Presented by: Dr. Peter Larose

Focus of the Presentation

1. Role of Financial Intermediation in Different Phases of the Business Cycles

2. New Internal Rules on Corporate Governance

3. Front-Office Commercial Strategies

4. Information Technology Revolution

5. Tightening of New Prudential Norms

6. Strengthening Skills and Intellectual Capital

7. Dealing with Greater Uncertainty in the Credit Market

8. More Emphasis on Risk Management

9. Strategies Needed in the New Banking Environment

10.Prevention of Banking Crisis

Changing Landscape In Banking

The face of financial services sector, as we are all aware is changingvery rapidly.

Many industrial nations including the emerging markets in South EastAsia are focusing on the 21st Century banking in terms of financialconglomerates, whereby “one-stop financial services boutique” isbecoming the norm.

Pressure to compete within the bank’s incorporated jurisdiction isalso increasing rapidly by the days.

Cross-border transactions are also being increased with new productson offer in relation to the multitude of business risks.

As a results banks and other provider of financial services are having toprepare for changes in the international regulatory framework.

Role of Financial Intermediation in Different Phases o the Business Cycles

It is understood by most players in the financial services sector

perceived that banks no longer operate as the principal mobilizer of

funds for organic growth.

The new paradigm shift is about “ efficiency in the financial

intermediation activities” .

The business cycles are now considered a very important factor in the bank’s forward planning process.

With these economic development and strategies being considered

Many well established banks are now having to consider administrative reforms in order to accommodate the changes.

New Internal Rules on Corporate Governance

The Enron, Worldcom and Tyco type of corporate collapses has created a condition, whereby the Board of Directors responsibilities are now more pronounced that previously in place.

The new rules states that there should be a separation of power between the Chairman of the Board of Directors and the Chief Executive Officer (CEO).

The need for independent directors has arisen because of the potential divergence of interests between the providers of capital, i.e. shareholders, and management.

The directors of a Board must be qualified in their respective fieldof specialization so that they can bring a blend of collective knowledge to run the business with prudence.

Front-Office Commercial Strategies

There is no longer the “job for life” for banks’ employees. Most banks require thattheir employees can create a good image vis-à-vis the customers in a cordial andcustomer-relationship management.

Front-Office employees are trained to create the “first-hand impression” for thecustomers to use the banks’ services more frequently and economically.

Many improvement are being made in the manner that the banks recruit theiremployees to have a long-lasting impression on the customers’ minds.

Customer-relationship is now the motto of all banks to achieve without having tosacrifice the standard of services and its prices.

The new work culture is to deal with employees as groups or teams of people,who can use their targets as benchmarks in evaluating their performance.

Modern Labour Force

The need for productivity and efficiency will create new sources labor and work practices.

The new labour force will have to follow the modern setting of acustomer-demand environment that they are the “boss”.

It is expected that there will also be intense competition to attract and retain professional in all fields so as to satisfy the clientele’s profile.

Training costs are expected to increase progressive with the level of revenue that the banks generate.

The cost of gathering marketing intelligence will also increase correspondingly with the level business activities.

More emphasis will be placed on marketing & selling skills.

Information Technology RevolutionSince the 1990s, the banking systems worldwide has witnessed a rapid transformation.Information Technology is considered as one of the “key drivers” in a bank’s operations.

There has been a spate of merger, and acquisition transactions due mainly to the linkof information technology.

A new style of management also emerged as a result of the advancement in newtechnology – manage by wire.

This development has caused the individual management to channel their resourceson the “universal banking” concept.

While the consolidation process has brought about new opportunities, there has alsobeen some identifiable risks with the rapid development in I.T (e.g. concentration riskand security aspects).

The general trend that emerged from the I.T. revolution is the combination of non-banking activities (e.g. insurance, pension, investment banking, mortgage finance,and financial securitization) with the hope that there will be internal synergies andeconomies of scale.

There is also the global consideration, where non-banking activities can be conductedat the subsidiaries level.

Technology Issue

The key driver of all this change will be technology that supports efficient, accurate decision making and greater operational flexibility and efficiency.

The speed in the performance of transactions will be the main issue between success or failure.

Customers are now more educated and sophisticated in their demands for services.

The successful banks will be those who can track and analyze specific customer needs at all level.

As more sophisticated information technology is required, banks will have ton consider their investment well in advance in their financial planning.

Tightening of New Prudential Norms

Banks are having to prepare for the new Basel Accord II, which accentuates on thefollowing considerations:

(a) Minimum Capital Requirement(b) Supervisory Review, and(c) Market Discipline.

The primary focus of the new Capital Adequacy Accord is based on improving themeasurement of risk in all its dimension.

The process of measurement of market risk is to be maintained.

There will be 3 alternatives for a start on how to calculate Credit Risk:

(i) Standardized Approach (SA) – this approach employs by less complex banks (as 1988 Accord) it expands the scale of the risk weights and also uses external rating agencies (e.g. S&P, Moodys’, Fitch, Capital Intelligence etc).

(ii) Banks with more advanced risk management structure can also employ an internal ratings based on (IRB) methodology – (foundation & advanced).

(iii) Basic Indicator Approach (BIA) -

Strengthening Skills and Intellectual Capital

The new banking era in the 21st Century place a heavy demand on how the bank’smanagement utilize its human resources skills for greater efficiency.

Factors such as: knowledge of the products/laws/customers/economic environment,general service attitudes to identify the customers’ needs, and the selling skills todeal with existing and potential customers are all important factors in the survivalin a dynamic market.

Banks no longer rely on the quantity of its labour force to show the sign of beingpowerful institutions, but on the quality of its employees to convince the customers.

Management’s focus in the integration of its skillful human capital in a holisticmanner with other departments in a professional way.

Most of the qualities demanded in the banking sector are: added value, creativity,manage changes, flexibility and team work.

Management are now emphasizing on performance management, competencies,and a forward-looking approach by all employees in the bank’s hierarchy.

Dealing with Greater Uncertainty in the Credit Market

The credit market can be subject to a multitude of factors that may createuncertainty for the banks:

(a) Inflation,

(b)Adverse Movement in Interest rates

(c) Adverse Movement in Exchange rate

(d)Change in the Gross Domestic Products (GDP)

(e)New Investments

(f) Change in Customers’ Attitudes & Expectations

(g) Intensity of Competition

(h)Change in Government Policy

More Emphasis on Risk Management

Risk management is an important aspect of all our daily lives.

We are all exposed to risk daily, as soon as we open our eyes in the morning and sometimes even in our deep sleep.

It is our utmost duty as an individual that we make provision in our lives to identify the risks, make an evaluation, quantify them, insure or shift therisks unto another party, if we cannot deal with them.

More emphasis is placed on banks to manage their risks more prudently so that the banking system is not place at risk.

Any regulatory agency in the world would ensure that there is always a safe and sound banking system at all times.

Otherwise, the public money may be used to “bail out” distressed banksand there will be a lost of confidence in the banking system.

No jurisdiction can afford to deal with a banking crisis.

More Emphasis on Risk Management continues

What is the relationship between effective enterprise risk

management and improved financial reporting and transparency?

There are natural linkages between enterprise risk management, improved financial reporting and transparency.

The new Framework requires that organizations establish a risk appetite, measure actions and decisions against that risk appetite and communicate results.

Communication of enterprise risk management to users of financial information clearly enhances transparency.

Sarbanes-Oxley Act 2002 is quite specific on this issue

Co

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Commercial Banking

Investment Banking

Other Commercial Activities in Subsidiaries

Professional Services

Taxation PlanningAccountingPension Fund ManagementInvestment Management AdviceFinancial PlanningReal Estate Management Advice

Travel AgencyInsurance CompanyRetail/SupermarketI.T. CompaniesOthers

Conglomerate Approach

Banks are no longer content to remain with its core business, they are more eager to develop a “conglomerate business style” that is, a “one-stop financial services boutique”.

It means that the customers’ profile are used more productively to cross-sell other subsidiary services, such as: insurance, pension fund, financial planning, taxation advice, corporate restructuring, investment banking faculties, invoice discounting,travel facilities, and a host of other services to meet the customers’ needs.

While there are business opportunities to deal in such a corporate manner, there areequally a certain degree of risks as well. In the event that one of the subsidiariesfailed then how is the regulatory going to deal with the parent company.

This issue has been the concerns of most regulatory authorities – that is, which part ofbusiness that should be closed in the event of a financial problem, and then, shouldthe shareholders of the parent company absorb the loss of the subsidiaries and towhat extent?

This issue also involved cross-border operations, where a bank has foreign subsidiaries

Transparent Regulations

Banks will be required to comply with more stringent andtransparent regulations that must be enforced internationally.

The key to such a development (e.g. Basel II) will force thebanks to be more accountable in the adoption of an integrated risk management infrastructure.

Business continuity planning is a tool that cannot be shelvedas an administrative document only.

New Corporate Strategies Needed

(a) New target market

(b) Employment options (if needed)

(c) Improve Infrastructure

(d) New Approach to Business Style

(e) Pro-active Management

New Target Market

Banks must be able to identify business areas and mountStrategies to win the new market. Banks must also do their best to maximize operational efficiency.

Where possible they should endeavour to enter into strategicAlliances with the identifiable partners that will provide a“win-win” result.

The economic cost of this strategy must be adequately studiedwith a lot of prudence, bearing in mind, the risk factors.

Employment Options

Financial services players will need to integrate into their operational structures low-cost, highly flexible employment options.

For example, some jobs may be more cost-effective if they are processedoutside the main corporate offices.

Management must integrate the workforce in a holistic manner with all the rest of the operating system so that economies of scale and greater profitability is achieved.

Employees should feel that they are placed at the centre of developmentrather than considered as one of the resources.

Performance-related pay will be the mode of the employment contract,whereby the employees are expected to deliver on all the set targets.

Improvement in Infrastructure

NO bank can be complacent when it comes to investment in new orimproved infrastructure.

The infrastructure can be considered in the light of:

New office space, technology,communication system, and employees.

There will be more demands on the Board of Directors in terms ofcollective responsibility to ensure that they follow evolving developmentin all areas of the banks’ business.

A Board of Directors that failed to act responsibly will not survive theintense competition.

New Approach to Business Style

Since customers want more out of their banks, the management mustpay greater attention to the customers’ needs in a cost-effective manner.

More information should be made available whereby the customers canget easy access in order to increase the level of their transactions.

The new business paradigm is for the management to visit the customersregularly with the view to strengthen the banker-customer relationship.

Pro-active Management

Customers expect the banks to involve them in their forward planning processso that they can make their contribution.

Bank Managers must be ready to keep in touch with the customers at all timesso as to identify their needs under one roof – that is, “one-stop financial servicesboutique”.

The role of advocacy must be more pronounced with the evolving complexityof the financial market and the business cycles.

New products/services must be timely released on the market.

It will be a matter of becoming more innovative with changes in the market.

Main Causes of A Banking Crisis

Non-Performing Loans & Bad Loans

Inadequate Market Discipline (captured by Basel II)

Unsustainable Macro-economic Policies

Poor Regulatory & Supervisory Framework

Poor or Reckless Management

Prevention of Banking Crisis

As competition intensify for banks to maximize the returns on their investmentsthere will be opportunities for banks to take on new businesses without payingmuch attention to the risk aspects.

As the risk level increase, the chance of a banking crisis emerging can also beapparent, if the Regulatory Agency does not spot the danger in good time.

Even with Basel II, a less prudent management can conceal the risks by usingdifferent accounting methods to suit the bank.

The past banking crises must be used as lessons to be learnt.

Will the regulators have learnt enough experience from such crises?

(See; Next Slide for more information).

A Research Analysis on Banking CrisisProf. George G. Kaufman made the following statement as part of hisConcluding remark in a paper entitled “ Preventing Banking Crises in theFuture – Lessons from Past Mistakes”. Page 55 -77

This article was originally prepared for presentation at the annual meeting of the Japanese Society of Monetary Economics in Tokyo on 25 May 1996.Volume II, No.1, 1997.

Developed countries generally have better capitalized banking systems and the financial resources, although not always the political will, to recapitalizeindividual insolvent banks, which are too often state-owned institutions. Theyalso have a highly educated and sophisticated labor force from which to attract bank regulators and supervisors. Thus, they possess the most important prerequisites for the successful implementation of this reform.Less-developed countries are likely to have more poorly capitalized, ofteninsolvent, banking systems; to encounter more serious constraints in recapitalizing them; and to have fewer educated and trained bankers and examiners. These conditions make these reforms more difficult, but not impractical nor unimportant, to implement in these countries.

Non-Performing & Bad Loans

One of the dangers that a number of banks face is the amount ofnon-performing or bad loans in their portfolio of assets.

Normally, bad loans arises from poor lending practices, excessive risk taking, poor governance, weak risk management, lack of internal controls, focus on market share rather than profitability, and assetliability mis-match.

In fact, under the Basel II Accord, there will be more capital that must beprovided by banks to cover their credit risk from various asset exposures.

Management will be more restricted from taking excessive risk, unless ata huge cost to the shareholders.

Inadequate Market Discipline

Stefan Ingves of the IMF Monetary and Exchange Affairs Department quoted”

“If bank creditors have limited information on a bank's financial condition, they cannot exert discipline on the shareholders, due toopaque system.

This is typically the result of poor transparency and disclosure, poor accounting and auditing practices, especially due to the lack of properloan and collateral valuation methods and consolidation, which allow overstatement of capital adequacy.

Market forces are further impeded by weak frameworks for dealing with problem banks, including weak legal, judicial and institutional frameworks for dealing with failing banks and companies.

Expectations of depositor and creditor bailouts may overpower anypolicy to the contrary”.

Unsustainable Macro-economic Policies

Unreliable macro-economic policies made by a Government can have adevastating effect on the banking system especially for the credit market. With changes in the business cycles, the lending booms can easily puncturethe loan portfolio.

Changes in the interest rates can also affect the bank’s operations if theyare highly exposed without a hedging strategy.

Poor Regulatory & Supervisory System

Failure of the regulatory agency supervising the banks not to follow:

concentration risk, weak loan valuation, capital charge against the loan portfolio, asset-liability mis-match, andreckless management

Supervision may also lack authority, and have an insufficient number or professional employees that may be poorly motivated and compensated.

Poor or Reckless Management

Shareholders cannot afford to employ reckless management for the sake ofconcentrating mainly on profits as the “principal business motive”.

reckless management are most likely to cost:shareholders investment,the banking reputation, the taxpayers’ money (if there is a rescue), andperhaps, the entire banking sector (e.g. systemic risk).

It is absolutely crucial that the Board of Directors together with the assistanceof the Regulatory Agency to hire a management team with the highestintegrity.

This issue is a being addressed under the “operational risk” aspect underBasel II.

Post-Enron Episode Around the World

In USA, the New York Stock Exchange (“NYSE”) Corporate Accountability & Listing Standards Committee submitted a report to the NYSE’s Board of Directors on 6 June 2002.

The report makes recommendations to amend the NYSE’s listing standards withthe goal of enhancing the accountability, integrity and transparency of the NYSE’s listed companies and was accepted by NYSE Board of Directors on 1 August 2002.

In UK, Mr Derek Higgs has been asked to lead an independent review of therole and effectiveness of non-executive directors. In Mr Higgs’ consultation paper dated 7 June 2002.

Singapore has amended its Companies Act to establish a Council on Disclosure and Corporate Governance that will be an independent body overseeing corporate governance rules and accounting standards.

I Wish You AllGood Luck

In Your Studies

In life you can never stop learning.

Please feel free to contact me any timeEmail: larose@seychelles.net