ASSIGNMENT DRIVE FALL 2014

PROGRAM BBA
SEMESTER VI
SUBJECT CODE & NAME BBA603 & ROLE OF INTERNATIONAL FINANCIAL
INSTITUTIONS
BK ID B1905 CREDITS 4 MARKS 60

Q.No 1 Explain the main functions of banks. Write down the lending activities and
lending policies of bank.
(Functions of banks, Lending activities and lending policies of bank) 5+5= 10
Answer:
The main functions of the Bank are:
(i) To aid in the reconstruction and the developing of territories of its member governments by
facilitating investment of capital for productive purposes.
(ii) To advertize private foreign investment by guaranteeing or by participating in loans and
other investments of capital for productive purposes.
(iii) Where private capital is not available on fair terms, to make loans for productive purposes
out of its own resources or out of the funds borrowed by it.
(iv) To promote the long-range growth of international trade and uphold equilibrium in the
balance of payments of the members. International investment should be promoted for the
growth of the productive resources of members.
(v) The bank has adopted, as a principal object, a policy of lending for productive projects which
will lead to economic growth in its less developed member countries.
Lending Activities
The Bank can facilitate loans in the following ways:
By way of participation in direct loans out of its own funds.
By participating in direct loans out of funds raised in the market of a member, or otherwise
borrowed by the bank.
By guaranteeing in whole or part, loans made by private investors through the usual
investment channel

The Bank may give loans directly to member countries or it may guarantee loans granted to
member countries. It normally makes loans for productive purposes like agriculture and
surplus. The total amount of loans granted by the Bank should not exceed 100 per cent of its
total subscribed capital and surplus. After calculation of the interest, an additional commission
of 1 per cent for creating a special reserve against loss and 0.5 per cent for administrative
expenses are charged.
Lending policies
(i) All loans are for the governments or they must be guaranteed by the governments
(ii) Repayment period is within a period of ten to thirty-five years
(iii) Loans are only made in circumstances in which other sources are not readily available
(iv) Investigations are made regarding the probability of repayment, considering both the
soundness of the project and the financial responsibility of the government
(v) Sufficient surveillance is maintained by the Bank over the carrying out of the project to
assure that it is relatively well executed and managed
(vi) Loans are sanctioned on economic and not on political considerations
(vii) The loan is meant to finance the foreign exchange requirements of specific projects;
normally the borrowing country should mobilize its domestic resources.

Q2 Write the objectives of global financial regulation. Explain the key features of
Basel III and its impact.
(Objectives of global financial regulation, Key features of Basel III and its impact) 5+5=10
Answer:
Objectives of Global Financial Regulation

Some of the objectives of the global financial regulations should be:

Greater financial integration and harmony
Greater sensitivity to changing macroeconomic conditions
Greater coordination of activities of the sectoral and national regulators
High level of capital in the banking and insurance sector
To monitor the shadow banking system.
To have a system-wide and global view of behavior of financial markets.
Ways to make the financial system more efficient and responsive to needs of the real sector
Key features of Basel III:
Better capital quality: This implies that banks will be stronger and will have higher loss
absorbing capacity.
Capital conservation buffer: This means that banks maintain an extra cushion of capital
that can absorb losses in times of financial and economic stress.
Countercyclical buffer: This innovative buffer has been introduced to increase capital
requirements in good times and decrease it in tough times.
Leverage ratio: Taking a lesson from the financial crisis of 2008, this is a safety net which
has been introduced in Basel III to cap the increase of leverage in the banking sector at the
global level.
Liquidity ratios: A framework of liquidity risk management will be created under Basel III.
Minimum common equity and Tier I capital requirement: The minimum common
equity capital requirement has been increased from 2 per cent to 4.5 per cent and the minimum
Tier I capital requirement has increased from 4 per cent to 6 per cent under Basel III. Although
the minimum total capital requirements remains at 8 per cent but combined with capital
conservation buffer, it has become 10.5 per cent.
Systematically important financial institutions: It will be required to maintain capital
beyond the Basel III requirement as part of the macro prudential framework.
Impact of Basel III on Indian Banking System:
Implementation of Basel III by Indian Banks will not only be a challenging task for the banks
but also for the Government of India as `6,00,000 crore will have to be raised by Indian banks
by 2020. This may reduce their margins.

Q3 Explain the role of government in financing international trade.

(Write about the EXIM, Various operations groups in that and credit services) 5+5=10
Answer:
Role of Government in Financing International Trade
In emerging economies government plays a very important role in trade financing. This is
because owing to the under developed money and financial markets the traders have limited
access to financing and that too accompanied by many constraints. A government can either
directly provide credit guarantees or trade finance or indirectly support the development of a
trade financing organization.
Cheaper credit can also be provided by the government by supporting or offering the following:
(a) Specialized financing institutes like Factoring Houses or Export-Import Banks
(b) Central Bank Refinancing schemes
(c) Assistance from Trade Promotion Organizations
(d) Export Credit Insurance Agencies
(e) Collaboration with Enterprise Development Corporations (EDC) or State Trading
Enterprises STE)
Export and Import Bank of India
The Export and Import Bank of India, commonly known as the EXIM bank was established in
1982, by an Act of Parliament to facilitate, finance, coordinate and promote Indias foreign
trade. Exim Bank lays special emphasis on extension of Lines of Credit to overseas entities,
national governments, regional financial institutions and commercial banks. Exim Bank also
extends buyers credit and suppliers credit to finance and promote countrys exports. The bank
also provides financial assistance to export-oriented Indian companies by way of term loans in
Indian

rupees

or

foreign

currencies

for

setting

up

new

production

facility,

expansion/modernization or upgradation of existing facilities and for acquisition of production

equipment or technology. The various operating groups which handle the functions of the EXIM
bank are:
The Trade Finance or Project Finance Group: This group provides whole lot of services
like pre-shipment credit, suppliers credit, buyers credit, forfeiting, guarantees and consultancy
services to export companies.

 The Corporate Banking Group: Many diverse financing programmes for importers and
export oriented units (EOUs) are being looked after by this group.
The Agri Business Group: This handles agriculture based projects.
The Export Services Group: This group focuses on different value added and advisory
services aimed at investment promotion.
The Lines of Credit Group: This group provides a risk free mode of non-recourse financing
to Indian Exporters.
The Support Services Group: This group handles loan recovery, research and planning,
internal audit, legal affairs, corporate affairs, human resource management and management
information systems.
The Small and Medium Enterprise (SME) Group: This group manages the credit
proposals to SMEs under the different programmes offered by EXIM bank.
The Fee-based Export Marketing Group: This group helps Indian companies to market
their products in overseas market.
The various credit services provided by EXIM Bank to exporting companies are:
It provides equipment finance and project finance to exporting companies
Term finance is provided by EXIM bank to exporting companies for export product
development, domestic acquisition of brands/companies/ businesses and importing technology
and related services.
It provides working capital and general corporate finance to exporting companies etc.

Q4 There are different determinants in exchange rates. Explain all the

determinants of exchange rates.
(Write all the 14 points under determinants of exchange rates) 10
Answer:

Determinants of Exchange Rates

Although in a free market the exchange rate should be determined by the demand and supply of
currencies, there are many other factors which influence the exchange rates, such as:
Balance of Payment (BOP): The BOP position of a country is a clear indicator of the demand
and supply of foreign currency. If a country has a BOP surplus i.e. more supply of foreign
currency, then foreign currency will be cheaper than the domestic currency i.e. domestic
currency will appreciate and vice versa.
Strength of the economy: The demand and supply of foreign currency also depends on the
relative strength of the country. An economy with a faster growth rate as indicated by various
parameters such as Gross Domestic Product, and Gross National Product, drop in
unemployment level, growth in industrial production and capacity utilization, etc. may lead to a
better performance on balance of trade. However, it is also possible that in the short run,
increasing economic activity may lead to higher imports as compared to exports.
Interest rate differential: A higher rate of interest in a particular country may lead to a
demand of the currency of that country and greater supply of the foreign currency as speculative
capital is attracted provided there are no controls.
Inflation rate differential: When two countries have different inflation rates, the currency of
the country whose inflation rate is higher will depreciate vis--vis the other country. This will
lead to a change in exchange rate.
Fiscal policy: If an expansionary policy is followed by the government by lowering the interest
rates, which in turn may fuel economic growth, it may lead to increase in exports. On the
contrary, if the expansionary policy is followed by resorting to higher budget deficit and
monetizing this deficit, this may result in high inflation in the economy and can be detrimental
for the growth in export.
Monetary policy: The monetary policy of any country is an important tool to control money
supply in a economy, keep a check on inflation, ensure price stability and growth of the
economy. It also gives an indication of the interest rates in the economy. Too much of money
supply leads to inflation. In such as case, the central bank raises the interest rates, sells
government securities and may raise reserve requirements. It is, therefore, clear that the

monetary policy influences inflation, interest rates, employment etc. and thereby affects the
exchange rates.
Speculation: Speculators influence exchange rates by buying and selling a particular currency
in the expectation of making profits and as a result may strengthen or weaken any currency in
the short run. This is known as the bandwagon affect.
Government interventions: Sometimes the government of a country intervenes in the foreign
exchange market by imposing restrictions on currency movements, restrictions on currency
dealings and by their monetary and taxation policies. All this influences the exchange rate of the
country.
Central bank interventions: The central bank of a country can influence the exchange rate of
the country by selling and buying foreign currency in the foreign exchange market. For example,
RBI buys dollars whenever the rupee starts appreciating beyond a particular level and sells
dollars whenever the rupee starts depreciating beyond a desired level. This is called open
market operations of the central bank. A highly appreciating rupee is favorable to importers and
unfavorable to exporters and vice versa. However, it is important to understand that for these
operations, the central bank of the country should have huge reserves of dollar.
Market expectations: The demand and supply of foreign currency will also be affected by
market expectations like changes in policy with respect to foreign trade, taxation, changes in
government, inflation, and trade and industrial policies.
Political factors: In case there is a likelihood that the government of a particular government
may fall, it will have an impact on the exchange rate. However, whether the currency of any
country will weaken or strengthen, will depend upon the policies implemented by the new
government. At such times, it is tendency of the people to move funds into safe haven
currencies like dollar and Swiss franc.
Technical factors: These factors can impact the exchange rate in the short run. For example, if
the central bank makes it mandatory to limit the size of open position and if the banks have
huge short positions, they may have to buy foreign exchange in order to cover such positions.
Similarly, if the central bank raises the reserve requirement limits for deposit money banks, it
will impact the exchange rate.

 Exchange controls: Exchange rate controls are imposed by countries to restrict free capital
flows and thus impact the exchange rates. By this mechanism, the countries are able to keep the
price of their currency at an artificial level. For example, China has kept it currency pegged to
the dollar at an artificial low level in order to benefit from exports. In this way it has
accumulated huge reserves of foreign exchange to the tune of $4.3 trillion, thereby leading to
global imbalances. However, it is important to understand that if the exchange rate is artificially
kept low, it tends to accelerate inflation.
Overseas investment: If overseas investment from any country, let us say the US, increases in
India, the supply of dollars will increase leading to a downward pressure on the dollar and
strengthen the rupee.

Q5 Explain the Balance of Payment (BOP) accounting with sources and uses of
funds with examples. How is accounting equilibrium different from accounting
disequilibrium?
(Explanation of BoP accounting with the sources and uses of funds and give examples,
Explanation of accounting equilibrium and disequilibrium) 5+5=10
Answer:
Balance of payment also follows a principle of double-entry book-keeping, like any other
accounting statements. This means that every international transaction should lead to a debit
and credit entry of equal magnitude. It is important to understand that balance of payment
statement is neither a balance sheet nor an income statement. It is a statement of sources and
uses of funds, which reflects the changes in assets, liabilities and net worth over a period of time.
As per the double-entry book-keeping, sources and uses of funds should always match.
Debits and Credits
Credit transactions are those which earn foreign exchange and are recorded as inflow ( ) or plus
(+) whereas debit transactions are those which use foreign exchange and are recorded as
outflow ( ) or minus ().
Sources of funds/credits: in assets or in liabilities or net worth

Examples of sources of funds: Export of goods and services, investment and interest
earnings, loans from foreigners & unilateral transfers (gifts) received from abroad
Uses of funds/debits: in assets or in liabilities or net worth
Examples of uses of funds: Import of goods and services, loans to foreigners, transfer
payments abroad, increase in reserve assets & dividend paid to foreign investors
Capital inflows: Involves payment by foreigners
Example: (a) Decrease in a countrys assets abroad
(b)Increase in foreign assets of the country
Capital outflows: Involves payment to foreigners.
Example: (a) Decrease in foreign assets of a country
(b)Increase in countrys assets abroad
Accounting Equilibrium
Since BoP is always constructed on the basis of double-entry book-keeping, credit is always
equal to debit. If the credit on the current account is lower than the debit, then funds will flow
into the country and will be recorded as credit of the capital account. Thus, the excess of debit
on the current account is balanced. Hence BoP is in equilibrium when the combined balance of
current account and capital account is equal to zero i.e. the sum of debits and credits in the
current and capital account is zero so that the official reserve account balance becomes zero.
Current Account + Capital Account = 0
The accounting balance is an ex post concept. It describes what has actually happened in a
specific period in the past.
Accounting Disequilibrium
Accounting disequilibrium occurs when the two sides of the autonomous flow differ in size, but
in such cases, adjustments bring the BoP back into equilibrium.

Though several external economic variables influence the BoP and give rise to
disequilibrium, variables like money supply, exchange rate, interest rate, national output and
national spending are more significant.
If national income is more than the spending, the excess amount will be invested abroad
resulting in capital account deficit. Conversely, if national spending exceeds national income,
then borrowings from abroad will take place, thereby creating capital account surplus.

Q6 Explain the challenges and emerging trends of international finance.

(Write down all the challenges and all the 4 steps of emerging trends in global trade.) 10
Answer:
Challenges for International Finance:
Policy options: The key policy priorities remain to restore the health of the financial sector
and to maintain supportive macroeconomic policies until the recovery is on a firm footing, even
though policymakers must begin preparing for an eventual unwinding of extraordinary levels of
public intervention. The premature withdrawal of stimulus seems the greater risk in the near
term, but developing the medium-term macroeconomic strategy beyond the crisis is key to
maintaining confidence in fiscal solvency and to price and financial stability. The challenge is to
map a middle course between unwinding public interventions too early, which would jeopardize
the progress made in securing financial stability and recovery, and leaving these measures in
place too long, which carries the risk of distorting incentives and damaging public balance
sheets.
The key issues facing monetary policymakers are when to start tightening and how to
unwind large central bank balance sheets. Advanced and emerging economies face different
challenges. In advanced economies, central banks can (with few exceptions) afford to maintain
accommodative conditions for an extended period because inflation is likely to remain subdued
as long as output gaps remain wide. Moreover, monetary policy will need to accommodate the
impact of the gradual withdrawal of fiscal support.

Rebalancing global demand: Achieving sustained healthy growth over the medium term
also depends critically on rebalancing the pattern of global demand. Specifically, many current
account surplus economies that have followed export- led growth strategies will need to rely
more on domestic demand growth to offset likely subdued domestic demand in deficit
economies that have undergone asset price (stock and housing) busts. By the same token, many
external deficit countries will need to rely less on domestic demand and more on external
demand. This will require significant structural reforms, many of which are also necessary to
boost potential output, which has taken a hit as a result of the crisis.
Foreign exchange fluctuations: Foreign exchange fluctuation is the risk due to the rise or
fall of value of one currency against another. Devaluation might affect future sales, costs and
remittances. International trade and transaction always runs the risk of losing in these cases of
unfavourable exchange rate. For example, if the Indian rupee gains, the foreign buyer/borrower
has to repay the loan.
Financing facilities: Raising funds on favourable terms is another major concern for the
finance managers. The funds can be raised either from an internal source or from an external
source.
Emerging Trends in Global Trade:
1. Trade interconnectedness: Not only has the number of systemically important trading
nations increased over time, their trade links have also multiplied. A chief contributor is the
growing role of global supply chains in overall trade, facilitated by lower tariffs and technologyled declines in transportation and communication costs.
The expansion of global and regional trade was driven by trade liberalization and
subsequently by vertical specialization and income convergence. Multilateral and bilateral
liberalization since early 1950s has led to significantly lower trade barriers in advanced
economies followed more recently by developing countries.
Advanced countries and EMEs play different roles in global supply chains. Advanced
economies tend to be upstream in the supply chain. This position is reflected in relatively small
foreign contents in their exports and relatively large contributions towards other downstream
countries exports.

2. Emerging market economies as major players: In the early 1970s, trade was largely
confined to a handful of advanced economies, notably the United States, Germany, and Japan,
which together accounted for more than a third of the global trade. By 1990, the global trading
landscape had become more diversified to include several EMEs, especially in east Asia. By
2010, China became the second largest trading partner after the United States, overtaking
Germany and Japan.
3. The structure of trade has been characterized by a rising share of higher
technology goods: The role of global supply chains for trade in high technology goods has
increased over time, especially in China. The increase is particularly pronounced for China
imported content of Chinese high-technology exports increased by close to 30 percentage points
from themid-1990s to the mid-2000s.
This result confirms that the emergence of China as a major exporter of high technology
goods has been boosted by processing trade, with significant imported contributions from Japan
and other countries in the Asian supply chain. By the mid-2000s, China has by far the largest
imported content in its high technology exports. Japan and the United States make significantly
less use of imported intermediates.
4. The Asian supply chain is more dispersed compared to those in North America
or Europe: In the Asian supply chain, goods-in-process cross borders several times, including
through the hub (Japan), before reaching their final destination. In contrast, in other regions,
almost all foreign input is imported directly from the hubthe United States in NAFTA and
EU15 in Europe. The greater dispersion of production in the Asian supply chain renders it
potentially more vulnerable to disruptions of trade flows, whether policy induced, such as
preferential/regional trade agreements, or naturally caused, such as the recent Tsunami in
Japan.