PURE CONTAGION EFFECTS IN INTERNATIONAL BANKING THE CASE OF BCCI by jadakiss

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									         PURE CONTAGION EFFECTS IN
            INTERNATIONAL BANKING:
          THE CASE OF BCCI’S FAILURE
INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
OUTLINE OF OUR PRESENTATION

• What is “Contagion Effect”

• The Bank of Credit and Commerce
  International (BCCI)

• The Case Study

• Conclusion

• Our Words and “Imar Bankasi”
 INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
 What is “Contagion Effect”

• What is a contagious illness?
  “It‟s an illness which can spread quickly among
    human beings.”
  In Our Case
• Illness is “The failure of a large bank”
• Contagious is “Undermining the whole
  public confidence in the banking system”


  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
 What is “Contagion Effect”

• Contagion effects arise due to the
  heterogeneity of bank assets.

• What do depositors do when a bank
  encounters financial difficulties?
  • investigate the problems OR
  • withdraw their funds completely from the
    banking system?

  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
 Studies to prevent contagion effects

• Diamond and Dybvig (1983)
  Stronger government regulation

• Dothan and Williams (1980)
  Holders of claims against banks are the most
  effective monitors of banks‟ activities.

• Flannery (1995)
  Regulation to mitigate contagion effects may be
  inefficient and counterproductive
  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
 Consequently

• If one bank fails, the others can be
  affected rapidly and perhaps severely

• Benston (1973), and Aharony and
  Swary (1983) suggest two major causes
  for bank failures:
  1. losses due to risky loans and investments
  2. fraud and internal irregularities that are
     unrelated across banks ->
       „pure‟ contagion effects
  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
 THE CASE OF BCCI’S FAILURE:

 Pure contagion effects in international
  banking arising from the failure of the
  BCCI.

 BCCI‟s failure was due to massive fraud

 and is one of the largest bank failures
  that have taken place worldwide

  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
Bank of Credit and Commerce
International (BCCI)
 Founded in Pakistan in 1972

 Ranked the 7th largest private bank,

 the 83rd largest in Europe,

 the 192nd worldwide,

 with total assets which amounts to $20billion
  located in more than 400 offices in 73
  countries,
  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
Bank of Credit and Commerce
International (BCCI)
• The largest bank registered in
  Luxembourg and the Cayman Islands.

• Traded internationally through companies
  registered in these two countries

• Each was audited by different
  accountants

• The BCCI group was managed from its
  headquarters in London.
  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
Bank of Credit and Commerce
International (BCCI)
• Unlike any ordinary bank, BCCI was
  made up of multiplying layers of entities

• The complex BCCI family of entities was
  able to evade ordinary legal restrictions
  on the movement of capital and goods

• BCCI was a vehicle fundamentally free of
  government control
  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
Bank of Credit and Commerce
International (BCCI)

• Abedi, founder of BCCI, says…


“The only laws that are permanent are the
  laws of nature. Everything else is flexible.
  We can always work in and around the
  laws. The laws change.”

  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
Bank of Credit and Commerce
International (BCCI)
• Specific crimes admitted to by BCCI's
  liquidators,
  • Seeking deposits of drug proceeds and laundering
    drug money
  • Seeking deposits from persons attempt to evade
    U.S. income taxes
  • Using "straws" and nominees to acquire control of
    U.S. financial institutions
  • Lying to regulators and falsifying regulatory
    documents
  • Creating false bank records and engaging in sham
    transactions to deceive regulators.
  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
Bank of Credit and Commerce
International (BCCI)
• BCCI's financial empire was built by the
  deposits of rich Arabic businessmen

• who seeks for high returns without taking
  risks

• BCCI‟s seemed not to have enough
  capital base anytime since it has founded

• So they were forced to depend on
  deposits to meet its operating expenses.
  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
The Case Study - Data
• In this case, there are three developed
  economies namely
  • the US,
  • the UK and
  • Canada

• For each of these three countries, it
  considers the three largest individual
  banks or banking institutions

  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
The Case Study - Data
• The sample of banks includes:

• Barclays, National Westminster                                                               (Nat
  West), and Midland for the UK;

• Citicorp, Bank of America, and Chase
  Manhattan for the US; and

• the Royal Bank, the Canadian Imperial
  Bank of Commerce, and the Bank of
  Montreal for Canada.
  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
The Case Study - Event study
• The analysis considers the three largest
  individual banks in each country, and

• Examines whether there are pure
  contagion effects using event study
  methodology,

• Namely considering time windows
  surrounding known BCCI-related events
  and announcements.
  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
The Case Study - Candidate Event
Dates
1. 10 October 1990: The first Price Waterhouse report
   was published raising suspicions of fraud

2. 4 March 1991: When the Bank of England aware that
   significant accounting transactions appointed Price
   Waterhouse to investigate these allegations.

3. 21 June 1991: When the Price Waterhouse report to
   the Bank of England was published documenting
   evidence of large-scale fraud over several years.

4. 5 July 1991: the date of closure

  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
The Case Study - Empirical findings:
UK
• These results suggest that the UK market
  have responded to the news of the report on
  10 October 1990

• The later events, including that of the official
  closure, appear to be of no importance in
  terms of market reaction.

•     Overall, there is strong evidence of pure
     contagion effects in the UK banking sector
     caused by the publication of the initial Price
     Waterhouse report on 10 October 1990
    INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
The Case Study - Empirical findings:
USA
• There is no evidence of negative
  abnormal returns for any of the three
  banks at any of the four event dates.

• Thus there are no contagion effects in
  the form of negative abnormal returns.



  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
Reasons for the lack of contagion
effects in the US
1. The relatively large size of the US deposit
   insurance coverage

2. The perception that even uninsured
   depositors will not lose in the case of a bank
   failure

   In the US, up to a maximum of US$ 100,000

   while in the UK the maximum amount insured
   is Pound Sterling 10,000 per depositor per
   institution.
  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
Reasons for the lack of contagion
effects in the US
3. Another factor is the relatively large distance
   of BCCI‟s headquarters, located in London,
   from the headquarters of the US banks.

   “The smaller the distance of a solvent bank‟s
   headquarters from the headquarters of a
   large failing bank, the weaker will be the
   negative impact on the solvent bank‟s stock
   return.”
                Aharony and Swary (1996)
  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
The Case Study - Empirical findings:
Canada
• No evidence of negative abnormal returns for
  any of the three banks at any candidate event
  date is found

• These are in contrast to the findings of Jayanti
  et al. (1996), who found some evidence of
  negative abnormal returns and negative
  cumulative abnormal returns on the Canadian
  banking sector following the collapse of two
  domestic banks
  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
The Case Study - Empirical findings:
Canada
Reasons for the contrast,
• CCB and Northbank were relatively
  larger banks in Canada than BCCI-
  Canada

• The large distance of BCCI‟s
  headquarters from the headquarters of
  the Canadian banks

  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
The Case Study - Empirical findings:
Canada
• The smaller the relative size of the
  assets of the failed bank in one country,
  the higher the ability of „rival‟ banks to
  withstand financial distress
        Akhibe and Madura (2001)

• In addition, the deposit insurance
  coverage in Canada is relatively higher,
  which is up to US$ 52,000.
  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
CONCLUSION
• This study has examined the issue of
  contagion effects in international
  banking arising from the failure of BCCI,
  one of the largest multinational banks.

• As BCCI was a multinational bank, the
  repercussions of its failure were truly
  international in scope.

  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
CONCLUSION
• The regulation and supervision of BCCI‟s
  activities were undertaken by different
  national supervisory bodies across
  countries

• Communication and action coordination
  of the home supervisor with other
  supervisors may affect the effectiveness
  in preventing contagion effects
  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
CONCLUSION
•    There is no evidence of pure contagion effects
     in the US and Canada

•    The regulatory measures available in these
     two countries appear to be sufficient in
     preventing contagion effects arising from the
     failure of a large bank with fraudulent
     activities.

•    The standard regulatory measures available,
     such as deposit insurance, appear to be
     sufficient in protecting against contagion
     effects.
    INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
CONCLUSION
•    Our analysis provides strong evidence of pure
     contagion effects in the UK

•    Stock prices of all three UK banks reacted negatively
     to information about fraud in a large bank‟s activities.

•    UK capital markets were concerned about the
     supervision of BCCI and the adequacy of the
     regulatory system to prevent the collapse of the
     bank.

•    This interpretation is in line with the Bingham Report
     commissioned in the UK after BCCI‟s failure.
    INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
CONCLUSION
• This report raised several issues in
  relation to the supervision of BCCI in
  the UK and offered a number of detailed
  suggestions to strengthen it, such as:

  •     including the need for greater cooperation
  •     greater sharing of information
  •     strengthening of internal communications
  •     more efficient supervision of internationally
        spread banking groups like BCCI.
  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
A good supervisory system relies on
four levels of control:
1. internal controls operated by the management of the
   bank itself,

2. controls exercised by the Board of Directors over the
   management, which involve an effective system of
   corporate governance,

3. controls exercised by external auditors appointed by
   the shareholders to ensure that the Board‟s financial
   statements properly represent the true state of the
   bank.
4. control exercised by the bank supervisory agency on
   behalf of depositors and the public at large
  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
1. Internal controls operated by the
   management of the bank itself
The Basel Committee Principles for the Assessment
   of Internal Control Systems
• Management oversight and the control culture
• Risk Recognition and Assessment
• Control Activities and Segregation of Duties
• Information and communication
• Monitoring Activities and Correcting
   Deficiencies
• Evaluation of Internal Control Systems by
   Supervisory Authorities
  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
2. Corporate Governance
•    The Basel Committee has also paid attention
     to corporate governance of banks.

•    The role of the board of directors is stressed

•    particularly the need to ensure that the
     board is composed in such a way that it can
     exercise effective control over the
     management
    INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
3. External Controls
The Basel Committee, in the paper referred
“the role of auditors is vital to the corporate
   governance process.”
1. recognizing the importance of the audit
   process and communicating this importance
   throughout the bank;

2. taking measures that enhance the
   independence and stature of auditors;

3. utilizing, in a timely and effective manner, the
   findings of auditors;
  INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
3. External Controls
 4. ensuring the independence of the head
    auditor through his reporting to the board or
    the board's audit committee;

 5. engaging external auditors to judge the
    effectiveness of internal controls; and

 6. requiring timely correction by management
    of problems identified by auditors”.

 INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
“IMAR BANKASI”
 •     One of the principal factors contributing to bank
       problems in Turkey has been inappropriate
       ownership of banks

 •     Many banks are owned by powerful commercial
       groupings

 •     While in many countries such ownership structures
       are illegal, in those where such an affiliation is
       permitted there are strict rules.
 INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
“IMAR BANKASI”
 • It is important that owners do not see banks
   as a financing mechanism for their other
   commercial interests

 • Supervisory authorities should have the
   power to ensure that controlling shareholders
   in banks do not abuse their positions




 INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
“IMAR BANKASI” - Where did it fail?
 •     The bank was run as a „company‟ bank

 •     All its lending was to group companies

 •     The accounting system was designed to ensure that
       the bank was run in accordance with the major
       shareholders‟ wishes

 •     False financial statements were produced to the
       creditors of the banks, including its depositors and

 •     Misleading reports to the supervisory authorities
       over a prolonged period
 INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin
THANKS FOR YOUR
    PATIENCE



INTERNATIONAL BANKING 2007 - Ozgecan Ozten, Bilal Soybelli, Okan Torlak, Esra Bukus, Berkay Aytekin

								
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