1

Table of Contents
TRENDS IN FOREIGN BANKING ENTRY IN EMEs ...................................................... 3
1. INTRODUCTION .............................................................................................................. 3
2. TRENDS IN FOREIGN BANKING ENTRY IN EMEs .................................................. 3
2.1. The external drivers of Foreign Bank entry ................................................................ 3
2.2. Aggregate trends: Foreign banks tend to invest in EMEs ........................................... 5
2.3. Drivers for investment in EMEs market ..................................................................... 5
2.4. Which banks expand in EMEs? .................................................................................. 7
2.5. Subsidiary by M&A .................................................................................................... 8
3. CONCLUSION .................................................................................................................. 8
RECENT DEVELOPMENT IN BANKING REGULATIONS .......................................... 9
1. INTRODUCTION .............................................................................................................. 9
2. RECENT DEVELOPMENT IN BANKING REGULATIONS ........................................ 9
2.1. The need of banking regulation ................................................................................... 9
2.2. Basel Framework....................................................................................................... 11
2.3. Money Laundering .................................................................................................... 14
2.4. Other developments in banking regulation ............................................................... 16
3. CONCLUSION ................................................................................................................ 17
REFERENCES ....................................................................................................................... 19
APPENDIX - TABLE ............................................................................................................ 24


2

List of tables
Table 1 Number of banks by host country, Aggregates by income Level and Region (Stijn &
Neeltje, 2012) ........................................................................................................................... 24
Table 2 Foreign banks most common corporate structures .................................................... 24
Table 3 Summary statistic for bank M&A transaction ............................................................ 25
Table 4 Key international standards for sound financial system (Financial stability forum,
2011) ........................................................................................................................................ 26
Table 5 Changes in Basel III .................................................................................................... 27

List of figures
Figure 1 Number and share of Foreign Banks, 1995-2009 (Stijn & Neeltje, 2012) ................ 30
Figure 2 Number of entries and exits of Foreign banks (Stijn & Neeltje, 2012) ..................... 30
Figure 3 Relative Foreign bank presence across Host countries (Stijn & Neeltje, 2012) ....... 30
Figure 4 Economies share of world GDP ............................................................................... 31
Figure 5 GDP growth and the banking sector (PCW, 2013) ................................................... 31
Figure 6 FDI inflows to EMEs 1990-2008 (Arbatli, 2009) ..................................................... 32
Figure 7 Colume of world trade (Federal Reserve bank of Dallas, 2012) ............................... 32
Figure 8 Banking return on asset ratio (PCW, 2013)............................................................... 33
Figure 9 E7 v. G7 total domestic credit (PCW, 2013) ............................................................. 33
Figure 10 Four-phase location ................................................................................................. 34
Figure 11 Size of the financial market by country, region (Allen et al., 2004) ....................... 35
Figure 12 Number of Bank failures 1980-1994 (FDIC, 2001) ................................................ 35
Figure 13 Measures of Bank Performance 1980-2008 (FDC, 2009) ....................................... 35


3

TRENDS IN FOREIGN BANKING ENTRY IN EMEs
1. INTRODUCTION
Over the last two decades, emerging markets economies (EMEs)
1
has seen an unprecedented
development of globalization, especially in foreign bank entry
2
. They effect strongly on
domestic economies and then reform EMEs financial system. Understanding the important
of foreign bank entry, this paper aims to discuss on the trends of foreign bank entry in EMEs
with updated information to answer prominent questions on why they are going abroad,
where they intend to enter, which banks are likely to invest in emerging market, which
business model they will use in host countries as well as what is their future development
strategies.
2. TRENDS IN FOREIGN BANKING ENTRY IN EMEs
In general, number of foreign banks in the world increases rapidly in the last two decades
from 774 in 1995 to 1334 in 2009 as mention in IMF report (Stijn & Neeltje, 2012) (See
Table 1). As a result, the share of foreign bank also increased from 18% to 36% (See Figure
1). This is the result of two balanced trends. Firstly is the decreasing of domestic banks. In
2009, the number of domestic bank is 17% lower than in 1995 due to the consolidation driven
by technological changes and deregulation in many countries. In addition, the financial crisis
also forces many banks to go bankrupt or changing their ownership to foreign banks (Stijn &
Neeltje, 2012). Secondly, the numbers of foreign bank increased sharply before the financial
crisis, and it is continue in present. In Figure 2 and Figure 3, the number of bank entry was
always higher than exit even during financial crisis, especially in 2006 and 2007.
2.1. The external drivers of Foreign Bank entry
With regard to the reason for foreign bank entry, many researches has found that the needs of
serving international customers, higher profit opportunities, lower entry barriers and
technology development are the main reasons. This is the basic understanding for further
discussion on the trends of foreign bank entry.
Internationalize of banks customers

1
Countries on the transition from developing to developed (Citibank, 2012)

2
Foreign bank entry refers to a process by which foreign banks set up operations in a host country
mainly by either opening up a branch or a subsidiary (Citibank, 2012)
4

The first reason is that foreign banks, at first, open their business in other countries to serve
their international customers. Many of the earlier study have found a strong relationship
between the entry of German banks in other countries and the level of German non-financial
FDI in those countries (Brunch, 2000; Wezel, 2004). In addition, the research of Yamori
(1998) stated that Japenese bank were more interested to invest in countries which has high
financial demand from Japan companies.
High opportunities of host countries
The second reason is that foreign bank wants to pursue economic opportunities in the host
countries. They are the countries which have high GNP and GDP leading to high
development chance. This argument was supported by the research of Goldberg & Johnson
(1990), Goldberg & Saunders (1980), Goldberg & Saunders (1981), Buch & Lipponer (2004)
and Yamori (1998) which stated that foreign bank participation level have positive
correlation with GNP, GDP of host countries as well as the size and growth of banking
sector. Especially for EMEs, Leung et al., (2008) and Lee (2003) also proved that foreign
bank entry level is related to the development of local banking industry.
Lower entry barrier
The third reason is the lower of entry barrier. Many researches indicated that foreign bank
invest more in countries with easier regulation on foreign bank activities as well as lower
taxes. (Goldberg & Grosse, 1994; Focarelli & Pozzolo, 2000; Buch & DeLong, 2004; Buch
& Lipponer, 2004; Galindo et al., 2003 and Claessens et al., 2000)
Development of technology
The next reason is that technology development helps foreign bank to lower information cost
between countries as well as to build better management and control system at international
level.
There are many other reasons such as common languages and common other framework.
However, there are not famous studies to prove these arguments in recent
I ncome diversification and excess managerial capacity
An important factors motive banks to invest overseas is the needs of diversify profits. It helps
them to continuously increase their income, take the advantage of economic of scale and,
5

more important, they can also reduce risk of single-country investment. In addition, bank
needs to recruit and train many expertises even if they are not necessary at the moment.
Entering a new geographical market can helps them to efficiently use these resources (Casu et
al., 2006).
Location and the product life cycle
The product life cycle and the location relationship can be another reason for overseas
movement. Banks can be more flexible in finding new market with high income, low cost and
allocate their resources more effectively. They can develop in four phrases (Figure 10). In
phase one, they only work in their home country and export services to customer abroad. In
the next phase, they can set up new business oversea to serve more customers. For the next
development process, they concentrate on the host country production is they have
advantages over home country. In the last phase they can totally change their business to host
country if the cost of host country is much lower.
2.2. Aggregate trends: Foreign banks tend to invest in EMEs
With all of these reasons, many banks open their business abroad and EMEs becomes the
main market for foreign bank entry. In 1995, 31% of foreign bank distribution is in OECD
countries, 4% in high-income countries, 23% in develop countries and 43% in emerging
market (Wezel, 2004). Table 1 show that EMEs always maintain the leading position in
foreign bank distribution by 43% in 2009 when OECD decreases to 25%. The number of
foreign bank in emerging market is counted for 330 in compared with 569 in 2009 (Stijn &
Neeltje, 2012), so it grew by 72%. All of these evidences prove that foreign bank tends to
invest their business in EMCs rather than in OECD and high-income country.
2.3. Drivers for investment in EMEs market
Following the fact that EMEs banking investment is increasing rapidly, the important
question is why they choose this market. There are four basic reasons which are economic
growth, internationalization of customers, baking return on assets, regulation reform and
strategic shift.
Economic growth
EMEs as in it definition is the countries which is transforming from developing to developed
countries. However, the difference is that they have more opportunities for banking
6

investment when the entry barriers and domestic competition is not as hard as in developed
countries. Page (2013) predicted that in the next 40 years, E7 emerging market will got
higher GDP than G7 with the growing rate of 4.7% in compare with 2.1% of G7 countries or
in the forecast of World Bank (2010), Economies share of world GDP will be higher in
emerging market and lower in Developed countries in 2020 (Figure 4). In addition, PCW
(2013) found out a significant positive relationship between GDP per capita growth and the
average annual rise in the domestic credit to GDP ratio (Figure 5). Therefore, with very fast
economy develops, the banking system of EMEs will growth faster and become and attractive
markets for foreign banks.
I nternationalization of bank customers
EMEs is opened its door for foreign investment in their countries. As a result, with high
economic growth of EMCs, many customers of banks expanded their business in these
countries. The forecast of IMF said that FDI inflow of EMEs will develop very fast in the
next 20 years (Arbatli, 2009). In their historical data, the percent FDI to GDP in EMEs
increased continuously (Figure 6). In addition, the import and export of EMEs is higher than
global and developed country as in the report of (Federal Reserve bank of Dallas, 2012). As a
result, foreign bank investment is higher in EMCs.
Higher banking return on assets
EMEs are expected to get high banking return on asset which is important for foreign
banking investment (Figure 8). It helps them to receive higher development opportunities.
According to PCW (2013), by 2050, total banking assets in the E7 tends to exceed those of
G7 (Figure 9). Furthermore, banking profit pools in the E7 markets are will also higher than
those of G7. EMEs have very low labour cost as well as operation cost for new business. In
addition, they have more opportunities for expert recruitment.
Strategic shift
Banks in developed countries have changed their strategies to invest in EMEs. They want to
make large portfolio in their investment to get back investors loyalty during the financial
crisis of US and Europe. Investments in EMEs help them to maintain profit and from that,
reduce the risk of doing business in one country.
Regulation reforms
7

Emerging market policy was changed positively in the past 20 years. It helps foreign banks
easier for entry. In the report of HSBC, Mr. Emmett said that Emerging markets are
developing at a phenomenal pace and are set to reshape world trade patterns over the next 20
years (Adam, 2013). As a result the banking system of these counties will develop stronger
with more foreign bank.
2.4. Which banks expand in EMEs?
It is a fact that many banks want to enter to EMEs, but it cannot be all of them. Only banks
with suitable size, doing business efficiently and being allowed by home country regulation
can invest in emerging market.
Size
There are many reasons for the argument that larger banks tends to expand their business in
EMEs. Firstly, larger banks have more international and giant customers. Therefore, they are
more likely to open their business in EMEs to offer services. Secondly, larger banks which
have larger home-market share is more motivated to make risk diversification in EMEs.
Tschoegl (1983) proved that larger banks exhinit a greater possibility of precense worldwide.
Efficiency
There are two conditions for business efficient of banks in host country if they intend to open
their business in EMEs. The first condition is that foreign bank entrant business in host
country is more efficient than domestic banks of host countries. This statement is confirmed
by the research of Barajas et al (2000). They found out that a larger number of foreign bank
have fewer non-performing loans, lower reserve requirements, and are more productive.
Lastly, Focarelli & Pozzolo (2000) found out that there is a positive relation between banks
return on assets and the possibility of global expanding. They believe that these banks look
for new profit opportunities and large share and revenue in EMEs.
Home country regulation
Home country regulation is a very important factor effect on foreign bank entry. These
include regulation or restriction on international investment in regard to how much benefit
the investment will give back to the home country. Focarelli & Pozzolo, (2000) stated that the
higher restriction on domestic banks activities, the lower degree of bank globalization.
8

2.5. Subsidiary by M&A
There are four main mode of entry for foreign bank in EMEs which are representative offices,
agencies, branches, and subsidiaries (Table 2). However, representative office and agencies
can only provide on a limited services when branches and subsidiary can performs as a
domestic banks, so they effect stronger in domestic economy and is more important for
foreign banks. In total, foreign banks usually open their new business as subsidiaries because
of four main reasons.
Easier regulation: The restriction of foreign banks entry under branches is stricter
than opening subsidiary. This is true for both home and host country regulation. On
the other hands, foreign banks can usually open subsidiaries by M&A. This is usually
the result of a non-efficient financial system which can happen in EMEs.
Taxation: Subsidiary can helps foreign banks to receive the advantage of lower
corporate tax because they have seen as a domestic bank.
Risk matter: Subsidiary is prefer by parent banks because it can limit the risk by
making hard limited liability.
Size: Subsidiary is more suitable to open large business in host country because it
helps them to be more flexible in managing their business and to be easier to expand
them in different locations.
There is a recent trend in which foreign bank usually open subsidiary in host countries to be
benefit from lower taxation and easier regulation as well as more opportunities to expand
their business. The number of banking M&A in emerging market is increased as in Table 3.
This is the result of M&A of foreign banks in EMEs. There are two main reasons for this
attitude. The first is that the deregulation of EMEs as proves in the report of Hawkins &
Mihaljek (2001). The second reason comes from the financial benefit of M&A. In this
business, acquirer shareholders do not lose value as a result of M&A announcement. On the
other hand, they also create more value for shareholders of acquired bank (Goddard et al.,
2010).
3. CONCLUSION
The number of foreign banks in the world is increasing rapidly, especially in EMEs. These
markets have very fast economic growth in the recent years and also in future, this will higher
baking return on assets for foreign banks. In addition, they have to follow their customers
9

who invest in EMCs to maintain their business. However, only the banks with large size have
efficient business tends to expand in EMEs. They tend to invest a large amount of money in
these markets. Furthermore, there is a trend of subsidiary mode in foreign bank entry through
M&A in EMEs. With these discussion, the assignment answered the entire prominent
questions on why they are going abroad, where they intend to enter, which banks tend to
invest in emerging market, which banking model they will use in host countries as well as
what is their future development strategies.
RECENT DEVELOPMENT IN BANKING REGULATIONS
1. INTRODUCTION
In the last several years, the world has seen many abnormal changed in the banking industry.
In the 50s and 60s decades, the banking system is very stable, but in contrast, the frequency
of bank failures and financial crisis has increased dramatically since the Great Depression.
Because of their significant role in the economy, banking failure leads to the recession for
many economies. Therefore, banking regulators always try their best to prevent those
situations by continually improve the banking regulation system. This paper will discuss on
the recent development of banking regulation all over the world. The discussion will focus on
Basel by assessing the development in the entire three versions of this framework. In
addition, a deep review on money laundering will be also conducted.
2. RECENT DEVELOPMENT IN BANKING REGULATIONS
2.1. The need of banking regulation
Bank's role in the economy
Bank plays a very important role in the economy and the development of every country. It is
because banks ensure and facilitate the efficient allocation of resources. They play the role of
delegated mentors and ensure borrowers (households and firms) to use funds effectively
(Diamond, 1984). They connect different lenders to borrowers, funds to firms and therefore
they are both lenders and borrowers in the financial market. As a result, they help
government to develop economy and increase GDP (Gorton & Winton, 2003). More
specifically, according to Allen & Carletti (2011), banks have four basic functions. At first,
they ameliorate the information problem (moral hazard and asymmetric information) between
investors and borrowers. In addition, they also provide insurances to savers against
unpredicted consumption shock. Lastly, as mentioned, they contribute to the growth of the
10

economy and help corporate governance. In the real economy, as in the Figure 11, bank loan
is always the most and or the second biggest market at abouthe United States, except for
United States, and this position is almost unchanged historically.
The risk of bank runs and of moral hazard banking and their effects on the economy
Because of the importance of the banking system, any failure in this industry may lead to the
damage of the whole economy. However, the bank industry faces with very high risk. The
first risk is bank runs
3
. Because all banks operate in the base of liquidity reserve, with a low
level of liquidity, a bank can be bankrupt by bank runs. There are many famous cases in the
literature when many depositors withdraw money at the same time because of the concern
about bank solvency. Lehmans Brother can be a significant evidence of this situation. In
parallel, another problem is the risk of excessive risk taking (moral hazard
4
) in banking. This
problem happened because the risk of investment failure is mostly carried by savers or
depositors when the profit is, in fact, come to the bank. They tend to invest in high risk
projects to earn more profit. Therefore the first important purpose of banking regulation is to
ensure the safety and stability of financial and the whole economic system (Bonn, 2005).
Another reason for banking regulation is to limit the negative effect of bank failure of the
economy. Specifically, they avoid the systemic dangers and the dangers of the payment
system. According to Feldstein (1991), the systemic dangers can be distinguished in two
situations. The first is a consequent failure when a bank failure results in decreasing in the
value of the assets sufficient to induce the failure of another bank. The second is contagion
failure when the bank failure of one bank lead to the failure of other fully solvent bank and
then damages the whole banking system due to the interrelation in the system. In terms of
dangers to the soundness of the payment system, bankruptcy of banks can stop the payment
system of the economy.
An overview of banking regulation
Any bank in the world is controlled by many national and international regulations. As
mentioned, all of them have the aims of ensuring sound and efficient payment system,
controlling liquidity of the banking system, regulating the allocation of financial resources as

3
The situation when all depositors demanded their deposits back at the same time
4
The risk that a party to a transaction has not entered into the contract in good faith, has provided
misleading information about its assets, liabilities or credit capacity, or has an incentive to take
unusual risks in a desperate attempt to earn a profit before the contract settles (Investopedia, 2013).
11

well as controlling cross-border flow. Table 4 shows the major international standards in the
banking system. However, in recent, Basel is one of the most discussed topics on banking
regulation. It is an international framework for all of the regulators in the world. In parallel,
money laundering is also an important issue since the scandal of HSBC. This is the focus of
this paper.
2.2. Basel Framework
I n the need of global regulatory framework
After the financial crisis, the question for all government in the world is how to better
regulate the financial system, especially the banking system. A famous evidences are the
unexpected recession of 1929 which caused by many bank-run in the U.S. and effect badly on
the economies as mentioned before. To stop bank-run, the first suitable action is to impose a
suspension on convertibility and so temporary limit deposit withdraw. In their research,
Diamond & Dybvig (1983) discuss on a better way as they believed which is deposit
insurance. The problem is that this insurance is very expensive. In addition, bank tends to
take more risky investment if this risk is limit of central bank insurance. As a result, different
country had built its own regulation based on different argument and make chaos. Therefore,
in 1988, the Basel Committee on Banking Supervision introduced Basel accord to control
banking system under the auspices of the G10 (Basel Committee on banking supervision,
2009). This helps the world to standardized and common the global banking assessment.
Later, in 2004, they created Basel II to deal with new problems in the market. And in recent,
they are working on Basel III with more development in banking regulation.
Basel I
5

The beginning of Basel Accord is, in fact, come from the 1980 crisis. At that time, a large
number of developing markets defaulted their loans in international banks. The crisis leads to
failure of 1,617 banks in the world (FDIC, 2001) (see Figure 12). However, the economic
development and the banks' business itself had developed strongly before that (Figure 13).
Many research, after that, found out that the most important reason is that failure bank has
very low capital in their balance sheet. Therefore, Basel Accord firstly pays attention to
capital adequacy requirement. This capital requirement is used to ensure that they will have
enough money to pay during bank run. In addition, this will help to improve customer loyalty

5
The more specific discussion on Basel I can be found in the appendix.
12

on bank solvency and do not withdraw money from the bank. Basel I requires banks to
control the capital based on the risk asset ratio.




However, later, they found out that market risk is also an important cause of bank failure. As
a result, they introduced market risk
6
as a new variance in Capital adequacy requirement in
the Amendment of Basel I. The new calculation, therefore:




Basel I recommend that bank must ensure the capital of equal or higher to 8% of total assets.
In addition, there must be 4% of Tier 1 capital.
Basel I have a lot of limitations which fixed in the next versions. At first, Basel I only base on
Capital requirement. Secondly, risk classification in Basel I is not really reasonable because
banks with the same capital adequacy ratio many deals with different customers and different
investment which cause different levels of risk. Thirdly, the framework did not mention about
the diversification of investment portfolio which can reduce risk. In addition, Basel I did not
pay attention to other risk such as operational risk. And lastly, Basel I cannot apply for banks
having a complex structure with many subsidiaries, branches in international levels (Barth et
al., 2012).
Basel I I
In 1999, by understanding the limitation of Basel I, Basel Committee on Banking Supervision
introduced Basel II. This new version is defined by three pillars. The first pillar is the
minimum capital requirement as in Basel I. However, in this version, the regulatory capital
will be calculated in three major components of credit risk, market risk and also the new
operation risk to avoid bankrupcy. In order to ensure that, the supervisory review process is a
tool for supervisor to check if that banks will follow the minimum capital adequacy
requirement. And the third pillar is the market discipline which help the free market to join in
the supervisory process.

6
Market risk include: Equity price risk, Interest rate risk associated with fixed income instruments,
Currency risk, Commodities price risk, Transaction activities which lead to market risk.
13





Basel II has many advantages over the old version. It concentrates more on the internal
control of the banks itself and also the role of external supervision of other organizations.
Furthermore, it allows regulators and bank management to be more flexible in applying the
new accord in order to fix the one size fit all problem. It also accepts the existence of risk
reducing technique such as positioning netting and portfolio diversification.
Basel I I I -recent and future development of banking regulation (Table 5)
Although Basel II is not fully applied in the world, in 2008, the financial crisis proved that
Basel II needs to be improved. This crisis occur even the entire capital adequacy of the
banking system was strong (Figure 13). A famous case is Lehman Brothers when it has very
strong capital ratios as in their report right before the bankruptcy. Later research stated that
they made their balance sheet become more attractive than it must be. In addition, their asset
has very low liquidity. Therefore, Basel III tends to fix this problem and also improve their
previous policy through informing new requirement on: minimum capital requirement,
leverage ratio and liquidity ratio.
In terms of minimum capital requirement, Basel II requires an additional of 2.5% Capital
Conservation Buffer and also allows governments to increase a counter-cyclical buffer. The
evaluation of risk weight will depend on market risk, credit risk, operational risk and also
liquidity risk.
Basel II was not good at credit valuation when a bank can use leverage ratios of non-risky
assets put on their balance sheet when it is riskier than that they write. Therefore, instead of
only calculate leverage ratio of risk based, Basel III minimum this ratio of 3% and that is not
based on the risk weights (Auer & Pfoest, 2012).
The third important change in the new accord is Liquidity standards which have not been
considered in a very long time. This new ratio includes short-term ratio called liquidity
coverage ratio (LCR) and the long-term ratio of net stable funding ratio respectively (NSFR)
(Michail & Tim, 2012). The LCR ensures that bank has high liquid assets. To prove this, the
bank must calculate the cash flow in over 30 days with stress testing. The high liquid asset
must equal or greater than the measured cash flow. About NSFR, this force banks to ensuring
that long-term assets will be funded by stable liabilities. With this aim, banks have to increase
14

long-term funding for low quality liquid assets as well as for assets which is important in the
economic crisis.
With the new development of Basel III in response to the 2008 crisis, each country can
consider applying in their national regulation. It is expected to reduce risk in the banking
industry and then strengthen the financial system.
2.3. Money Laundering
Recent issues of Money laundering
In the recent time, money laundering becomes a significant problem for the whole economic
system. Money laundering is becoming more complex with cross - border transactions
between many different international banks. However, rapid development of the international
banking system is one of the extremely supportive tools for this violation. HSBC can be a
good example in this case. According to BBC (2012), HSBC was punished $1.9bn for money
laundering scandal. Between 2007-8, HSBC Mexico, HBMX and HSBC US transferred $7bn
around. HBMX had a high profile customers which involved in drug transferring, they also
have millions suspicious dollar of travelers checks. In the past, they also had a scandal on
laundering $19.7bn of Iran. Or in the most recent news in March 2013, they are believed to
relate to a money laundering scandal of $77m in Argentina (BBC, 2013). Although paying
too much attention to the anti-money laundering system by investing $290m on the system of
preventing money laundering, and also be supervised strictly by the government, the relation
between money laundering and HSBC cannot be broken. This is a big problem for also other
banks and it can damage the economy.
Money Laundering
Money laundering is defined as the act of transforming profits earned from a criminal
activity into legal profit (Heffernan, 2007). This action can be confused as flight capital
which is a legal work of transfer money from one place to another to make more profit or to
prevent risk. However, flight capital is usually after-tax money which has been proved the
original source when money laundering has not. Money laundering can be performed by a
Smurf organization who helps to transfer money through three steps: placement, layering and
integration (Heffernan, 2007) . In the placement phase, money will be put into a financial
institution. Then, they will be moved to another institution one or many times to hide the
15

original sources. Lastly, at the integration phase, they will use washed money to invest in
legal business.
Banking regulation on money laundering
The bank is the most useful channel for money laundering, therefore, many regulations has
been supervising banks strictly to avoid this violate. Willful negligence is one of them which
has a very high penalty. Many countries require that banks must report suspicious
transactions
7
to the government. In addition, they must establish an internal control system
for all of their business operations to prevent money laundering from any organization or
individual. One of the famous programs is Know your customers. This program expects the
banks to evaluate their customers identity, the sources of money in all aspects of bank
business before transaction. They are also forced to have an adequate recordkeeping system
to control the currency purchases over a limit value.
In the US, the most important regulation in money laundering is Bank Secrecy Act (1970)
which stated that banks must record transaction of $10,000 or more and the government can
lower this value requirement. The history of US anti-money laundering laws also include the
money laundering control act (1986), Anti-drug abuse act 1988, Annunzio-Wylie anti-money
laundering act (1992), Money laundering suppression act (1994), Money laundering and
financial crimes strategy act (1998), USA PATRIOT act (2001) (US states department of
treasury, 2013). The most recent development in US anti-money laundering program is the
Intelligence reform & Terrorism prevention Act introduced in 2004. This forces Secretary of
the Treasury to create regulations in which require banks to report cross-border transaction or
funding even on the electronic channel. The reason is that they found out money laundering is
operated at an international level these days.
In the UK, there are also many laws on money laundering which can be listed such as The
1986 drug trafficking offenses act, the 1987 prevention of terrorism act, the criminal justice
act of 1990 and the criminal justice act of 1993. And the most recent law in the UK is the
money laundering regulations 2007 (UK Law, 2007). This new regulation, in general requires
banks to assess the risk of being used by criminals to launder money, check customers and
beneficial owners identity, monitor customers business activities, provides internal control
system, keep all documents related to any transaction as well as make sure that banks

7
Suspicious transactions include which is just below $10,000 (in US), high cash flow from industry
which is in depression or someone who show the teller a suitcase of cash.
16

employees are aware of the regulations through training (HMRC, 2013). The similar
regulation was also applied in many other countries.
2.4. Other developments in banking regulation
There are many other developments in the banking system, especially in developed countries.
They focus on different activities of the business and also in all of the relative bodies such as
regulators, the board of management and supervisors.
Recent development in Bank supervision and corporate governance
At the international level, in October 2010, BCBS introduced 14 principles for enhancing
bank supervision and corporate governance. This new paper requires banks to build an
appropriate system to manage risk, remuneration, conflict and auditing (Jordan, 2012). In
addition, follow new rules, board of parent banks will take all responsibility for overseeing
corporate governance. Then in June 2011, they published a new framework on operation risk
control which related to the role of board of management. More recent, on 28 June 2012, they
also issued supervisory guidance on the internal audit function to help supervisor joining to
the audit process (Putnis, 2012).
In Europe, the European commission published Green Paper in June 2010, and updated this
paper on 5 April 2011 with the aims of improving Corporate Governance in Europe
(European Comission, 2011). They also emphasis on the function of boards of management,
but also require the participation of shareholders. The European Banking Authority also
issued the Guidelines on 27 September 2011 in corporate with the Committee of European
Banking Supervisors with new know-your-structure policy which requires better
management, communication and information transferring process (European Banking
Authority, 2011). In UK, UK Corporate Governance Code 2010 and UK Stewardship Code
2010 also follow these agreements (Financial reporting council, 2010).
Recent development of Payment system
In terms of payment system, the EU Payment Services Directive (PSD) provides a
foundation and recommendation on the Single Euro Payments Area. It seems like they are
stricter in money transferring control and intend to increase bank entry to EU. In May 2011,
they also pay attention to the e-commerce by introducing Electronic Money Regulations 2011
17

(EMR). It is a proof that the future business of banks will only base on technology system
(EU Payment Services Directive, 2011).
Recent development in Stress testing
At EU level, CEBS issues a guideline on stress testing which helps banks to build and
implement the stress testing program with a robust governance structure. In the updated
version in 2011, they show that they are tighter in tier 1 capital control by introducing new
consistent capital benchmark of this capital type (Committee of European Banking
Supervisors, 2011). In the UK, government and the FSA also require banks to build a robust
stress testing program for controlling purpose of capital and liquidity in different business
situation (Financial Services Authority, 2011).
Recent development in Shadow Banks
8

Shadow bank is believed to become a big problem in the banking system. They have a high
risk of facing with bank-runs when regulators, at recent, cannot control their business. In
addition, they do not have access and deposit insurance from the central banks which lead to
the low confident level for investors and customers. However, shadow banks failure can lead
to unwelcome effect on the financial system and also the whole economy by their relationship
with the regular banking system. The Financial Stabilities Board has proved that they will use
all of regulation effort to minimize risk of bank-runs and the contagion effect of shadow
banks (Financial stability board, 2012). The European Commission also wants to control
these banks through five they area: banking regulation, asset management regulation issues,
securities lending and repurchase agreement, securitizations and general work on shadow
banking entities starting in 2013 (European commission, 2012).
3. CONCLUSION
The banking regulation system has changed too much in the last 5 years because of their
important role in the economic system. In general, regulators want to internationalize banking
laws. Basel is the most famous one. In recent, they want to improve the bank supervisory by
publishing Basel II and recommend Basel II concept. They introduced new regulations on
capital, liquidity and leverage ratio requirement. Furthermore with the fast
internationalizations of the banking system, regulators are paying more attention to money

8
The FSB has recently defined shadow banking as credit intermediation involving entities and
activities outside the regular banking system (FSA, 2012).
18

laundering. They control this problem through many different regulations with high
punishment. In conclusion, to face with the high level of internationalization and the more
complex situation of banking business, regulators have changed and issues new laws which
require better management system of banks. They force management and also shareholder to
participate in internal and international control of their business system with better payment
system, and better risk calculation methodology such as stress testing. In the following year,
shadow banks will be also regulated as expected. However, regulators do not want to meet
one size fit all problem. They tend to give more regulations covering more aspect of the
banking system but with more flexibility and options for different business situation.
Word count: 4,163

19

REFERENCES
Adam, E., 2013. foxbusiness.com. [Online] Available at:
http://www.foxbusiness.com/news/2013/02/26/emerging-markets-are-reshaping-world-trade-
hsbc/ [Accessed 28 March 2013].
Allen, F., Chui, M. & Maddaloni, A., 2004. Financial Systems in Europe, the USA, and Asia.
Oxford Review of Economic Policy, (20), pp.490-508.
Arbatli, E., 2009. Economic Policies and FDI Inflows to Emerging Market Economies. IMF
working paper. IMF.
Auer, M. & Pfoest, G.V., 2012. Accenture, Basel III Hand-book.
Barajas, A., Steiner, R. & Salazar, N., 2000. Foreign Investment in Financial Sector. In
Internationalization of Financial Services: Issues and Lessons for Developing Countries.
Boston.
Barth, J.R., Gan, j. & Nolle, D., 2012. Global Banking Regulation & Supervision: What Are
the Issues and What Are the Practices? Working paper. U.S. Treasury Department.
Basel Committee on banking supervision, 2009. History of the Basel Committee and its
Membership.
BBC, 2012. BBC.co.uk. [Online] Available at: http://www.bbc.co.uk/news/business-
18880269 [Accessed 28 March 2013].
BBC, 2013. BBc.co.uk. [Online] Available at: http://www.bbc.co.uk/news/business-21840052
[Accessed 28 March 2013].
Bonn, A., 2005. An increasing role for competition in the regulation of banks. Report paper.
World Bank.
Brunch, C.M., 2000. Why Do Banks Go Abroad Evidence from German Data. Financial
Markets, Institutions and Instruments, 9(1), pp.33-67.
Buch, C.M. & DeLong, G., 2004. Cross-Border Bank Mergers: What Lures the Rare Animal?
Journal of Banking and Finance, 28, pp.2077-102.
20

Buch, C.M. & Lipponer, A., 2004. FDI Versus Cross-Border Financial Services: the
Globalization of German Banks. Discussion Paper.
Carletti, E., 2004. The Structure of Bank Relationships, Endogenous Monitoring and Loan
Rates. Journal of Financial Intermediation, (13), pp.58-86.
Casu, B., Girardone, C. & Molyneus, P., 2006. Introduction to Banking.
Citibank, 2012. citibank.com. [Online] Available at:
http://www.citibank.com/ipb/europe/globalpages/glossary.htm#e [Accessed 28 March 2013].
Claessens, S., Demirg-Kunt, A. & Huizinga, H., 2000. The Role of Foreign Banks in
Domestic Banking Systems.
Committee of European Banking Supervisors, 2011. CEBS guidelines on Stress testing.
Diamond, D., 1984. Financial Intermediation and Delegated Monitoring. Review of Economic
Studies, (51), pp.393-414.
Diamond, D.W. & Dybvig, P.H., 1983. Bank runs, Deposit Insurance, and Liquidity. The
Journal of Political Economy, 91(3), pp.401-19.
EU Payment Services Directive, 2011. Financial services and market - The electronic Money
regulations.
European Banking Authority, 2011. EBA Guidelines on Internal Governance. London.
European Comission, 2011. Green paper: The EU corporate governance framework.
European commission, 2012. Green paper - Shadow banking.
FDC, 2009. fdc.gov. [Online] Available at: www2.fdc.gov/qdp [Accessed 28 March 2013].
FDIC, 2001. Financial Crisis Statistic. Report Paper. FDIC Division of Research and
Statistics.
Federal Reserve bank of Dallas, 2012. Emerging market economy.
Feldstein, M., 1991. The Risk of Economic Crisis. Chicago.
Financial reporting council, 2010. The UK corporate governance code. London.
21

Financial Services Authority, 2011. Stress and Scenario Testing. Policy Satement. Financial
Services Authority.
Financial stability board, 2012. Global Shadow Banking Monitoring Report 2012.
Financial stability forum, 2011. Banking regulation.
Focarelli, D. & Pozzolo, A., 2000. he Determinants of Cross-Border Shareholding: An
Analysis with Bank-Level Data. Working paper. Federal Reserve Bank of Chicago.
Focarelli, D. & Pozzolo, A., 2000. The Determinants of Cross-Border Shareholding: An
Analysis with Bank-Level Data from OECD Countries. Economic Working Paper Series.
Bank of Italy.
FSA, 2012. FSB April 2012 Report.
Galindo, A., Micco, J. & Serra, C., 2003. Better the Devil that you Know: Evidence on Entry
Costs Faced by Foreign Banks. Working Paper. IDB Research Department.
Goddard, J., Molyneux, P. & Zhou, T., 2010. Bank mergers and acquisitions in emerging
markets: evidence from Asia and Latin America.
Goldberg, L.G. & Grosse, R., 1994. Location Choice of Foreign Banks in the United States.
Journal of Economic and Business, 46, pp.367-79.
Goldberg, L.G. & Johnson, D., 1990. The Determinants of US Banking Activity Abroad.
Journal of International Money and Finance, 9(2), pp.123-37.
Goldberg, L.G. & Saunders, A., 1980. he Causes of U.S. Bank Expansion Overseas: The
Case of Great Britain. Journal of Money, Credit and Banking, 12(4), pp.630-43.
Goldberg, L.G. & Saunders, A., 1981. The Determinants of Foreign Banking Activity in the
United States. Journal of Banking and Finance, 5, pp.17-32.
Gorton, G. & Winton, A., 2003. Financial Intermediation.
Hawkins, J. & Mihaljek, D., 2001. The banking industry in the emerging market economies:
competition, consolidation and systemic stability an overview. Working paper. Bank for
International Settlements.
Heffernan, S., 2007. Modern Banking.
22

HMRC, 2013. HMRC.gov.uk. [Online] Available at:
http://www.hmrc.gov.uk/MLR/getstarted/intro.htm#3 [Accessed 28 March 2013].
Investopedia, 2013. investopedi. [Online] Available at:
http://www.investopedia.com/terms/m/moralhazard.asp [Accessed 28 March 2013].
Jordan, N., 2012. 2013 Banking outlook: Surviving and thriving in the "new normal" world of
banking regulations. Handbook. Grant Thornnton.
Lee, B., 2003. The Determinants of Foreign Banks' Entry in Korea and Its Effects on Korean
Domestic Banks' Performance. Economic Papers, 6, pp.42-65.
Leung, M.K., Young, T. & Fung, M.K., 2008. The Entry and Exit Decisions of Foreign
Banks in Hong Kong. Managerial and Decision Economics, 29, pp.503-12.
Michail, K. & Tim, K.A., 2012. A global regulatory framework for more resilent banks and
banking system. Research paper. Gothenburg University.
Page, N., 2013. Brave new world. New York.
PCW, 2013. banking 2050: How big will the emerging markets get? UK.
Putnis, j., 2012. The banking regulation review. Law Business Research. London: Gideon
Roberton Law Business Research Ltd.
Stijn, C. & Neeltje, H.v., 2012. Foreign Banks: Trends, Impact and Financial Stability. IMF
working paper. IMF.
Tschoegl, A.E., 1983. Size, Growth, and Transnationality among the Worlds Largest Banks.
Journal of Business, pp.187-201.
UK Law, 2007. The money laundering regulations 2007.
US states department of treasury, 2013. FinCEN. [Online] Available at:
http://www.fincen.gov/news_room/aml_history.html [Accessed 28 March 2013].
Wezel, T., 2004. 01/2004 Foreign Bank Entry into Emerging Economies: An Empirical
Assessment of the Determinants and Risks Predicated on German FDI Data. Discussion
Paper. Deutsche Bundesbank.
World Bank, 2010. Global at a glance.
23

Yamori, N., 1998. A Note on the Location Choice of Multinational Banks: The Case of
Japanese Financial Institutions. Journal of Banking and Finance, 22(1), pp.109-20.


24

APPENDIX - TABLE
Table 1 Number of banks by host country, Aggregates by income Level and Region (Stijn &
Neeltje, 2012)

Table 2 Foreign banks most common corporate structures
A subsidiary is an independently capitalized, separate legal entity established under the
supervision and rules of the host country regulator. a A subsidiary has the same legal rights
and obligations as a home country bank. A foreign bank can establish a subsidiary either by
acquiring an existing bank or by creating a new subsidiary de novo. The assets of the parent
bank do not back the liabilities of subsidiaries. Protectionist countries may oblige foreign
banks to establish subsidiaries by legal restrictions.
In contrast to a subsidiary, a branch has no assets that are independent of the foreign parent
bank. They are not separately capitalized, stand-alone legal entities. A branch is empowered
to receive deposits, grant loans, and to generally undertake banking functions, opposed to
agencies or representative ofces. Host-country regulations may impose limits on their
activities that do not apply to subsidiaries and domestic banks.
Similar to a branch, an agency is part of the foreign parent bank; however, it cannot take
deposits from host country residents. The main sources of funding are funds from the parent
25

bank, interbank market funds, or other money market transactions such as short-term
certicates of deposit or repurchase agreements. Agencies are attractive forms oforganization
for banks interested in wholesale banking. They can make loans, pay checks,and maintain
credit balances.
Similar to a branch and agency and unlike a subsidiary, a representative ofce is part of the
parent bank and not a separately capitalized, distinct legal entity. By regulation, it cannot
perform any of the core banking functions such as taking deposits, maintaining credit
balances, granting loans, or providing payments services. Representative ofces are often
established either to provide services to customers based in the home country of the parent
bank or to explore market entries.
Finally foreign banks can participate in consortium banks with other banks. This type of
foreign bank entry is often used to explore foreign markets. The parent bank is not
responsible for the liabilities of this bank and is only involved as a shareholder. Particular
host country regulations may deviate from this summary. The summary here is based on
modern banking principles in advanced economies.
As discussed in the text, most regulators from Latin America impose the same capital and
liquidity requirements for branches and subsidiaries.


Table 3 Summary statistic for bank M&A transaction

26

Table 4 Key international standards for sound financial system (Financial stability forum,
2011)

27

Table 5 Changes in Basel III



28


29



30

Appendix Figure
Figure 1 Number and share of Foreign Banks, 1995-2009 (Stijn & Neeltje, 2012)


Figure 2 Number of entries and exits of Foreign banks (Stijn & Neeltje, 2012)

Figure 3 Relative Foreign bank presence across Host countries (Stijn & Neeltje, 2012)
31


Figure 4 Economies share of world GDP

Figure 5 GDP growth and the banking sector (PCW, 2013)
32


Figure 6 FDI inflows to EMEs 1990-2008 (Arbatli, 2009)

Figure 7 Column of world trade (Federal Reserve bank of Dallas, 2012)
33


Figure 8 Banking return on asset ratio (PCW, 2013)

Figure 9 E7 v. G7 total domestic credit (PCW, 2013)
34


Figure 10 Four-phase location

35

Figure 11 Size of the financial market by country, region (Allen et al., 2004)


Figure 12 Number of Bank failures 1980-1994 (FDIC, 2001)

Figure 13 Measures of Bank Performance 1980-2008 (FDC, 2009)
36



37

Basel I
Basel I original



Tier 1 or core capital: common equity shares, disclosed reserves, non-cumulative preferred
stock, other hybrid equity instruments, retained earnings, minority interests in consolidated
subsidiaries, less goodwill and other deductions.
Tier 2 or supplementary capital: consisting of all other capital but divided into (1) upper tier
2 capital such as cumulative perpetual preferred stock, loan loss allowances, undisclosed
reserves, revaluation reserves (discounted by 55%) such as equity or property where the value
changes, general loan loss reserves, hybrid debt instruments (e.g. convertible bonds,
cumulative preference shares) and (2) lower tier 2 subordinated debt (e.g. convertible
bonds, cumulative preference shares).
Risk weights are assigned to assets by credit type. The more creditworthy the loan, the lower
the risk weight.
0%: cash, gold, bonds issued by OECD governments.
20%: bonds issued by agencies of OECD governments (e.g. the UKs Export and
Credit Guarantee Agency), local (municipal) governments and insured mortgages.
50%: uninsured mortgages.
100%: all corporate loans and claims by non-OECD banks or government debt, equity
and property.
Market risk calculation
There are two approaches to calculate market risk: The internal model approach and the
standardised approach
The internal model approach

Bank models must compute VaR on a daily basis.
38

Where: V
x
: The market value of portfolio
dV/dP:The sensitive to price movement
P
t
: The adverse price movement
The four risk factors to be monitored are interest rates (for different term
structures/maturities), exchange rates, equity prices and commodity prices.
Basel species a one-tailed 99% condence interval, i.e. the loss level is at 99%; the loss
should occur 1 in 100 days or 2 to 3 days a year. Recall the choice of 99% is a more risk
averse/conservative approach. However, there is a trade-off: a choice of 99% as opposed to
95% means not as much historical data are available to determine the cut-off point
The choice of holding period (t in the equation above) will depend on the objective of the
exercise. Banks with liquid trading books will be concerned with daily returns and compute
DEAR, daily earnings at risk. Pension and investment funds may want to use a month. The
Basel Committee species 10 working days, reasoning that a nancial institution may need
up to 10 days to liquidate its holdings.
Basel does not recommend which frequency distribution should be used. Recall that
Riskmetrics employs a variancecovariance approach. Banks that use variancecovariance
analysis normally make some allowances for non-linearities, and the Basel Amendment
requires that non-linearities arising from option positions be taken into account. For either
approach, Basel 2 requires the specication of a data window, that is, how far back the
historical distribution will go, and there must be at least a years worth of data. Generally, the
longer the data run the better, but often the data do not exist except for a few countries, and it
is more likely that the distribution will change over the sample period.
The standardised approach:
Instead, the amount of capital to be set aside is determined by an additive or building bloc
approach based on the four market risks, that is, changes in interest rates (at different
maturities), exchange rates, equity prices and commodity prices. In every risk category, all
derivatives (e.g. options, swaps, forward, futures) are converted into spot equivalents.
39

Specific information on market risk
Equity risk:
Determining the market risk arising from equities is a two-stage process, based on a charge
for specic risk (X) and one for market risk (Y). To obtain the specic risk the net (an offset
of the long and short of the spot and forward position) for each stock is computed. The net
exposure of each share position is multiplied by a risk sensitivity factor, which is 8% for
specic and market risk, but if the national regulator judges the portfolio to be liquid and well
diversied, the systematic risk factor is reduced to 4%. In the example below, it is assumed to
be 4%.
Foreign exchange and gold risk
Recall that all derivatives have been converted into the equivalent spot positions. A banks
net open position in each individual currency is obtained all assets less liabilities, including
accrued interest. The net positions are converted into US$ at the spot exchange rate. The
capital charge of 8% applies to the larger of the sum (in absolute value terms) of the long or
short position, plus the net gold position. Alternatively, subject to approval by national
regulators, banks can employ a simulation method. The exchange rate movements over a past
period are used to revalue the banks present foreign exchange positions. The revaluations
are, in turn, used to calculate simulated prots/losses if the positions had been xed for a
given period, and based on this, a capital charge imposed.
I nterest rate risk
The capital charge applies to all debt securities, interest rate derivatives (e.g. futures,
forwards, forward rate agreements, swaps) and hybrid instruments. The maturity approach
involves three steps:
Obtain a net overall weighted position for each of 16 time bands. Before they are summed,
the net position in each time band is multiplied by a risk factor, which varies from 0 at the
short end to 12.5 at the long end.
10% of each net position in each time band is disallowed to take account of the imperfect
duration mismatches within each time band known as vertical disallowance.
40

There is another problem: the interest rates in the different time buckets may move together,
which is resolved through several horizontal disallowances, which vary from between 30%
and 100% (i.e. no disallowance) in recognition that the degrees of correlation will vary. The
matched long and short positions between the time buckets can be offset, but:
a 40% disallowance applies in the rst set (01 year);
a 30% disallowance applies to the other two sets of time bands, i.e. 14 years and
over 4 years;
there is a 40% disallowance for adjacent time buckets, and a 100% disallowance between
zones 1 and 3.
Commodities risk
This risk is associated with movements in prices of key commodities such as oil, natural gas,
agricultural products (e.g. wheat, soya) and metals (e.g. silver, copper, bronze) and related
risks such as basis risk, or changes in interest rates which affect the nancing of a
commodity. The capital charges are obtained with a methodology similar to that used for the
other three categories, but it will not be discussed here.