of WTO-facilitated free trade are not shared equally, citing the outcomes of negotiations and data showing a continually widening gap between rich and poor nations Seven rounds of negotiations occurred under GATT . The first real GATT trade rounds (1947 to 1960) concentrated on further reducing tariffs. Then the Kennedy Round in the mid-sixties brought about a GATT anti-dumping agreement and a section on development. The Tokyo Round during the seventies represented the first major attempt to tackle trade barriers that do not take the form of tariffs, and to improve the system, adopting a series of agreements on non-tariff barriers, which in some cases interpreted existing GATT rules, and in others broke entirely new ground. Because not all GATT members accepted these plurilateral agreements, they were often informally called \"codes\". The Uruguay Round amended several of these codes and turned them into multilateral commitments accepted by all WTO members. Only four remained plurilateral, but in 1997 WTO members agreed to terminate the bovine meat and dairy agreements, leaving only two. Despite attempts in the mid-1950s and 1960s to establish some form of institutional mechanism for international trade, the GATT continued to operate for almost half a century as a semi-institutionalized multilateral treaty regime on a provisional basis. Well before GATT's 40th anniversary, its members concluded that the GATT system was straining to adapt to a new globalizing world economy. In response to the problems identified in the 1982 Ministerial Declaration, the eighth GATT round known as the Uruguay Round was launched in September 1986, in Punta del Este, Uruguay. It was the biggest negotiating mandate on trade ever agreed: the talks aimed to extend the trading system into several new areas, notably trade in services and intellectual property, and 131 CU IDOL SELF LEARNING MATERIAL (SLM)
to reform trade in the sensitive sectors of agriculture and textiles; all the original GATT s were up for review. The Final Act concluding the Uruguay Round and officially establishing the WTO regime was signed 15 April 1994, during the ministerial meeting at Marrakesh, Morocco, and hence is known as the Marrakesh Agreement. The GATT still exists as the WTO's umbrella treaty for trade in goods, updated as a result of the Uruguay Round negotiations. GATT 1994 is not. However, the only legally binding agreement included via the Final Act at Marrakesh; a long list of about 60 agreements, annexes, decisions, and understandings was adopted. The highest decision-making body of the WTO, the Ministerial Conference, usually meets every two years. It brings together all members of the WTO, all of which are countries or customs unions. The Ministerial Conference can take decisions on all matters under any of the multilateral trade agreements. Some meetings, such as the inaugural ministerial conference in Singapore and the Cancun conference in 2003 involved arguments between developed and developing economies referred to as the \"Singapore issues\" such as agricultural subsidies; while others such as the Seattle conference in 1999 provoked large demonstrations. The fourth ministerial conference in Doha in 2001 approved China's entry to the WTO and launched the Doha Development Round which was supplemented by the sixth WTO ministerial conference which agreed to phase out agricultural export subsidies and to adopt the European Union's Everything but Arms initiative to phase out tariffs for goods from the Least Developed Countries. At the sixth WTO Ministerial Conference of 2005 in December, WTO launched the Aid for Trade initiative and it is specifically to assist developing countries in trade as included in the Sustainable Development Goal 8 which is to increase aid for trade support and economic growth. 6.9 UNCTAD The United Nations Conference on Trade and Development (UNCTAD) was established in 1964 as an intergovernmental organization intended to promote the interests of developing states in world trade. UNCTAD is the part of the United Nations Secretariat dealing with trade, investment, and development issues. The organization's goals are to: \"maximize the trade, investment and development opportunities of developing countries and assist them in their efforts to integrate into the world economy on an equitable basis\". UNCTAD was established by the United Nations General Assembly in 1964 and it reports to the UN General Assembly and United Nations Economic and Social Council. The primary objective of UNCTAD is to formulate policies relating to all aspects of development including trade, aid, transport, finance and technology. The conference ordinarily meets once in four years; the permanent secretariat is in Geneva. 132 CU IDOL SELF LEARNING MATERIAL (SLM)
One of the principal achievements of UNCTAD has been to conceive and implement the Generalized System of Preferences (GSP). It was argued in UNCTAD that to promote exports of manufactured goods from developing countries, it would be necessary to offer special tariff concessions to such exports. Accepting this argument, the developed countries formulated the GSP scheme under which manufacturers' exports and import of some agricultural goods from the developing countries enter duty-free or at reduced rates in the developed countries. Since imports of such items from other developed countries are subject to the normal rates of duties, imports of the same items from developing countries would enjoy a competitive advantage. The creation of UNCTAD in 1964 was based on concerns of developing countries over the international market, multi-national corporations, and great disparity between developed nations and developing nations. The United Nations Conference on Trade and Development was established to provide a forum where the developing countries could discuss the problems relating to their economic development. The organization grew from the view that existing institutions like GATT, the International Monetary Fund (IMF), and World Bank were not properly organized to handle the particular problems of developing countries. Later, in the 1970s and 1980s, UNCTAD was closely associated with the idea of a New International Economic Order (NIEO). The first UNCTAD conference took place in Geneva in 1964, the second in New Delhi in 1968, the third in Santiago in 1972, fourth in Nairobi in 1976, the fifth in Manila in 1979, the sixth in Belgrade in 1983, the seventh in Geneva in 1987, the eighth in Cartagena in 1992, the ninth at Johannesburg in 1996, the tenth in Bangkok in 2000, the eleventh in São Paulo in 2004, the twelfth in Accra in 2008, the thirteenth in Doha in 2012 and the fourteenth in Nairobi in 2016. The fifteenth session is due to be held in Bridgetown from 3-8 October, 2021. Currently, UNCTAD has 195 member states and is headquartered in Geneva, Switzerland. UNCTAD has 400 staff members and a bi-annual regular budget of $138 million in core expenditures and $72 million in extra-budgetary technical assistance funds. It is a member of the United Nations Development Group. There are non-governmental organizations participating in the activities of UNCTAD. As of May 2018, 195 states are UNCTAD members all UN members plus UN observer states Palestine and the Holy See. UNCTAD members are divided into four lists, the division being based on United Nations Regional Groups with six members unassigned: Armenia, Kiribati, Nauru, South Sudan, Tajikistan, Tuvalu. List A consists mostly of countries in the African and Asia-Pacific Groups of the UN. List B consists of countries of the Western European and Others Group. List C consists of countries of the Group of Latin American and Caribbean States (GRULAC). List D consists of countries of the Eastern European Group. 133 CU IDOL SELF LEARNING MATERIAL (SLM)
The lists, originally defined in 19th General Assembly resolution 1995 serve to balance geographical distribution of member states' representation on the Trade Development Board and other UNCTAD structures. The lists are similar to those of UNIDO, an UN specialized agency. 6.10 SUMMARY The World Bank is the general name of a number of international organisations whose original body the International Bank for Reconstruction and Development (IBRD)) was created at the Bretton Woods Conference in July 1944, along with its sister institution, the International Monetary Fund (IMF) The Bretton Woods Conference was a gathering of 730 delegates from 44 allied nations. The membership of the Bank was open to all nations. As it can be understood from its original name, its primary function was to make long-term loans to governments for reconstruction and the economic development of member territories, by facilitating the investment of capital for productive purposes, including the restoration of economies destroyed or disrupted by the Second World War. The new international development paradigm has influenced the Bank’s official goal and it has evolved from having virtually no presence in poverty reduction in low- income countries, to being the world’s largest financial contributor to development- related projects after the 1960s. In recent years, the Bank has adopted several new policies and programs which incorporate the notion that development must be inclusive and comprehensive. The main goals of the World Bank are now to end extreme poverty and boost shared prosperity across the globe by granting loans to developing countries. On the other hand, the political aspect of the organisation on projects is examined by borrower countries, including the dominance of the Western on the Bank’s administration, and in particular the dominance of the United States. The Bank has always been more than an economic institution. Juan Domingo Peron criticised the activities of the Bank in the following terms: Both the World Bank and IMF had come to play a dominant role in the world economy and when the conditions attached to their loans had provoked protests, especially among the debtor nations. 6.11 KEYWORDS Eligible Acceptance – A banker’s acceptance that meets Federal Reserve requirements related to its financing purpose and term. 134 CU IDOL SELF LEARNING MATERIAL (SLM)
Embargo – A partial or total prohibition on trade initiated by the government of one country against another for political or economic reasons. Eurobank – A bank that regularly accepts foreign currency denominated deposits and makes foreign currency loans. Foreign Bonds – Bonds issued by non-residents but underwritten primarily by banks registered in the country where the issue is made. Foreign Deposits – Those deposits that are payable at a financial institution outside the jurisdiction of the U.S. government and in the currency of the country in which the depository is located. See also Nostro Account. 6.12 LEARNING ACTIVITY 1. Create a survey on Microfinance. ___________________________________________________________________________ ___________________________________________________________________________ 2. Create a session on Bank Lending in Emerging Economies. ___________________________________________________________________________ ___________________________________________________________________________ 6.13 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Define Microfinance? 2. Define the term banking? 3. Write the full form of WTO? 4. Write the full form of IDB? 5. Write the full form of UNCTAD? Long Questions 1. Explain the concept of Bank Lending in Emerging Economies. 2. Explain the concept of Microfinance. 3. Illustrate the concept of International Monetary System (IMF). 4. Illustrate the concept of World Bank. 5. Examine the concept of UNCTAD. 135 CU IDOL SELF LEARNING MATERIAL (SLM)
B. Multiple Choice Questions 1. What is a person who agrees to buy an asset at a future date has gone? a. Long b. Short c. Back d. Ahead 2. What does a short contract require the investor? a. Sell securities in the future. b. Hedge in the future. c. Close out his position in the future. d. Buy securities in the future. 3. What does a contract that requires the investor to sell securities on a future date is called as? a. Short contract. b. Long contract. c. Hedge d. Micro hedge. 4. What if a bank manager chooses to hedge his portfolio of treasury securities by selling futures contracts, he deems to? a. Gives up the opportunity for gains. b. Removes the chance of loss. c. Increases the probability of a gain d. Both (a) and (b) are true. 5. What happens when one has to say that the forward market lacks liquidity? a. Forward contracts usually result in losses. b. Forward contracts cannot be turned into cash. c. It may be difficult to make the transaction d. Forward contracts cannot be sold for cash Answers 136 CU IDOL SELF LEARNING MATERIAL (SLM)
1-a, 2-d, 3-a, 4-d, 5-c 6.14 REFERENCES References book DeAngelo, Linda, 1981, Auditor size and audit quality, Journal of Accounting and Economics. Diamond, Douglas, 1984, Financial intermediation and delegated monitoring, Review of Economic Studies. Diamond, Douglas, 1991, Monitoring and reputation: the choice between bank loans and privately-placed debt, Journal of Political Economy. Textbook references Easterbrook, Frank, 1984, Two agency costs explanations of dividends, American Economic Review. Fox, Charles, 1989, Structuring and documenting syndicated bank credits, in The Banker’s Guide to Multi-Bank Credits. Gorton, Gary and Joseph Hubrich, 1990, The loan sales market, in George Kaufman, Ed.: Research in Financial Services: Private and Public Policy. Website https://en.wikipedia.org/wiki/United_Nations_Conference_on_Trade_and_Developm ent https://r.search.yahoo.com/_ylt=Awr9DtRvGw5hDgMA3HxXNyoA;_ylu=Y29sbwN ncTEEcG9zAzgEdnRpZANEMTA0NV8xBHNlYwNzcg-- /RV=2/RE=1628343279/RO=10/RU=https%3a%2f%2functad.org%2fabout%2fhistor y/RK=2/RS=ooE2ulQJeCXOI15FhLmRWdRK1DY- https://en.wikipedia.org/wiki/World_Trade_Organization 137 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT 7 – INTERNATIONAL BANKS AND FINANCIAL MARKETS STRUCTURE 7.0 Learning Objectives 7.1 Introduction 7.2 Foreign Bonds 7.3 Eurobonds 7.4 Bonds Underwriting Mechanism 7.5 Summary 7.6 Keywords 7.7 Learning Activity 7.8 Unit End Questions 7.9 References 7.0 LEARNING OBJECTIVES After studying this unit, you will be able to: Examine the concept of Foreign Bonds Illustrate the concept of Eurobonds Explain the concept of Bonds Underwriting Mechanism 7.1 INTRODUCTION A financial market is a word that describes a marketplace where bonds, equity, securities, currencies are traded. Few financial markets do a security business of trillions of dollars daily, and some are small-scale with less activity. These are markets where businesses grow their cash, companies decrease risks, and investors make more cash. A Financial Market is referred to space, where selling and buying of financial assets and securities take place. It allocates limited resources in the nation’s economy. It serves as an agent between the investors and collector by mobilizing capital between them. In a financial market, the stock market allows investors to purchase and trade publicly companies share. The issue of new stocks is first offered in the primary stock market, and stock securities trading happens in the secondary market. 138 CU IDOL SELF LEARNING MATERIAL (SLM)
It’s a broad term and includes various types of markets where money can be borrowed at a low cost by companies requiring investment. Investors often trade in securities to earn profit be it in the long term or short term. Depending upon the economy, millions of dollars of money are traded daily in the financial market. For example, the New York Stock Exchange (NYSE), National Stock Exchange (NSE), etc. These financial markets are regulated by independent regulatory bodies with strict rules and regulations. They have stringent and mandatory reporting and compliance standards. Any violation by companies, investors, brokers, banks, financial institutions or any other authorized bodies, can lead to heavy penalties and in extreme cases cancellation of license. To begin looking at the financial markets it makes sense to first make it clear how the different parts fit together. At their heart we have the capital markets which are the markets where we raise and place wholesale funds. Capital markets are so-called because the main purpose of raising funds in this way is to raise long-term capital, funds needed for more than a year. We will talk about short-term debt though this is more often used for day-to-day financing, as there are some products that we would consider do form part of our financial markets, and we will discuss the crossover between financial markets and traditional bank financing. In the centre of the diagram, we still see capital markets but this time we have also added FX and Derivatives. These markets are not part of capital markets, they do not raise funds, but they are very important ancillary markets, providing the means to change and control the exposures that arise from our capital markets activity. We will be looking at each of these in turn. We will also introduce the key players in the market and come to an understanding of the motivations for their various activities so that we can build up a sense of how these markets work, and indeed thrive. As you work through the sessions you will see that we have included several questions for you to stop and test yourself. You will find the answers to these questions at the end of the session so that you can check how well you did. There is also a glossary reminding you of some of the key terminology we have introduced in this part of the material, just giving a quick reminder of what these expressions mean Financial markets are all about money. At their heart is the idea of moving money from those that have to those that want, but it is the way in which this happens that makes financial markets so complex and fascinating. Financial markets have been around for many centuries and we can trace the development of our key products from these early times, but it is really only in the last few decades that we have seen the markets evolve to the level of sophistication that we encounter today. As we go through this course, we are going to see a range of products that the market has created to fulfil the various needs of participants and we will start to build our understanding of why the markets have developed in this way. To begin, though, we need to get our heads around the basic purpose of financial markets which, as we have said, is moving money from those who have to those who want. We also need to 139 CU IDOL SELF LEARNING MATERIAL (SLM)
look at how this fits in with traditional banking, a related but different way of achieving the same aim. Traditionally if you were looking to raise money you would go to an institution whose business was to facilitate the movement of funds in an economy: in other words, a bank. These institutions were set up with the purpose of moving the commodity of money, taking from those who have and giving to those who want, to enable liquidity in the economy. The bank stands as a middleman in the transaction and therefore takes a fee, often expressed as the difference between the rate they charged for borrowing money and the rate they paid to those who gave them money. Their success hinges on having enough customers on both sides of this fence. In this deal the customer will borrow money from the bank and will pay the cost, expressed as an interest rate to the bank. In this way we can see the bank as a provider of liquidity, facilitating that movement of funds in the economy. This deal, of course, is dependent on the bank having the funds available in the first place. Earlier we described the money in this deal, the funds being lent, as the “commodity” of money and this is just how the bank must consider it. In other words, like any trade transaction, in order to be able to sell you must be able to buy (or have) the commodity. Therefore, in this instance, to be able to provide funds you need to be able to find them. In the ideal world this will come from another customer. The provider of funds is hoping to make a return on their money, again an interest rate that they will receive. This will come from the bank, who will pay the lender a part of the interest rate that they receive from the taker of funds, the borrower. So, the borrower pays interest, let’s say ten percent (10%) to the bank for borrowing the funds; the bank then pays the investor five percent (5%) interest on the money they have placed and the bank’s profit comes from the five percent (5%) they have retained on the deal. If the bank manages to find these two matching customers, we have a perfect intermediated model of moving funds: Of course, when we say we have a perfect model of moving funds this does depend on both sides of the trade matching in terms of the size of funds and amount of time for which they are available and required, and very often we will not find this perfect match. This is part of what makes this a risky model. Typically, the bank will not be able to match up one customer with another but instead will look to try and balance books of different providers and takers of funds, matching up as best they can, but often being confronted with significant mismatches in maturity that leads to an ongoing need to fund existing loans. This leads to Liquidity Risk – the risk that they may not be able to find the funds that they need. Liquidity risk also arises if the providers of funds change their mind about leaving their cash with the bank. It could be that the customer said they were placing funds for one month but then decide they want their money back after one week; the funds are theirs so if they require them to be returned the bank will have to do this and so then they will need to go out and find replacement funds. Another significant risk we can see in this model is Credit Risk. The way we have looked at this movement of funds is as two separate transactions that we have joined 140 CU IDOL SELF LEARNING MATERIAL (SLM)
together. The lender lent to the bank; the borrower borrowed from the bank. If the borrower, for some reason, cannot repay the money then they will default to the bank. The bank carries this credit risk. The funds may have come from the lender but the borrowing contract is with the bank. Of course, this default could mean that the bank cannot repay the lender, which shows that the lender has credit risk to the bank. Importantly, though, whilst it may be the borrower’s default that in turn caused the bank to default the lender has no recourse beyond the bank. Their contract is with the bank – both transactions are separate from one another. 7.2 FOREIGN BONDS In finance, a bond is an instrument of indebtedness of the bond issuer to the holders. The most common types of bonds include municipal bonds and corporate bonds. Bonds can be in mutual funds or can be in private investing where a person would give a loan to a company or the government. The bond is a debt security, under which the issuer owes the holders a debt and is obliged to pay them interest or to repay the principal at a later date, termed the maturity date. Interest is usually payable at fixed intervals. Very often the bond is negotiable, that is, the ownership of the instrument can be transferred in the secondary market. This means that once the transfer agents at the bank medallion stamp the bond, it is highly liquid on the secondary market. Thus, a bond is a form of loan or IOU: the holder of the bond is the lender, the issuer of the bond is the borrower (debtor), and the coupon is the interest. Bonds provide the borrower with external funds to finance long-term investments, or, in the case of government bonds, to finance current expenditure. Certificates of deposit (CDs) or short-term commercial paper are considered to be money market instruments and not bonds: the main difference is the length of the term of the instrument. Bonds and stocks are both securities, but the major difference between the two is that stockholders have an equity stake in a company, whereas bondholders have a creditor stake in the company. Being a creditor, bondholders have priority over stockholders. This means they will be repaid in advance of stockholders, but will rank behind secured creditors, in the event of bankruptcy. Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks typically remain outstanding indefinitely. An exception is an irredeemable bond, such as a console, which is a perpetuity that is, a bond with no maturity. Bonds are issued by public authorities, credit institutions, companies and supranational institutions in the primary markets. The most common process for issuing bonds is through underwriting. When a bond issue is underwritten, one or more securities firms or banks, forming a syndicate, buy the entire issue of bonds from the issuer and resell them to investors. The security firm takes the risk of being unable to sell on the issue to end investors. Primary issuance is arranged by bookrunners who arrange the bond issue, have direct contact 141 CU IDOL SELF LEARNING MATERIAL (SLM)
with investors and act as advisers to the bond issuer in terms of timing and price of the bond issue. The bookrunner is listed first among all underwriters participating in the issuance in the tombstone ads commonly used to announce bonds to the public. The bookrunners' willingness to underwrite must be discussed prior to any decision on the terms of the bond issue as there may be limited demand for the bonds. In contrast, government bonds are usually issued in an auction. In some cases, both members of the public and banks may bid for bonds. In other cases, only market makers may bid for bonds. The overall rate of return on the bond depends on both the terms of the bond and the price paid. The terms of the bond, such as the coupon, are fixed in advance and the price is determined by the market. In the case of an underwritten bond, the underwriters will charge a fee for underwriting. An alternative process for bond issuance, which is commonly used for smaller issues and avoids this cost, is the private placement bond. Bonds sold directly to buyers may not be tradeable in the bond market. Historically, an alternative practice of issuance was for the borrowing government authority to issue bonds over a period of time, usually at a fixed price, with volumes sold on a particular day dependent on market conditions. This was called a tap issue or bond tap. A foreign bond is a bond issued in a domestic market by a foreign entity in the domestic market's currency as a means of raising capital. For foreign firms doing a large amount of business in the domestic market, issuing foreign bonds, such as bulldog bonds, Matilda bonds, and samurai bonds, is a common practice. Since investors in foreign bonds are usually the residents of the domestic country, investors find these bonds attractive because they can diversify and add foreign content to their portfolios without the added exchange rate exposure. Nevertheless, there are still some unique risks of owning foreign bonds. Because investing in foreign bonds involves multiple risks, foreign bonds typically have higher yields than domestic bonds. Foreign bonds carry interest rate risk. When interest rates rise, the market price or resale value of a bond falls. For example, say an investor owns a 10- year bond paying 4% and interest rates increase to 5%. Few investors want to take on the bond without a price cut for offsetting the difference in income. Foreign bonds also face inflation risk. Buying a bond at a set interest rate means the real value of the bond is determined by the amount of inflation taken away from the yield. If an investor purchases a bond with a 5% interest rate during a time when inflation is 2%, the investor’s real playout is the net difference of 3%. Currency risk is still an implicit issue for foreign bonds. When income from a bond yielding 7% in a European currency is turned into dollars, the exchange rate may, for example, 142 CU IDOL SELF LEARNING MATERIAL (SLM)
decrease the yield to 2% because of exchange rate differences. Note, however, that this risk is not explicit in the sense that these bonds would always be priced in dollars. For political risk, investors should consider whether the government issuing the bond is stable, what laws surround the bond’s issuance, how the court system works, and additional factors before investing. Foreign bonds face repayment risk. The country issuing the bond may not have enough money to cover the debt. Investors may lose some or all of their principal and interest. 7.3 EUROBONDS A Eurobond is a fixed-income debt instrument denominated in a different currency than the local one of the countries where the bond’s been issued. Hence, it is a unique type of bond. Eurobonds allow corporations to raise funds by issuing bonds in a foreign currency. The bonds are also called external bonds because they can be originated in a foreign currency. If a Eurobond is denominated in US dollars, then it can be called a euro-dollar bond. If it is denominated in Chinese yuan, then this would be named euro-yuan bond. The essence of Eurobonds is that a company can choose any country to issue bonds depending on its economic and regulatory environment. What makes the bonds attractive among investors is a small notional amount of a bond, which means that the bond is relatively cheap to obtain. Importantly, Eurobonds are highly liquid and can be converted into cash within one fiscal year. The categorization of Eurobonds is dependent on the currency in which the bonds were issued. If a US-based company decides to release Eurobonds in China in British pounds, then the bonds will be categorized as euro-pound bonds. Typically, financial institutions, such as investment banks, issue bonds on behalf of the borrower. If a bank will be responsible for the underwriting process, it implies a guarantee to the borrower that the whole bond issue will be sold in the primary market during the initial debt offering process. Please note that the term “Eurobond” refers only to the fact that the bond was issued in a different country and currency. It does not need to be a country in Europe. It can be whatever country in the world. The primary reason for issuing Eurobonds is a need for foreign currency capital. Since the bonds are fixed-income securities; they usually offer a fixed interest rate to investors. Imagine, as an example, a US company aims to permeate into a new market and plans to erect a large factory, say, in China. The company will need to invest large sums of money in 143 CU IDOL SELF LEARNING MATERIAL (SLM)
local currency – the Chinese yuan. As the company is a new entrant to the Chinese market, it may lack access to credit in China. The company decides to go with yuan-denominated Eurobonds in the United States. Investors who hold yuan in their accounts will invest in the bonds, which will provide funds to a new facility in China. If a new factory is profitable, the cash flow will go to settling the interest to US-based bondholders. 7.4 BONDS UNDERWRITING MECHANISM As a matter of strategy, banking fi rms purchasing bonds on the primary market have two sources of compensation: the underwriter’s discount and other fees and commissions associated with the sale and any trading gains that they are able to capture from the difference in the buy and sell prices. The firm makes a profit as long as the fees are sufficient to offset any trading losses that they experience from holding and reselling the bonds. When we think about underwriting behaviour, we and reselling the bonds. When we think about underwriting behaviour, we imagine the activity of buying securities from governments and holding them until they are resold, thus taking on the risk that interest rates or demand will change before we are able to resell them. Banks would be better off if they knew with certainty that the bonds that they bought would be resold at a predetermined price. Brokers buying on behalf of their customers, for example, could subscribe their customers to sales at predetermined prices before they are brought to the market. Brokerage of this sort avoids the underwriting risk associated with buying and holding bonds to resell later to parties unknown. We believe that this distinction between underwriting and brokerage behaviour is important for government borrowers to understand. Brokerage and underwriting are different services. Firms conducting underwriting could justifiably demand greater compensation for the risk to which they are exposed. Issuers observing this distinction might be better able to evaluate options when it comes to negotiating banking fi rm compensation. This sets out to better understand this distinction by looking for evidence of it in the trading behaviour of fi rms buying and reselling municipal bonds. We begin the discussion with a background section that reviews the relevant literature on brokerage and underwriting and describes the bond sale process and the role of the banking fi rm in that process. The following section makes our case for brokerage as distinct from underwriting. In the methodology section, we describe the process we used to collect and analyse data from a small set of bond sales selected in order to facilitate this taxonomy. The findings section categorizes the sales analysed into cases where substantial risk is present and cases where it is not, showing the distinction between brokerage and underwriting. In the concluding section, we explain the distinction further and argue why it is important. The firms compete with each other to win the bonds. The firm that competes with each other to win the bonds. The firm that bids the lowest overall interest cost is awarded the bonds. Municipal bonds are different from other government services that might be awarded on the 144 CU IDOL SELF LEARNING MATERIAL (SLM)
basis of a low bid. For architectural services, for instance, there are quality concerns—one architect might produce higher quality work than another— and in this case, awarding to the lowest bidder might not be the best choice. There are no analogous quality concerns for municipal bond sales. That is, money raised by one firm is the same as money from any other. For negotiated sales, the banking fi rm is intricately involved in the origination of the issue. The fi rm negotiates with the issuer all aspects of the sale, such as the principal maturity schedule, the interest rates for each maturity, and discounts and/ or premiums. The fi rm might also help the issuer obtain a rating, produce the official statement, and otherwise manage the issue origination. The percentage of municipal bonds sold by sale type since 1996. The number of private placements has recently increased as bankers see the advantages of loaning directly to issuers. However, the vast majority of municipal issues are sold either competitively or through negotiation, with negotiated sales typically outnumbering competitive sales three or four to one by volume. Banking fi rms are involved in just about every municipal bond sale, given that almost every bond is sold either through negotiation or competitively. There is a rich literature about the interest cost implications of selling competitively or through negotiation. The vast majority of research studies suggest that, on average, competitive sales result in lower interest rates because they take advantage of market forces. Arguments for the use of negotiated sales revolve around two possible conditions. First, there might be circumstances where timing of the issue matters. For example, negotiated sales could provide more timing flexibility for a refunding sale if the issuer has a clear present value savings target in mind. It might be, for instance, that the refunding sale is delayed until some target present value can be achieved and then the issue quickly comes to market. A certificate of a promise to repay a debt with interest, issued from a bond issuer to a bond purchaser, is known as a bond. A bond underwriter acts as a middleman, purchasing these securities from the bond issuer at a discount and then reselling the bonds to potential investors. Profits thus depend on the difference between the initial purchase price and the resell price of the bond. This margin is called the underwriting spread. In general, the bond underwriter's task is to manage this spread, making sure to make choices that are profitable both to him- or herself and to the bond issuer. 7.5 SUMMARY So, this brings us to the end of our tape on bond and fixed income investing. Lately it seems, bonds have become the Rodney Dangerfield of the investment world -- they don't get any respect. However, there's probably a good reason for this. Bonds were a terrible investment in the 1970s, but were better in the 1980s and 1990s. Stocks, meanwhile, have been great investments in the 1980s and early 1990s. 145 CU IDOL SELF LEARNING MATERIAL (SLM)
The relationship between bonds and stocks is like the relationship between having a job and being the owner of a business. If you have a job, you'll be able to eat, but you'll never get rich on wages. To get rich you need to have ownership in a company. Likewise, bonds provide steady income, but not the profit potential offered by stocks. Although you'll never get rich with bonds, they do provide a steady stream of income like wages from a job. And especially if you're retired, a steady stream of income is nothing to sneeze at. So, thanks for listening, and remember to check out the luhman.org web site and our other audio tapes for more help with your finances. Most investors can improve their balance between risk and return by placing 25% of their portfolio in different bond investments, both investment-grade and high yield. As with stocks, you can do well for yourself by selecting the right bond investments even if you choose not to adjust your portfolio once you set it up. The investments discussed in this chapter are excellent candidates for a buy-and-hold bond program. As an example, Table 7.5 suggests a specific portfolio suitable for investors who do not want to tinker with their holdings once they get their bond investments set up. If your tax situation does not warrant holding municipal bonds, you can replace the tax- exempt bond funds in Table 7.5 with taxable alternatives: Vanguard Short-Term Investment Grade instead of Vanguard Short-Term Tax Exempt, and one of the bond funds recommended in Table 8.5 such as Pimco Total Return instead of the Nuveen High Yield Municipal Bond Fund. Investors who are willing to follow their bond investments can utilize the investment- grade bond ETFs (AGG or CIU) discussed in Chapter 8 for up to half of their bond investments, and can utilize floating rate funds and high yield bond funds for an equal amount. Even a bond investor willing to utilize the active strategy of Chapter 8 might want to place some capital into TIPS or Munis for a really high degree of safety. 7.6 KEYWORDS Eurobank – A bank that regularly accepts foreign currency denominated deposits and makes foreign currency loans. Eurobond – A medium or long-term debenture underwritten by an international syndicate that is denominated in a currency other than that of the country of origin. Usually, a bond issued by a non-European entity for sale in Europe. Instrument may also be called a global bond. Global Bond – A temporary debt certificate issued by a Eurobond borrower, representing the borrower’s total indebtedness. The global bond will subsequently be replaced by individual bearer bonds. 146 CU IDOL SELF LEARNING MATERIAL (SLM)
Global Line – A bank-established aggregate limit that sets the maximum exposure the bank is willing to have to any one customer on a worldwide basis. Guidance Line – An authorization, unknown to the customer, or a line of credit. If communicated to the customer, the guidance line becomes an advised line of credit commitment. 7.7 LEARNING ACTIVITY 1. Create a session on Bonds Underwriting Mechanism. ___________________________________________________________________________ ___________________________________________________________________________ 2. Create a survey on Eurobonds. ___________________________________________________________________________ ___________________________________________________________________________ 7.8 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Define Eurobonds? 2. Define Bonds? 3. What are Foreign Bonds? 4. What is leading bank? 5. Define the term Underwriting? Long Questions 1. Explain the concept of Eurobonds. 2. Explain the concept of International Banks. 3. Explain the concept of Foreign Bonds. 4. Illustrate the Bonds Underwriting Mechanism. 5. Illustrate the concept of Financial Markets. B. Multiple Choice Questions 1. What is a disadvantage of a forward contract is? a. It may be difficult to locate a counterparty. b. The forward market suffers from lack of liquidity. 147 CU IDOL SELF LEARNING MATERIAL (SLM)
c. These contracts have default risk. d. All of these. 2. Why forward contracts are risky? a. Are subject to lack of liquidity b. Both (a) and (b) are true c. Are subject to default risk d. Hedge a portfolio. 3. What is the advantage of forward contracts over future contracts? a. Are standardized. b. Have lower default risk. c. Are more liquid. d. None of these. 4. What are issued by public authorities, credit institutions, companies and supranational institutions in the primary markets? a. Bonds. b. Liability. c. Assets d. Euro. 5. What are forward contracts limited to usefulness to financial institutions? a. Of default risk b. It is impossible to hedge risk. c. Of lack of liquidity d. Both (a) and (c) of the above Answers 1-d, 2-b, 3-d, 4-c, 5-d 7.9 REFERENCES References book 148 CU IDOL SELF LEARNING MATERIAL (SLM)
Gorton, Gary, and George Pennachi, 1989, Are loan sales really off-balancesheet? Journal of Accounting, Auditing, and Finance. Gorton, Gary and George Pennachi, 1995, Banks and loan sales: Marketing nonmarketable assets, Journal of Monetary Economics. Greenbaum, Stuart and Anjan Thakore, 1987, Bank funding modes: Securitization versus deposits, Journal of Banking and Finance. Textbook references James, Christopher, 1987, Some evidence on the uniqueness of bank loans, Journal of Financial Economics. James, Christopher, 1988, The use of loan sales and commercial letters of credit by commercial banks, Journal of Monetary Economics. Klein, Benjamin and Keith Leffler, 1981, The role of market forces in assuring contractual performance, Journal of Political Economy. Website http://moneyhop.com/scripts/bonds/180-conclusion-for-bond-investing https://www.icbc- us.com/ICBC/EN/GlobalMarket/ProductsServices/Underwritingofdebtinstrumentsbyf inancialenterprises/UnderwritingofFinancialBondCommercialBank/ https://www.wise-geek.com/what-does-a-bond-underwriter-do.htm 149 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT 8 – INTERNATIONAL BANKS AND FINANCIAL MARKETS STRUCTURE 8.0 Learning Objectives 8.1 Introduction 8.2 International Equity Issues 8.2.1 General Overview and Differences 8.2.2 Market Microstructure 8.3 Foreign Listing and Equity Underwriting Process 8.4 Summary 8.5 Keywords 8.6 Learning Activity 8.7 Unit End Questions 8.8 References 8.0 LEARNING OBJECTIVES After studying this unit, you will be able to: Illustrate the concept of International Equity Issues. Explain the concept of Market Microstructure. Illustrate the concept of Foreign Listing and Equity Underwriting Process. 8.1 INTRODUCTION In order to adequately provide needed international banking services, commercial banks establish a network of foreign correspondent banks to supplement their own facilities worldwide. Frequently, the expense of establishing a related banking entity, such as overseas branch, is not warranted due to the low volume of transactions concluded for the bank’s international clients. Therefore, to provide services while keeping costs minimal, account relationships are developed with foreign banks to facilitate international payment mechanisms between the institutions. Deposit accounts are opened at the correspondent banks, which enable them to make direct payments overseas by means of debiting and crediting the respective accounts with settlement to be made at a later date. Such accounts are termed due to accounts and due from accounts on the bank’s books. In addition to payment 150 CU IDOL SELF LEARNING MATERIAL (SLM)
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