The Future Of Multinational Banking

More than 160 years after the first wave of multinational banking, it is clear that the future for MNBs will not merely be an 'extension of the past' (Khambata, 1996, p. 286). Powerful forces in the global financial system are producing rapid changes in both the structure of financial markets and the role that banks play within them. Market structure is undergoing significant change driven by the processes of consolidation, conglomeration and specialization in the provision of banking and financial services. Financial disintegration and securitization have changed the very nature of financial intermediation. MNBs have been forced to rethink their strategies as financial markets play an increasing role in channelling funds from net lenders to net borrowers.

Current models of financial intermediaries identify the basis of financial intermediation as the presence of asymmetric information and transaction costs. The models also imply that, where markets are perfect and complete, there is no role for financial intermediaries. Firms interact directly with households through financial markets (Allen and Santomero, 1998, p. 1462). Improvements in the availability of information and in information technology, as well as financial deregulation, have moved the world closer to the textbook model of perfect and frictionless markets. A broad range of substitutes for traditional financial intermediation is now available and banks are increasingly bypassed in favour of direct market participation. Further advances in information technology, communications and openness of markets are expected to accelerate the trend towards disinter-mediation. In addition, non-bank financial institutions continue to offer bank-like products in competition with banks. This development is set to continue with further deregulation of national financial systems.

The diminishing role of traditional banking is reflected in the increasing migration of financial activity off-balance sheet. Loan securitization is an example. While banks traditionally originated loans and held them on-balance sheet until maturity, the trend is for loans to be on-sold in secondary markets and traded in the same way as other securities.

Despite the growth of loan securitization and other forms of off-balance sheet financing, the role of banks in the lending process is unlikely to be eliminated entirely. Banks will continue to originate the loan transaction which then becomes a tradable commodity. Thus banks will act as 'brokers' of loans rather than traditional balance sheet financial intermediaries. Currently, the growth of loan securitization is limited only by the development of sophisticated secondary markets to facilitate trading. Secondary markets currently exist for the trading of mortgage loans, automobile loans and credit card receivables (ibid., p. 1472).

The phenomenon of loan securitization demonstrates that the underlying basis of financial intermediation is shifting. Nevertheless, the costs of participating directly in financial markets are significant. There are costs in learning about each financial instrument, requiring time and effort on behalf of the investor (ibid., p. 1481). Further, markets must be monitored on a continuous basis in order to adjust the mix of assets for optimal risk management (ibid.). Additionally, there is the cost of trading itself.

Arguably, financial institutions are able to perform these functions at a lower cost than firms or individuals. Provided they continue to enjoy a competitive advantage over firms and households, banks will be free to serve as financial services brokers, interfacing with the market, much as stockbrokers mediate between stockholders and the stock exchange.

In addition to changes in the very nature of financial intermediation, banks are playing a prominent role in the provision of risk management services, trading and managing asset holdings of firms and households. This shift in core business is reflected in the volume of derivatives traded by banks, including futures, swaps and options on financial assets. MNBs and other financial institutions are now in the financial risk business, managing and trading financial instruments to minimize risk for their customers (ibid., p. 1478). The provision of risk management services by financial intermediaries is predicated on the lower market participation costs enjoyed by some intermediaries. If this advantage were to disappear, so too would the role of intermediaries in the business of risk management.

The traditional distinction between banks and financial markets is breaking down (ibid., p. 1474). Balance sheet intermediation is a decreasing part of banks' core business as their involvement in financial markets grows. In this sense, traditional multinational banking is a thing of the past. Banks have become the dominant players in financial markets, with offbalance sheet trading forming the bulk of their core business. A more apt description of such institutions is multinational 'financial services providers' rather than multinational 'banks'.

Competitive pressures are also producing rapid change in the market structure of the banking industry. Conglomeration and consolidation, which began in the 1980s, continue to intensify as banks try to achieve the benefits of increased scale and scope. The underlying causes are varied but include technological progress, excess capacity, globalization and deregulation, and an improvement in the quality of financial institutions (Berger et al., 1999, p. 148). The result is MNBs that are able to offer the full range of banking and financial services. The decline of traditional banking has catalysed the process as banks seek to lower costs and to diversify into other financial services.

Some multinationals defy the trend, however, and remain largely un-diversified in their activities, specializing in a particular subset of banking and financial services. A prominent example is J.P. Morgan who specializes in investment banking and funds management services. Competitive pressures are polarizing the industry into specialists at one extreme and universal banks at the other. For the universal banks, conglomeration combined with consolidation is creating one-stop financial services supermarkets able to provide the full range of sophisticated banking and financial services. CitiGroup is a classic example of a financial conglomerate, where loans, risk management services, insurance, pensions, funds management and the like can be obtained from the market through the interface of a single financial services provider.

Rapid change in the provision of financial services presents great challenges to regulators. Existing regulation is increasingly outmoded. First, the growth in securitization and off-balance sheet activity means that the multinational bank of the future will have little need for capital

(Cecchetti, 1999, p. 2). Selling loan assets on a secondary market results in a matching of assets and liabilities of the financial institution and, unlike traditional financial intermediation, no balance sheet risk (ibid.). With the movement of activity/assets away from balance sheets and on to the market, regulation focusing on balance sheets will be rendered redundant.

Second, the globalization of financial services also creates unique problems for regulators. The advance of technology means that national boundaries no longer exist in financial services. A loan can be originated in 'cyberspace' and exist on electronic markets that have no jurisdiction. Such transactions raise issues concerning the most effective form of regulatory regime and appropriate enforcement bodies. Third, the growth of conglomerates raises questions about the most effective way to regulate their different components. Collectively, these changes indicate that regulation needs to be reconfigured and coordinated across the entire global financial system.

With a move to increased off-balance sheet activity, greater reliance will need to be placed on disclosure rather than direct controls. Direct controls that attempt to limit off-balance sheet activity will become ineffective as new instruments continue to evolve (Canals, 1997, p. 319). The most appropriate form of regulation in a market-based environment is to maximize the volume and quality of information available to market participants. This ensures that market prices reflect all available information and effectively disciplines market players (Cecchetti, 1999, p. 4). A complement to market-based discipline is a change in the focus of regulation away from the balance sheet towards evaluation and supervision of internal controls of financial institutions, including audit procedures and other back-office control systems (ibid.).

Globalization and technological advances dictate that regulation must be applied consistently on a global scale. The Basle Accord has already made inroads into this process, introducing minimum capital requirements for MNBs in 1987. These efforts demonstrate that a uniform global regulatory regime is achievable. Although the focus of the Basle Accord is predominantly on the balance sheet, the scheme has been modified to take into account off-balance sheet exposures of MNBs. Again, as the activity of MNBs shifts away from the balance sheet, these regulations will need to be more focused on disclosure of off-balance sheet activity to enforce market discipline. The Basle Committee on Banking Supervision is currently developing a set of recommendations for public disclosure of trading and derivatives activities of banks and securities firms in recognition of this development.18

The nature of financial intermediation is changing and the challenge for

MNBs is to find gaps in the market mechanism. As financial markets move closer to perfection, however, such gaps will become fewer and smaller, and the scope for financial intermediaries of the traditional type will inevitably diminish. If MNBs survive at all, it will be as institutions whose role complements that of the market rather than substituting for it.

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