The Banking industry is ever changing and versatile. Banks are constantly looking to adapt to the pressures they face, and one way to do so, is by adding or removing aspects of their international operations. Canadian offshore assets have increased by 38% in the last 10 years and there’s now over $1trn offshore in Chinese banks. Japanese and Indian banks have also seen an increase in their international operations. Meanwhile American and European banks are retrenching. There a number of positives and negatives when it comes to international expansion, below is a brief synopsis of some of the main points.

Why banks expand globally?

• Client retention
• • Client retention is one of the biggest reasons for international expansion. Naturally, banks with a strong and positive reputation are more likely to retain and attract new customers. Finding solutions to existing client needs, even if that means navigating difficult regulation changes and operating in new areas, is an excellent way to build that kind of reputation. Operating internationally provides banks with further opportunities  for investing in differing markets.
• Economies of scale
• • International expansion maximises production of procurement, systems, operations, research, and marketing and minimises the costs involved.
• Geographic diversification
• • Unsurprisingly, international expansion mitigates against geographical market fluctuations, through geographic diversification. This puts the bank in a stronger position as it is part of several markets. Therefore, it is less likely to be negatively impacted by a single market downturn.

Difficulties with international expansion

• Additional costs associated with country risk
• • Unexpected changes in the host country’s environment can result in additional costs for foreign firms. Anything from economic growth to national debt, inflation to exports can affect country risk and cause banks to make changes accordingly.
• Differences in culture, language and economic development
• • Larger banks often find it easier to expand into new places, as international expansion is often complex and can be costly due to differences in culture, languages and economic development. These differences can reduce efficiency and present challenges, such as dealing with regulations and the sharing of information.
• Political instability and risk
• • Political Risk is the exposure to the effects of foreign governments’ actions on the value of investment in the foreign country. Therefore, before expanding their operations internationally, banks need to have a clear picture of the political environment of a country. Political instability can discourage banks from staying in a country, as demonstrated by CaixaBank (see figure 1), following the Catalan referendum. Due to the economic uncertainty, resulting from the referendum, the bank’s share price dropped and caused them to relocate to Valencia.

In short, changes in the global presence of banks are fuelled by a focus on the earning power of each country. Generally, banks should engage in international expansion, as it will allow them to reach a wider audience for their services, minimise transition costs, as well as diversify the sources of income. However, geographical expansion is more of a double- edged sword than previously thought, as banks will face additional operating costs, as well as face risks of political instability. Nonetheless, banks can still offset these potential risks by carefully choosing an adequate environment, which is not prone to political tensions (unlike the UK, which is still in the process of finalising its withdrawal from the EU).

One of the major difficulties that small businesses and new start-ups face is obtaining funding. In our contemporary society and with the use of technology, new firms have access to a plethora of fund sources. These include using the Internet for crowd-funding or even peer-to-peer lending. However, these sources are often uncertain as the firms do not know how much funding they will get with these methods. This means, that those start-ups often find themselves having to find funding from venture capitalists. The venture capital market plays a significant role in providing capital to a wide variety of enterprises. Although there are multiple benefits, new business owners need to be aware of the risks they are taking when engaging with venture capital firms.

So why accept the funding?

The first benefit of securing funding from a Venture Capitalist is that the business owner is not taking a loan. Therefore, the costs of operation will not include interest payments.

Apart from the financial safety, engaging with a venture capital firm may bring additional benefits. Inexperienced entrepreneurs stand to gain a great deal from venture capitalists’ wealth of start-up experience; they can gain insights on what to expect at various stages, what to worry about and what not to, and on how they are progressing. Tapping into this expertise can prove to be tremendously valuable in terms of business decisions or even human resource management, as the VC will help with the recruitment of top talents to maximize the productivity of the business. Being able to make better and informed decisions in these key areas, will be crucial for the growth of the firm. Moreover, if the owners have little experience in running a business and lack the knowledge to make informed decisions, the investors, holding a significant share of the equity, will be able to step in and have a say in how the business should run. This can be extremely valuable considering venture capitalists have extensive knowledge and experience in starting a business and how best to expand.

One striking example of a small project
backed by venture capital firms to become
 a global success is Google. It started as a 
project from two doctoral students who 
later gained backing by Venture Capitalist 
firm Sequoia Capital and Kleiner, Perkins,
 Caufield and Byers (KPCB). The business 
received $25 million, as the investors were 
confident about the potential growth of the
 business, at a time when the Internet was
 booming. In 2001, on Sequoia Capital’s 
advice, Google founders hired the company’s first CEO, Eric Schmidt who remained the head of the firm until 2010. During this decade, we can see how much Google grew in terms of revenue (as seen in figure 1,) starting at nearly $70 million in 2001, to almost $25 billion in 2010.

But should small businesses be wary?

Of course! As a small business, turning to venture capital firms for a source of funding can prove to be a double-edged sword. So when opting for venture capital funds, instead of paying back as a loan repayment scheme, owners of the business will have to give up a significant part of their equity. According to Hellman (1998), this process will then allow “venture capital firms to hold effective control over the board, typically through a voting majority, and sometimes through explicit contractual agreements”. This means that the investors will effectively be significant shareholders of the company, subsequently, profits will also have to be distributed accordingly.

Due to this, the investors then become shareholders in the company. The size of their investment could determine how much influence they have on company decisions.

For example, if the investors have 20% to 50% of the shares, they have significant influence over the decisions, which means they can voice their opinion and influence decisions. However, if they have more than 50% of the shares, then the owners of the business lose management control, which means they often assume more direct control by changing management and are sometimes willing to take over day-to-day operations themselves. Although this is to guarantee the company’s headway, it can generate serious internal problems between the owners and the investors’ team. A telling statistic is that after 4/5 years from investment, more than half of the founder CEO’s are replaced!

Company owners who have been ousted
 from their own businesses include Steve Jobs with Apple, and Sandy Lerner, co-founder of Cisco. Lerner is no longer part of the company after losing control to a management group led by its early investor, Sequoia Capital’s Don Valentine. Cisco’s CEO, John Morgridge saw Lerner as the weak link of the firm, and it became clear that they shared different aspirations for the company. Subsequently, the board of directors decided to side with the CEO and let go of the founders.

So should you accept the investment in your business?

From a small firm, looking to get capital from venture capitalists point of view, having recourse to such funds will be beneficial for the business. Not only will the investors provide adequate financing, but also the support needed to help grow the business, by seeking new talents to perform the jobs, as well as give invaluable advice to better manage the business, which was the case for the current world-leading tech company, Google.

However, you also have to keep in mind that in order to access all these services, your control over the operations will be diluted because the investors will also have stakes in the business, via a percentage of the shares, which in turn, means that you partially lose ownership of the company. However, it is possible to mitigate against these setbacks, primarily through an agreement on the terms and conditions, prior to starting the funding of the business.

So, the short answer is yes! Accept funding, grow your company, but be careful that you’ll still be the person in charge, making the decisions!

What exactly is QE?

Economic growth has been correlated to both volume and velocity of money. When banks reduce their borrowing and lending to each other (as they did in 2009 due to high interbank interest rates) and when individuals rather save than spend, the flow of capital dries up and the economy contracts. The solution to stop this is to increase liquidity.

However, to get the financial system moving again it is not as simple. Central banks cannot simply force society to borrow and spend money. Therefore, to stimulate the economy, the monetary policy committee voted to reduce the Bank of England’s interest rates after the financial crisis. Subsequently, through open market operations, interbank, corporate and personal loans became cheaper. The basic principle is to flood the market with extra liquidity and encourage borrowing and spending with the new and cheap money. However, banks act cautiously and utilise this ‘cheap money’, to invest in safe government bonds that pay around 2% or invest it on higher risk assets and do not lend it out to firms and individuals as they are seen to be too risky. Therefore, this initiative does not create economy wide liquidity.

The second arsenal that the Bank of England can use to stimulate growth is to buy assets, consequently increasing the size of their balance sheet. They particularly purchase long maturity government bonds in the open market with newly created digital money. Through purchasing large amounts of bonds and affecting convexity, the prices rise and yields drop. With reduced yields, bonds become less desirable for banks and push them to invest in riskier sectors such as stocks, corporate borrowing and real assets. Subsequently, borrowing costs correlated with long-term interest rates such as mortgages/corporate borrowing rates declined, incentivising individuals and corporate borrowers to pull forward future expenditure.

This process of trying to stimulate growth is called Quantitative easing, however the bank of England cannot constantly undertake this as it needs the country to make money.

So what happens when Quantitative easing is phased out?

Advantages

The UK economic recovery has been steadily expanding for over eight years, more than the average business cycle. Inflation is now significantly above the 2% target, unemployment rate is below 4.3% (the lowest for more than 40 years) and consumer borrowing has been rising at double-digit rates. However, the state of the UK economy is on a tender balance, demonstrated by the fact that the BoE talked about raising rates on a number of occasions, though not acting on their comments. The pressures arise from greater economic uncertainty against inflationary pressures consequential from a weaker pound raising the cost of imports. However, the BoE did state that it would not sell down its £435bn stock of assets until interest rates increased to around 2%. They are currently at 0.5%. Clearly, Quantitative Easing has helped restore the UKs economy, phasing out Quantitative Easing now will help the economy to go back towards the norm of pre-crisis levels, in order to have enough reserves to tackle the next crisis. These reserves are necessary so that quantitative easing can be used again in the future.

Furthermore, through keeping such an unconventional policy in place for a long time has led to distortion in the markets. Deutsche Bank chief John Cryan favoured tightening of monetary policy stating that the time of ‘cheap money’ needed to end as it causes price bubbles and volatility.

Withdrawing QE would entice institutional investors to re-think asset allocations. Similarly, a reduction in the banks’ balance sheets could also resolve the slope of the yield curve, which is abnormally flat. This results in distortions in discount rates and the way in which firms think about investments.

Disadvantages

As seen in the US in 2013, when there are rumours of QE tapering off, investors holding bonds rapidly withdrew their money from market – known as a Taper Tantrum. Consequently, bond yields drastically increased. This highlights the fact that timing is everything in QE and a move too soon is likely to put pressure on fragile companies and households by driving up rates on mortgages and loans. The IMF are warning that unwinding QE could cause a super taper tantrum increasing volatility in the markets. It is unlikely that a sell off can be avoided when the ‘unwind’ begins.

In the US, the Fed have also begun to consider for the long-term potential of the economy as the graph below shows. Without QE, rates are set to rise, which may signal the US economy and the world economy potentially overheating. This forecasted rise will affect duration.   

Figure 1: Copyright Financial Times. 2018.

Furthermore, studies have shown that banks have used a large amount of QE to meet their prescribed regulatory buffers. If this money were to be removed, the banks would contest over the remaining liquidity in order to stay within regulations. One way to mitigate against this is to reduce the amount of capital required to be held in buffers. However, this would reduce the banks capabilities to weather a financial storm.

In addition, through repurchasing those securities, central banks have been able to increase the size of their balance sheets, which will encourage other financial institutions to follow along the same path. By increasing the size of their balance sheets, and thus their equity capital, financial institution managers will be able to shield the institution against risks of insolvency as well as meet the necessary requirements for growth under the existing Basel III capital requirements set by regulators. However, whether this increase in size is a benefit to banks remain questionable as banks are known to hold non- performing loans, especially the likes of Italy and Greece due to their respective bailouts.

Additionally, since central banks have purchased roughly £11.3 trillion of financial assets since the crisis, unwinding this could potentially cause another. Reducing the new inflows of money could lead to severe asset decline and liquidity disruptions.

So should QE be done

Quantitative easing was a controversial untested policy in which the central banks had no other quick remedy to prevent a severe depression. The timing of when to unwind QE will play a crucial role in either returning economies to the status quo, or completely upsetting what has been dubbed as the ‘new normal’, leading to further financial pressures. The monetary policy should not defer for short term and temporary economic fluctuations. It should provide a confidence and stability for the economy, in order to guide business and financial decisions. The idea is simply that if unwinding QE has ill-effects, cutting rates remains an option to offset this. Therefore, the monetary policy committee should endeavour to explicitly state its agendas for the future ensuring symmetric information between themselves and the rest of the UK Economy and banking industry.

In summary

Quantitative Easing is suppose to help stimulate the economy but it can be a expensive process in which the benefits it provides can be completely undone when a government tries to halt it. However if they see no other option its crucial to attempt to kick start the economy and help it grow.

As I’m sure you’re all aware, Bitcoin is a peer-to-peer cryptocurrency, developed mid financial crisis, in 2009. Historically, banks have been cynical and untrusting of Bitcoin and cryptocurrencies, but there are a number of positives to be considered. Despite it being labelled as “a fraud” and “ponzy scheme” by CEO of JPMorgan, Jamie Dimon, it has risen way over $5000 in value. The system uses a shared ledger, known as a blockchain, which maintains and automatically updates a record of all transactions.

What’s so great about Bitcoin?

Well the highly encrypted, anonymous and decentralised cryptocurrency has no need for banks or institutions, meaning no transaction fees and almost instantaneous transfers. This means lower costs, less system based transaction errors and greater transaction transparency, which is beneficial for anyone from the individual to large businesses.

As mentioned, the system uses blockchain technology. If a user decided to change their personal Bitcoin balance, there would be a discrepancy amongst users’ records and the changes made would be ignored. Therefore, Bitcoins can’t be counterfeited, so no one has to worry about dealing with fake Bitcoin.

Although banks were sceptical towards Bitcoin and similar blockchain currencies, there has been increasing interest in the capabilities of the technology. BNP Paribas (France’s biggest bank) has started testing the potential of blockchain technology for post-trade processes. Even JPMorgan has since developed QuorumTM, a new network (with increased security and transaction speeds) using blockchain technology.

Sounds pretty good right, so what’s the problem?

The most obvious issue is its volatility. The market is highly uncertain, due to the lack of regulations regarding profits derived from cryptocurrencies. It’s also worth noting that as Bitcoin transactions declined between May 2017 and July 2017 (figure 1), so did its price. This demonstrates that if the liquidity of Bitcoin were to dry up, there can be a huge drops in value leading to a massive loss for Bitcoin investors.

One of the other issues, surrounds the poor security of cryptocurrency exchanges. Unlike, non-cryptocurrency exchanges there is a lack of investor protections, leaving the cryptocurrencies open for the taking. There have been numerous hacking heists on cryptocurrency exchanges often resulting in the exchange being shut down and filing for bankruptcy as was the case for Mt. Gox in 2014.

Stocks, commodities, Bitcoin and other cryptocurrencies can all experiencing these dramatic, wild price swings known as “Flash crashes”. However, cryptocurrency exchanges don’t have circuit breakers in place to halt trading during these periods. Kraken (a cryptocurrency exchange) came under attack, resulting in Ethereum (a cryptocurrency) falling by 70% on the exchange and traders’ leveraged positions were automatically liquidated. Naturally, this has a major impact on any portfolio which contains any form of cryptocurrency.

Another concern for the banking industry is the lack of regulation in the cryptocurrency market. Due to the recent fall in the price of Bitcoin, investors are trying to channel into property, but mortgage lenders and brokers who fear breaching anti money-laundering regulations are turning those investors away. Obviously, if the bank were found to have used the same exchanges to trade Bitcoin on behalf of their clients as criminals, then the bank’s reputation would be damaged.

What’s the verdict?

Well it’s clear that investing in Bitcoin is for the more risk-seeking investors. Bitcoins are traded on unregulated exchanges, not backed by any government or central bank. At present, Bitcoin can’t be the solution to creating faster and more secure transactions, as unregulated cryptocurrency exchanges are prone to market manipulation and vulnerable to hackers. Due to the lack of regulations regarding cryptocurrencies, any regulation that comes out will have an impact on the value of these currencies, which makes Bitcoin highly volatile and unpredictable. Currently, there are too many significant drawbacks and risks outweighing the positives, for Bitcoin to be viable as currency or a smart investment decision for banks. That said, there is still plenty to learn from Bitcoin and cryptocurrencies. Although bitcoin has seen sharp falls in recent months it is now starting to hold above $4,000 a coin, but could change at any moment. However, with the major US stock exchange, the Nasdaq intending to launch bitcoin futures in 2019 and bitcoins becoming more widely accepted as a form of payment throughout the world. There’s still hope for the crypto currencies yet…