International Finance

REGULATORY FRAMEWORK OF
INTERNATIONAL FINANCE: ROLE OF FEMA

INTRODUCTION
International finance is the branch of economics that studies the dynamics
of exchange rates, foreign investment, global financial system, and how these
affect international trade. It also studies international projects, international
investments and capital flows, and trade deficits. It includes the study of futures,
options and currency swaps. International finance is a branch of international
economics.
Important theories in international finance include the Mundell-Fleming
model, the optimum currency area (OCA) theory, as well as the purchasing power
parity (PPP) theory. Whereas international trade theory makes use of mostly
microeconomic methods and theories, international finance theory makes use of
predominantly macroeconomic methods and concepts.Inetrnational finance is the
branch of economics that studies.
International macroeconomics (or international finance) as a subject
covers many topical issues. As with international trade, international macro is the
result of the fact that economic activity is affected by the existence of nations. If
there were no national economies then we would not have this field. If there was
no international trade we would not need international macro either. But countries
do trade with each other, and because countries (not all, but many) use their own
currencies we have to wonder about how these goods are paid for and what
determines the prices that currencies trade at.
More subtly, however, we have to also consider the fact that countries
borrow and lend from each other: in other words, they trade inter-temporally
consumption today for consumption in the future. Because of international
borrowing and lending economic opportunities are expanded and households have
better options to smooth their incomes. These are good things. But just as the
existence of banks make bank panics possible, the existence of an international
financial system makes international financial crises possible. This is where all
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the interesting action of the course comes from. In order to understand such crises
we need to understand the nature of the international financial system.
DEFINITION:
The economic and monetary system that transcends national borders.
The field of international finance concerns itself with studying global capital
markets and might involve monitoring movements in foreign exchange rates.
global investment flows and cross border trade practices.
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NEED & IMORTANCE
Knowledge of international finance can help a financial manager decide

how international events will affect a firm and what steps can be taken to
exploit positive developments and insulate the firm from harmful ones.
Among the events that affect the firm and that must be managed are
changes in exchange rates as well as interest rates, inflation rates, and
asset values. These different changes are themselves related. For example,
declining exchange rates tend to be associated with relatively high interest
rates and inflation. Furthermore, some asset prices are positively affected
by a declining currency, such as stock prices of export-oriented companies
that are more profitable after devaluation.
Other asset prices are negatively affected, such as stock prices of

companies with foreign-currency denominated debt that lose when the
companys home currency declines: the companys debt is increased in
terms of domestic currency. These connections between exchange rates,
asset and liability values, and so on mean that foreign exchange is not
simply a risk that is added to other business risks.
Only by studying international finance can a manager understand matters

such as these. International finance is not just finance with an extra cause
of uncertainty. It is a legitimate subject of its own, with its own risks and
ways of managing them.
There are other reasons to study international finance beyond learning

about how exchange rates affect asset prices, profits, and other types of
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effects described earlier. Because of the integration of financial markets,
events in distant lands, whether they involve changes in the prices of oil
and gold, election results, the outbreak of war, or the establishment of
peace, have effects that instantly reverberate around the Earth.
The consequences of events in the stock markets and interest rates of one
country immediately show up around the globe, which has become an
increasingly integrated and interdependent financial environment.
The links between money and capital markets have become so close as to
make it futile to concentrate on any individual part. In this concerned with
the problems faced by any firm whose performance is affected by the
international environment.
Analysis is relevant to more than the giant multinational corporations

(MNCs) that have received so much attention in the media. It is just as
valid for a company with a domestic focus that happens to export a little of
its output or to buy inputs from abroad.
Indeed, even companies that operate only domestically but compete with
firms producing abroad and selling in their local market are affected by
international developments. For example, US clothing or appliance
manufacturers with no overseas sales will find US sales and profit margins
affected by exchange rates which influence the dollar prices of imported
clothing and appliances
Specifically, if governments increase interest rates to defend their

currencies when their currencies fall in value on the foreign exchange
markets, holders of domestic bonds will find their assets falling in value
along with their currencies: bond prices fall when interest rates increase.
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It is difficult to think of any firm or individual that is not affected in some

way or other by the international financial environment. Jobs, bond and
stock prices, food prices, government revenues, and other important
financial variables are all tied to exchange rates and other developments in
the increasingly global financial environment.
THE GROWING IMPORTANCE OF INTERNATIONAL FINANCE
The managerial issues of international finance, it is important to

emphasize that the international flows of goods and capital that are the
source of supply of and demand for currencies, and hence essential to the
subject of international finance, are fundamental to our well-being.
A strong currency, for example, ceteris paribus, improves a countrys

standard of living the currency buys more in world markets. Not only does
a strong currency allow citizens to buy more imports, they can also buy
more domestically produced products that are internationally traded
The gain in standard of living from a rising currency is also evident when
living standards are compared between nations. International rankings of
living standards require conversions of local currency incomes into a
common measure, usually the US dollar.
Citizens also gain from the efficient global allocation of capital when
capital is allocated to its best uses on a global scale, overall returns are
higher and these extra returns can be shared among the global investors.
Therefore pause to consider the evidence of the international movement of
goods and capital.
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OBJECTIVES OF THE STUDY
1. To study an international perspective, necessary in order to become an

effective professional working in todays global markets.
2. To study of level of understanding and working with financial models
required to become a financial professional.
3. To study of acquire the ability to compile financial data and the ability to
analyze such data to a professional level.
4. To study about an intuitive understanding of financial theory, necessary to
understand the workings of the modern financial market.
5. Essential finance and accounting knowledge and skills.
Objective of International Finance:
1.
Overall objective: to enable the Board to discharge those functions in the

international field which fall to it as the Monetary Authority of the United
States, especially by virtue of the unique international position of the United
States as the economic and political leader of the free world.

2. As adviser to the Board:The Division should be able
a. To advise the Board of foreign developments affecting, or likely to affect, the
level and direction of domestic economic activity, and, conversely, of the
effects of changes in the level of domestic economic activity (including the
b.
effects of domestic monetary policy) upon economic developments abroad.

To advise the Board of the significance of actions by foreign central banks,
and of foreign problems (including foreign methods of dealing with them)
which parallel the domestic problems faced by the board.
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c. To advise the Board on economic aspects of international operations and
foreign relations of the Federal Reserve Banks which, in accordance with
Section l4(g) of the Federal Reserve Act, are subject to special supervision by
the Board.
d. To maintain contact, and within the limits permitted by security requirements
to exchange information, with personnel of foreign central banks. This should
include continuing contacts with foreign central bank personnel temporarily
assigned to the International Monetary Fund, the International Bank for
Reconstruction and Development; and foreign embassies, as well as reception
of foreign visitors, and so far as the budget permits visits by staff members
abroad.
e. To arrange, on request of foreign central banks or other agencies of the U. S.
Government, for procurement of personnel for foreign missions to advise on
problems affecting central banks or monetary policy.
3. Subsidiary objectives as a unit of the Board's staff.
The Division should be able
a. To maintain close working relationships with other Divisions of the Board's
staff, especially with the Division of Research and Statistics and with the
Legal Division and the Division of Examinations.
b. To participate in staff work related to System economic research and the needs
of the Federal Open Market Committee.
c. To maintain close contacts with the officers and staff of the Federal Reserve
Banks.
d. To maintain informal contacts with professional economic research personnel
in other Government agencies concerned with related fields of study, in order
to help maintain a high level of technical competence and a broad
understanding of problems on the part of members of the Board's staff.
e. To maintain within the Division a lively spirit of inquiry; to be on the lookout for useful techniques of research and analysis; in general, to foster, in the
international field standards of professional performance consistent with the
high reputation of the Board's staff in the field of economic analysis.
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REASERCH METHODOLOGY
Research is an art of scientific investigation. In other words research is a
scientific and systematic search for pertinent information on a specific topic. The
logic behind taking research methodology into consideration is that one can have
knowledge regarding the method and procedure adopted for achievements of
objective of the project. With the adoption of this others can also evaluate the
results too.
The methodology adopted for studying the objective of the project was
surveying the bank account holders of the Cachar district. So keeping in view the
nature of requirement of the study to collect all the relevant information regarding
the comparison of public sector banks and the private sector banks direct personal
interview method with the help of structured questionnaire was adopted for
collection of primary data.
Secondary data has been collected through the various magazines and
newspaper and by surfing on internet and also by visiting the websites of Indian
Banking Association.
DATA COLLECTION
Data was collected by using two main methods i.e. primary data and secondary data.
PRIMARY DATA primary data is the data which is used or collected for the first time
and it is not used by anyone in the past. There are number of sources of primary data
from which the information can be collected. We took the following resources for our
research.
a) QUESTIONNAIRE This method of data collection is quite popular, particularly in
case of big enquiries. Here in our research we set 10 simple questions and requested the
respondents to answer these questions with correct information.
SECONDARY DATA Secondary data is the data which is available in readymade form
and which has already been used by other people for various purposes. The sources of
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secondary data are newspaper, internet, websites of IBA, journals and other published
documents.
This project is based on secondary Data.
OVERVIEW
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The global financial crisis that began in 2007 and deepened in 2008
exposed major weaknesses in financial and macroeconomic policy coordination,
and profound flaws in financial risk management and regulation in a number of
advanced countries. The severity of the crisis led global leaders to recognize that
they must find a way to reform the global regulatory architecture to ensure that
the financial system can absorb shocks while continuing to function efficiently.
In response to the crisis, the Group of Twenty (G20) met in November
2008, for the first time at the leaders level, to agree on a comprehensive strategy
to restore trust in the financial system and to limit the fallout from the crisis on
global output and employment. Currently, there is a complicated governance
structure for the program to reform the global architecture of financial regulation
that consists of three entities one ad hoc and self-selected (G20), one treaty-based
and systemic (International Monetary Fund [IMF]) and one a creation of the G20
(Financial Stability Board [FSB]). This paper undertakes an analysis of how
cooperation takes place among these actors to implement the fundamental reforms
needed to ensure that the global financial system is better able to withstand shocks
than it was in 2007-2008.
The analysis suggests a number of actions that the IMF and FSB should
take to strengthen their cooperation and effectiveness, and highlights some of the
problems created when no single agency has overall responsibility for the
regulatory oversight of the international financial system. More broadly, it
concludes that an appropriate framework for the governance of macroeconomic
and financial policy cooperation in an interconnected world is a bimodal structure
which includes both a restricted executive group of leaders who can implement
major changes in the strategic policy direction to meet unforeseen developments
and a universal, treaty-based official international financial institution that
provides regular, consistent policy advice to its members.
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A more effective structure of governance over international economic
policy cooperation would be possible if the countries and jurisdictions whose
leaders made up the restricted executive group were to be selected by a more
systematic and widely accepted process than at present. This raises the question,
addressed at the conclusion of this paper, of what the appropriate relationship
should be between the IMFs key governing body the International Monetary and
Financial Committee and an executive group such as the G20.
Finance is one of the world's biggest industries. The bulk of global finan
cial services production takes place in a few international financial centres: New
York, London, Singapore, Hong Kong and Tokyo. Finance production in these
cities creates high wage jobs and wealth. In addition, high quality financial
services supports high GDP growth in the hinterland. As an example, the presence
of Hong Kong as an international financial centre assists Chinese companies.
India is a large user of financial services, by virtue of a large and growing GDP
and a high rate of investment and savings. At present, India is consuming
financial services produced onshore as well as offshore. India requires
sophisticated financial services to fuel growth in the future. The financial system
determines the allocative efficiency of the use of capital; a sophisticated financial
system improves the GDP growth obtained out of a given flow of investment.
TRANSFORMING GLOBAL SCENARIO
Since the World Bank and the International Monetary Fund (IMF) were
launched at Bretton Woods more than 55 years ago, and the regional development
banks in subsequent decades, the global economy has undergone transformation
in several important respects1. Two fundamental transformations have taken place
in the role of the international financial institutions (IFIs); both of which are of
high significance for the global financial architecture. These changes are: First,
globalisation has progressed a great deal over the preceding quarter century. This
implies that foreign trade and private capital now play a far greater role in
economic development than ever before. Second, the poor performance of statist
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models of development so popular in the past led to a re-examination of the role
of the state, which in turn motivated a strong shift towards private, market-based
approaches. As a result of these transformations, the private sector and private
international finance have become prime agents of economic development.
The IFIs can pursue their mandates by creating the conditions for the right
kind of market-oriented growth and by forming partnerships with the private
sector. We argue that partnership with the private sector calls for significant
adjustments in the modus operandi of the IFIs as well as for clear principles of
engagement. IFIs must complement and catalyse private finance, they must not
displace it. A clearly defined approach to supporting private sector development
will carry the IFIs well into the 21st century.
The role of IFIs in the changing market place
In general terms the objectives of IFIs have always been poverty
alleviation, economic growth and protection of the environment.12 Traditionally,
IFIs have promoted these objectives by working with governments and
government agencies. This reflects the ideas and the capital structures which
prevailed at the time of their creation. Broadly speaking, the IFIs have pursued
these objectives with loans for public sector projects or programmes, technical
assistance, and policy-based lending. IFI loans have generally been made to, or
guaranteed by, the borrowing states.
The EBRD is different from the other IFIs. Its later foundation and the
special circumstances of this foundation pointed to a rather specific objective,
namely to foster the transition of its countries of operations to open market
economies. The founders took it that the transition would indeed raise living
standards over time as well as expanding basic choices and rights of the
population. In the new economic environment, the importance of IFIs and
bilateral aid as sources of funds has decreased. While private flows are rising,
official flows are constrained by tight budgets following fiscal laxity in the 1970s
and 1980s. As budgets get squeezed, official aid, both bilateral and multilateral,
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has been a vulnerable target. Furthermore, the collapse of centrally planned
economies and the poor performance of heavily distorted economies in Africa,
Latin America and the Middle East have led to a re-examination of the role of the
state in economic development. As a result, there is a growing understanding
among developing countries that to achieve market-oriented economic growth,
they must create the conditions in which a strong private sector can flourish.
Since the importance of IFIs as a source of funds has decreased while the
potential role of the private sector has increased, a central challenge for IFIs is to
find ways of fostering development through expanding opportunities for the
private sector. They should view the private sector as a prime vehicle for the
achievement of development goals. In so doing they must seek to ensure that the
poor participate in the growth process and that growth is environmentally
sustainable. There are two complementary ways in which the IFIs can pursue
these objectives:
i) they can help governments create the conditions for the right kind of marketoriented growth.
ii) they can become participant investors, working with the private sector to
expand and improve private capital flows.
THE DILEMMAS OF INTERNATIONAL FINANCIAL REGULATION
International finance has changed dramatically over the past two decades
as governments eliminated barriers to cross-border capital flows and opened their
domestic markets to foreign financial institutions. These changes produced an
increasingly integrated world of international finance. A number of policymakers,
who point to recent financial woes in Asia, Latin America, and Russia, worry that
this integration requires increased international regulation of financial institutions.
As a 1999 International Monetary Fund study lamented, these crises leave open
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the question of whether the official safety nets and monitoring systems have
adapted sufficiently to this new financial environment and whether they are still
ensuring that incentive structures encourage an appropriate amount of market
discipline.
Do we need international financial regulation? The consequences of one
regulatory effort, the 1988 Basle Accord that instituted international standards for
bank capital, suggests such regulation may be more harmful than helpful.
WHY NATIONS REGULATE BANKS
Governments regulate banks because of the need for a financial safety net
to protect depositors and bank shareholders. This safety net in the form of
explicit deposit insurance and implicit guarantees to shareholders is important
because a banking crisis and widespread financial insolvency would have a
devastating impact on real economic activity and could have serious political and
social repercussions. Conscious of such experiences as the Great Depression and
the 1997 Indonesian economic collapse, governments choose to bail out the banks
rather than accept widespread insolvency and social crisis.
Ironically, this safety net provides incentive for banks to take on additional risk.
Because of the insurance and guarantees, banks are inclined to extend highinterest loans to risky borrowers because such lending will yield a high return if
the loans are repaid, but society will shoulder the burden if the borrower defaults.
Because of the potential for economic and political crisis, governments
cannot counter this risk-taking by eliminating the safety net. But governments can
regulate banks to limit the banks exposure to risk. For instance, regulators can
impose capital requirements intended to ensure that banks have sufficient capital
on hand to cover unexpected losses in their lending portfolios. To accomplish this,
regulators can enact a standard requirement that forces banks to hold capital equal
to a specific percentage of their assets. Regulators can also implement a riskweighted requirement that requires banks to hold capital in proportion to the risk
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of their various loans. By matching capital requirements to the overall riskiness of
banks assets, regulators hope to discourage risky portfolios and ensure that banks
have resources sufficient to cover losses resulting from high-risk loans. This will
minimize the costs to society if and when banking crises do occur. Hence,
regulating banks capital standards is a solution to the problems generated by the
prior decision to extend a safety net to the banking system.
THE REASON FOR INTERNATIONAL REGULATION
Given that governments must regulate banks, is international financial
regulation necessary to manage international financial integration? That is, have
dramatic recent changes in financial activity eroded governments ability to rely
on domestic regulation to maintain the stability of banks incorporated in their
countries, thereby necessitating a move to international regulation? The short
answer is no; international financial integration creates no new market failures
that require governments to shift regulation away from independent national
authorities. There may be a need for international coordination of regulatory
responsibility (for instance, the determining of what country would oversee and
insure a multinational bank), but countries can arrange this coordination through
agreement and not by internationally harmonizing prudential regulation.
If national regulation and international agreements can handle risk and
insurance problems, then why does international financial regulation exist?
Countries forged this regulation primarily as a political response to banks
concerns about international competition. In a world in which national regulators
set rules independently, some banks in some countries operate under more
stringent regulatory standards than other banks in other countries. Disparate
national regulations create cost differentials that hurt and help different banks
bottom lines. Banks operating under lax regulation face lower costs than banks
under more stringent controls. Hence, the banks in less regulated countries can
offer banking services to customers at a lower price. International regulation, by
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requiring all governments to adopt a set of common standards, eliminates these
disparities, creating a level playing field in international finance.
The Basle Accord The political dynamic that produced the 1988 Basle
Accord nicely illustrates this pursuit of a level playing field. In the 1980s, many
of the largest U.S. commercial banks became imperiled by the Latin American
debt crisis. The nine largest U.S. commercial banks lent 140 percent of their
capital to three countries, Mexico, Argentina, and Brazil, all of which
subsequently became unable to service their loans. The dozen largest American
banks lent between 83 percent and 263 percent of their capital to five heavily
indebted Latin American countries that later announced they were incapable of
servicing their debts. Put simply, U.S. commercial banks were in trouble.
American policymakers tried to address this crisis through the
International Monetary Fund (IMF). The IMF was to provide Latin American
debtor governments with new credits that could then be used to service their
loans. This way, commercial banks transferred ownership of a portion of
developing countries debt to the public sector. As part of this arrangement,
commercial banks were to restructure their existing commitments and extend
additional loans.
To meet this obligation, the imf needed to boost its resources by 47
percent. Part of that revenue was to come from an $8.4 billion outlay from the
United States. Congress agreed to the expenditure, but demanded a tightening of
domestic banking regulations and an increase in commercial banks capital
requirements. This met predictable opposition from American commercial banks
who were facing tough competition from foreign, particularly Japanese,
commercial banks. American bankers argued that existing cross-national
differences in bank capital regulations directly contributed to their competitive
difficulties; further regulation would only increase that disparity. In response to
this opposition, Congress linked higher capital requirements in the United States
to the successful completion of an international agreement on capital standards.
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This led to the Basle Accord, signed by the leaders of the Group of Ten nations in
late 1987. Subsequently, more than 100 nations have adopted the standards.
The political dynamics underlying the emergence of the Basle Accord
suggest a more general political process lies at the center of international financial
regulation. Governments, wanting to avoid domestic squabbles with their own
banks, shift regulation out of the domestic arena and into the international arena.
International financial regulation, therefore, has little to do with correcting market
failures that arise from international financial integration. Instead, governments
adopt international regulations to minimize the distributional consequences of
regulatory reform in an increasingly integrated international financial system.
THE DANGER OF INTERNATIONAL REGULATION
It would seem that requiring all governments to regulate their banks in
accordance with a common set of standards would not harm banks safety and
would create a level playing field. But there is a potential for harm that arises
from the interaction between the unintended consequences of financial regulation
and the glacial nature of international decision-making. This interaction could
indeed create a less safe banking system.
The Basle Accords Unintended Consequences Regulation always has
unintended consequences, and these consequences often push regulators further
away from, rather than closer to, their goals. This has certainly been the case with
the Basle Accord. The accord imposed an eight-per-cent minimum capital
requirement on internationally active banks, but it required additional capital for
loans that are considered more risky. The accord established four risk categories,
assigning a zero risk weight to governments of nations in the Organization for
Economic Cooperation and Development (oecd), a 20 percent risk weight to oecd
banks and non-oecd governments, a 50 percent risk for mortgage lending, and a
100 percent risk to all other loans.
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Faced with this simple risk classification scheme, banks altered their
lending behavior in ways that regulators did not expect. For example, the risk
classification provides incentive for banks to hold riskier loan portfolios than they
would have held otherwise. Because the regulations assign the same risk
weighting and capital costs to all loans within a given category, banks have
incentive to shift toward higher-risk, higher-interest assets within each category.
For example, a loan to a triple-A rated corporation receives the same risk
weighting as a loan to a heavily indebted start-up firm, even though the loan to the
start-up has a much higher probability of default. Because the banks charge higher
interest to the start-up, they are more inclined to make that loan than to lend
money at a lower interest rate to the secure corporation.
The risk classification scheme also offers incentive for banks to engage in
regulatory capital arbitrage. When capital requirements are not based on a
standard like the probability of insolvency, banks can often restructure their
portfolios in order to reduce their regulatory capital requirements without
reducing their risk. By securitizing assets, banks can unbundle and repackage
risks to transform on-balance sheet assets into off-balance sheet assets that fall
into lower risk weight categories. While reliable information on the scale of
regulatory capital arbitrage is not available, the Federal Reserve has estimated that
securities used to engage in regulatory capital arbitrage account for more than 25
percent of total assets of the United States ten largest banks. In several individual
cases, those securities account for close to 50 percent of total assets.
The problems created by regulatory capital arbitrage pertain less to the offbalance sheet assets and more to the onbalance sheet assets. Banks can only
securitize high quality assets at acceptable cost; thus, regulatory capital arbitrage
moves higher quality assets off banks balance sheets in operations referred to as
cherry picking. This causes the average credit quality of banks on-balance
sheet assets to deteriorate as high quality assets disappear and low quality assets
remain. Against this lower-quality balance sheet, the Basle Accords eight percent
capital requirement may be insufficient and banks capital ratios may provide a
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misleading measure of banks true financial condition. Because market
participants use capital ratios to determine the health of lending institutions, the
weakened quality of this information may harm market discipline.
Revising International Regulations Given these unintended
consequences, the Basle Accord may have made banks less, rather than more,
secure. These problems have prompted regulators to call for refinement of the
accord. Unfortunately, their efforts reveal the difficulty of amending
internationally negotiated regulations.
The Basle Committee has proposed two alternatives for assigning risk
weights to different borrowers. The first option is to rely explicitly on external
ratings agencies, such as Moodys and Standard and Poors, who link their
assessments to explicit risk categories. While this approach would retain the same
number of risk categories introduced in the initial accord, it would add greater
nuance to the categories. The second option is to rely explicitly on banks internal
rating systems. Large banks rely increasingly upon sophisticated methods of
evaluating the risk of individual credit exposures. This option would allow banks
to rely upon these techniques to determine the risk attached to particular
exposures, subject to supervisory review.
While these proposals address many of the major weaknesses in the initial
accords risk classification scheme, distributive conflicts are frustrating efforts to
negotiate their adoption. German authorities delayed publication of the proposed
revisions in order to protect advantages the original accord gave to German banks
over other countries banks. The United States and European governments are
battling over whether to use banks internal rating systems to weight risk, with the
Europeans claiming that American banks would be unfairly advantaged because
European banks do not commonly use such rating systems. Small banks and large
banks worldwide are tussling over the same issue. Finally, banks worldwide are
arguing that, since the proposed accord does not place similar regulations on other
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institutions in the financial services industry, the proposals would affect crosssectoral competitiveness.
The current negotiations over reforming the Basle Accord are producing
several layers of gridlock. Better domestic banking regulation is being held
hostage until the conclusion of a better international banking agreement. A better
international agreement on banking regulation isbeing held hostage by distributive
struggles between banks incorporated in distinct jurisdictions, between banks of
different sizes, and between banks and other financial services providers. These
efforts to use international regulation to create a level playing field have created
harmful delays in the introduction of necessary regulatory reforms.
As long as government-devised regulations are imperfect, they will require
continual refinement and adjustment. The speed at which regulators must make
these adjustments depends upon the speed at which innovation and unexpected
negative effects render the regulations obsolete. In banking, where regulation
obsolesces quickly, governments must retain the ability to regularly adjust the
regulatory framework. International negotiations are not well suited to the task.
As international financial integration deepens, governments will continue
to confront a difficult regulatory dilemma. Domestic financial regulation is likely
to produce a safer financial system than international financial regulation, but it
can also cause financial institutions to shift their business to countries with less
demanding regulations. International financial regulation can eliminate the
unwanted competitive consequences of unilateral domestic regulation, but it may
produce a weaker financial system. Thus, a domestic approach to regulation
produces safer financial institutions but less domestic financial business, while an
international approach protects domestic financial business at the price of
potentially weaker financial institutions.
Instead of opting for either domestic or international regulation, the better
solution may lie in domestic regulation supported by an international agreement
on broad principles. Governments could move away from one-size-fits-all
international regulations in favor of establishing broad regulatory objectives that
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each nation could then pursue through domestic regulation. To ensure that each
country adopts regulations consistent with international goals, the international
community could implement a review process. Such an approach would reduce
the competitive consequences of purely domestic regulation while maintaining the
flexibility of domestic regulation.
REGULATORY FRAMEWORK OF INTERNATIONAL FINANCE

Foreign Trade Policy
Earlier this policy known as Export Import (Exim) Policy. Now this Policy
statement is referred to as Foreign Trade Policy. The Policy is a set of guidelines
and instructions related to the import and export of goods. The Government of
India notifies the Policy for a period of five years. The current policy covers the
period 2009-14. The Foreign Trade Policy is updated every year on the 31st of
March and the modifications, improvements and new schemes becomes effective
from 1st April of every year. All types of changes or modifications related to the
Policy is normally announced through an annual supplement to the policy by the
Union Minister of Commerce and Industry who coordinates with the Ministry of
Finance, the Directorate General of Foreign Trade and its network of regional
offices.
The Current policy was announced when the entire world was facing
unprecedent economic slowdown post war. WTO estimates that grim forecast
that Global trade is likely to decline by over 11 %. India was not affected to the
same extent. yet India exports had suffered decline due to contraction in demand
in traditional markets. Protectionist measures adopted by some countries have
also aggravated the situation. Therefore the strategies and policy measures have
been oriented towards catalyzing the growth of Exports. This would also involve
providing additional support to those sectors which have been badly hit by
recission in the developed world.
To meet these objectives Government is set to follow a mix of policy
measures, including: Fiscal incentives institutional changes Procedural
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Rationalization Enhanced Marketing Access across the world Diversification of
Exporters market Improvement of Infrastructure related to Exports Reducing
transaction costs Full refund of all indirect taxes and Levies.
The policy is directed towards:
Support to exporters especially, in times of stress, to such sectors such as
Textiles, Leather & Handicrafts.

To encourage Value addition in Manufactured Exports. To this end the govt.
has stipulated a minimum 15 % Value add on Imported inputs under the
Advance Authorized Scheme.

Diversify Export Markets of Africa , Latin America and CIS countries where
the disadvantages of higher Credit risks and Trade Costs are sought to be
offset by appropriate policy Instruments.

Addittional resources have been made available under Market Development
Assistance Scheme & Market Access Initiative Scheme.

Incentives have been rationalized to identify leading products that would
catalyze the next phase of export growth.

To Promote Brand India.
To enter into mutually beneficial trade agreements.
To promote Technological upgradation of Exporters by allowing import of
Capital Goods under the EPCG at Zero Percent Duty.

Government recognition of exporters based on Export performance called
Status Holdeers who will be permitted to import capital Goods free
( Through Duty Credits scrips equivalent to 1 Percent of the FOB value of
exports in the previous year, of specified product group.

Towns of export Excellence and units located therein would be granted
added focussed support & incentives.

Growth of Project Export facilitated by the formation of Coordination
committees involving the EXIM Bank, RBI, & the Department of Economic
Affairs.
Role of RBI with reference to International Finance
Page 22
Exchange Manager and Controller RBI manages exchange control, and represents India as a member of the
international Monetary Fund [IMF]. Exchange control was first imposed on India
in September 1939 when World War II started and continues till date. Exchange
control was imposed on both receipts and payments of foreign exchange.
According to foreign exchange regulations, all foreign exchange receipts, whether
on account of export earnings, investment earnings, or capital receipts, whether of
private or government accounts, must be sold to RBI either directly or through
authorized dealers. The Foreign Exchange Management Act from 1999 came into
force in June 2000. It should improve the foreign exchange market, international
investments in India and transactions.
Publisher of Monetary Data and Other Data RBI maintains and provides all essential banking and other economic data,
formulating and critically evaluating the economic policies in India. In order to
perform this function, RBI collects, collates and publishes data regularly.
International Users can avail this data in the weekly statements, the RBI monthly
bulletin, annual report on currency and finance, and other periodic publications.
Controller of Money Supply and Credit The International community needs to be assured that the Country they are
dealing with has a stable Monetary system In a planned economy, the central
bank plays an important role in controlling the paper currency system and
inflationary tendency. RBI needs to ensure promotion of maximum output, and
maintain price stability and a high rate of economic growth. To perform these
functions effectively, RBI uses several control instruments such as Open Market Operations
Changes in statutory reserve requirements for banks
Lending policies towards banks
Control over interest rate structure
Statutory liquidity ration of banks
Monitoring of overseas branches of Indian banks Page 23
The RBI Supervision department of the Head Office is in charge of the
reporting/monitoring system covering overseas operations of Indian banks.
Promotional Role of RBI Promotion of export finance
Promotion of credit guarantees
Exchange Control Regulations The exchange control regulations have been liberalized over the years to facilitate
the remittance of funds both into and out of India. The changes have been
introduced on a continuous basis in line with the government policy of economic
liberalization. Still, in few cases, specific approvals are required from the
regulatory authorities for foreign exchange transactions/remittances.
Role of Foreign Exchange Dealers Association of India (FEDAI) :

FEDAI was set up in 1958 as an Association of banks dealing in foreign
exchange in India (typically called Authorised Dealers ADs) as a self regulatory
body and is incorporated under Section 25 of The Companies Act, 1956. Its
major activities include framing of rules governing the conduct of inter-bank
foreign exchange business among banks vis--vis public and liaison with RBI for
reforms and development of forex market. Due to continuing integration of the
global financial markets and increased pace of de-regulation, the role of selfregulatory organizations like FEDAI has also transformed. In such an
environment, FEDAI plays a catalytic role for smooth functioning of the markets
through closer co-ordination with the RBI, other organizations like FIMMDA, the
Forex Association of India and various market participants. FEDAI also
maximizes the benefits derived from synergies of member banks through
innovation in areas like new customized products, bench marking against
international standards on accounting, market practices, risk management
systems, etc.
Page 24
Rupee Convertibility
Convertibility of Rupee: The most important measure for integrating the
economy of any country is to make its currency fully convertible i.e., allow it to
determine its own exchange rate in the international market without any official
intervention.
As a first step towards full convertibility of rupee, rupee was devalued
against major currencies in 1991. This was followed by introduction of dual
exchange rate system in 1992-93 and full convertibility of the rupee on trade
account in 1993-94. India achieved full convertibility on current account in
August, 1994.
Current account convertibility means freedom to buy or sell foreign-exchange
for the following transactions:
(i) All payments due in connection with foreign trade, other current account
business, including services and normal short term banking and credit facilities,
(ii) Payment due as interest on loans and as net income from other investments
(iii) Payments of moderate amount of amortization of loans or for depreciation of
direct investment and
(iv) Moderate remittances for family living expenses.
Certain steps towards full convertibility on capital account have also
been taken like authorized dealers have been allowed to invest abroad their
unimpaired Tier1 capital, they have been delegated powers to release exchange
for opening of offices abroad, banks fulfilling certain criteria have been permitted
to import gold for resale in India.
Non Resident Individuals and listed companies have been permitted to
invest in overseas companies listed on a recognized stock exchange (subject to
certain conditions), limit on banks investment from/in overseas markets has been
raised; Indian companies are allowed to access ADR/GDR markets through an
automatic route, Indian companies with a proven track record are allowed to
invest up to 100% of their net worth in a foreign entity, Ads (Authorized
Dealers) are allowed to issue international credit cards, NRIs are allowed to remit
Page 25
up to U.S. $1 million per calendar year out of their Non-resident ordinary
accounts / sale proceeds of assets and so on. Committee on fuller capital account
convertibility. (Tarapore Committee II) has chalked out a road map for capital
account convertibility. Strong macroeconomic framework, strong financial
systems and prudent regulatory framework are the preconditions for capital
convertibility. A Five year time framework (2007-2011) has been given for full
convertibility on capital account.
Finance SEZs in the context of India's economic policy strategy
Kandla EPZ in 1965 and SEEPZ in 1973 were novel projects. They
represented controlled experimentation with free trade while the Indian mainland
was not ready for such ideas. The success of those ideas shaped and enabled the
trade liberalisation which took place on an all-India scale in the following years.
Today, free trade in goods has largely been achieved and the importance of the
special dispensation that was given for Kandla or SEEPZ is low.
In similar fashion, Finance SEZs would be India's first experiment with
the Indian Financial Code. In some years, the Ministry of Finance will get this
Code enacted and implemented. Doing this immediately at Finance SEZs,
however, will be a test case where knowledge can be obtained about how this
works. In the long run, once the Indian Financial Code is implemented on an allIndia scale, there will be no need for this special treatment of Finance SEZs.
In the future, China and India will have full capital account convertibility.
In the short run, the debate about steps towards capital account liberalization for
India is taking place. However there can, however, have no objections to
removing restrictions for one physical location, as was done with trade account
restrictions in Kandla in 1965 and SEEPZ in 1973. Until India achieves full
convertibility, there is value in having an enclave like Hong Kong or GIFT, where
high value jobs are created and the domestic economy obtains a better connection
with financial globalisation. In the future, when free capital mobility has been
achieved, the importance of the special dispensation that is given for Finance
Page 26
SEZs will be low. Thus, in the future, Finance SEZs like GIFT will thrive or fail
on their own merits, competing with New York, London and Singapore. In the
short term, special efforts are required for embarking on this journey. India cannot
afford to wait for a long time before stepping into the ring in this global
competition.
Foreign Exchange Management Act, 1999

Introduction
The foreign exchange Management Act, 1999 (FEMA) replaces the foreign
exchange Regulation Act (FERA). FERA was introduced in 1974 to
consolidate and amend the then existing law relating to foreign exchange.
FERA was amended in 1993 to bring about certain changes, as a result of
introduction of economic reforms and liberalization of Indian Economy. But it
was soon realized that FERA had by and large outlived its utility in the
changed economic scenario and therefore replaced by FEMA in 1999.
Meaning
FEMA was introduced by the finance Minister in Lok Sabha on August
4, 1998. The Bill aims to consolidate and amend the law relating to foreign
exchange with the objective of facilitating external trade and payments and for
promoting the orderly development and maintenance of foreign exchange
market India. It was adopted by the parliament in 1999 and is known as the
Foreign Exchange Management Act, 1999. This Act extends to the whole of
India and shall also apply to all branches, offices and agencies outside India
owned or by a person resident in India.
Objectives and Reasons for enactment of FEMA
Page 27
FEMA was enacted to consolidate and amend the law relating to
foreign exchange with the objective of facilitating external trade and payments
and for promoting the orderly development and maintenance of foreign
exchange market in India (Preamble). The statement of objects and reasons set
the tone of the enactment of new legislation:
i. The foreign exchange Regulation Act, 1973, was reviewed in 1993 and
several amendments were enacted as part of the ongoing process of
economic liberalization relating to foreign investments and foreign trade for
closer interaction with the world economy. At that stage, the central
government decided that the further exchange of the foreign exchange
Regulation Act would be undertaken in the light of subsequent
developments and experience in relation to foreign trade and investment. It
was subsequently felt that a better course would be to repeal the existing
foreign exchange Regulation Act and enact a new legislation. A task force
constituted for the purpose submitted its report in 1994 recommending
substantial changes in the existing Act.
ii. Significant developments have been taking place since 1993 such as
substantial increase in foreign exchange reserves, growth in foreign trade,
rationalization of tariffs, current account convertibility, liberalization of
Indian investments abroad, increased access to external borrowings by
Indian corporate and participation of Foreign investors in the stock markets.
Accordingly, a bill to repeal and replace Foreign Exchange
Regulation Act, 1973 was introduced Lok Sabha on 04.08.1998. On
reference to the standing committee modifications and suggestions were
submitted by the standing committee in its report. After incorporating
modifications and suggestions of the standing committee, the central
government decided to introduce the new law, the Foreign Exchange
Management Bill and repeal the Foreign Exchange Regulation Act, 1973
Salient Features of FEMA
Page 28
FEMA extends to whole of India. It shall also apply to all branches,
offices and agencies outside India, owned or controlled by a person resident
in India and also to any contravention there under committed outside India by
any person to whom the Act applies. Therefore joint ventures or wholly owned
subsidiaries, though outside India, but controlled from India are intended to be
covered by the Act. The new Act is meant to be user friendly with the object to
facilitate external trade and payments for promoting the orderly development
of foreign exchange in India.
Under the new law, the emphasis for determining the residential status
is on the actual period of stay in India, whereas under FEMA, the emphasis
was on the intention of the person. Under the new law, it is not necessary that
the person should be continuously and physically present in India. It will be
sufficient the total of stay in India is 182 days or more during the year.
The central government may from time to time give general or special
directions to the Reserve Bank and Reserve Bank shall comply with such
directions. The central government may by notification make rules to carry out
the provisions of the Act. The Reserve Bank may by notification make
regulation to carry out the provisions of the Act and rules there under. Every
rule and regulation made under the Act shall as soon as after it is made, be laid
before each house of parliament. If any difficulty arises in giving effect ti the
provisions of the Act, the central government may by order, do anything not
inconsistent with the provisions if the Act for the purpose of removing the
difficulty.
Applicability of the Act
The act extends to the whole of India. Also, it applies to all the
branches, offices and agencies outside agencies outside India owned or
controlled by a person resident in India and also to any contravention there
Page 29
under committed outside India by person to whom this act appeals. The act has
come into force with effect from June 1, 2000.
Role of FEMA :
The exchange control regulations in India are governed by the Foreign
Exchange Management Act (FEMA). The apex exchange control authority in
India is the Reserve Bank of India (RBI) which regulates the law and is
responsible for all key approvals. FEMA is not only applicable to all parts of India
but is also applicable to all branches, offices and agencies outside India which are
owned or controlled by a person resident in India. FEMA regulates all aspects of
foreign exchange and has direct implications on external trade and payments.
FEMA is an important legislation which impacts foreign nationals who are
working in India and also Indians who have gone outside India. It is important to
be compliant with the exchange control regulations.
INTERNATIONAL FINANCIAL SERVICES CENTRE (IFSC)
An International Financial Services Centre (IFSC) is set up at
Gandhinagar, Gujarat as a part of a Special Economic Zone (SEZ). To
operationalise the IFSC, Notification under the foreign exchange management
act, FEMA shall be issued by Reserve Bank of India (RBI) in March 2015,
making regulations relating to financial institutions set up in the IFSC. The key
features of these regulations will be that any financial institution (or its branch) set
up in the IFSC,a) shall be treated as a non-resident Indian located outside India,
b) shall conduct business in such foreign currency and with such entities, whether
resident or non-resident, as the Regulatory Authority may determine, and
c)
subject to certain provisions, nothing contained in any other regulations shall
apply to a unit located in IFSC.

Page 30
Pursuant to the Regulations issued under FEMA, the respective regulators
would frame regulatory framework for provisions of financial services. IRDA of
India would be permitting insurers including foreign insurer or reinsurers to set up
branch in IFSC. Similarly RBI would permit the setting up of IFSC Banking Units
(IBUs) by banks. Government would be permitting IRDA of India to allow such
life and non-life insurance services, health insurance services and reinsurance
services, as may be specified. The Securities and Exchange Board of India (SEBI)
would allow setting up of exchanges and allow other activities for fund raising,
merchant banking, brokerage, fund management, private equity, etc. Activities like
currency derivatives, NIFTY futures, Depository Receipts, etc. would take place
on the exchanges like any other IFSC.
RBI has also formulated a Draft Scheme for the setting up of IFSC
Banking Units (IBUs) by banks, whose broad contours may be summarised as
follows:
Setting up of IBUs: Eligible banks intending to set up IBUs (which would
be regulated and supervised by RBI) would be required to apply to the
Department of Banking Regulation (DBR) of RBI under Section 23 of the
Banking Regulation Act, 1949. To begin with, only Indian banks (public and
private, authorised to deal in forex and foreign banks having a presence in India
would be eligible to set up IBUs. Banks already having offshore presence would
be preferred and each bank would be permitted to set up only one IBU in one
IFSC.
IBUs vis--vis foreign branches of banks: For most purposes, the IBU
will be treated on par with a foreign branch of an Indian bank, like the application
of prudential norms, the 90 days Income Recognition Asset Classification and
Provisioning norms, adoption of liquidity and interest rate risk management
policies.
Role of the Parent Banks Board: The banks Board would set
comprehensive overnight limits for each currency for IBUs, may set out
Page 31
appropriate credit risk management policy and exposure limits, and monitor
overall risk management and ALM framework of the IBU.
Capital Requirements: The parent bank would be required to provide a
minimum of used 20 million upfront as capital, and the IBU shall have to maintain
minimum capital on an on-going basis as may be prescribed.
Liabilities and Advances: The IBUs liabilities will be exempt both CRR
and SLR. But liabilities only with original maturity period greater than one year
are permissible, although short-term liabilities may be raised from banks subject
to RBI prescribed limits. Deposits will not be covered by deposit insurance and
RBI shall not provide liquidity or Lender of Last Resort support. Funds may be
raised only from entities not resident in India, though the deployment may also be
with entities resident in India, subject to FEMA, 1999. Advances by IBUs shall
not be a part of the Net Bank Credit of parent banks.
Permissibility of activities: Opening of current or savings accounts and
issuance of bearer instruments is not allowed. Payment transactions can only be
undertaken via bank transfers. IBUs can undertake transactions with non-resident
entities other than retail customers/HNIs, and can deal with WOS/JVs of Indian
companies abroad. They may undertake Factoring/Forfaiting of export
receivables, but are prohibited from cash transactions.
Ring Fencing: All transactions of IBUs shall be in currency other than
INR, and IBUs would operate and maintain balance sheet only in foreign
currency, except a Special Rupee Account to defray administrative and statutory
expenses. Separate Nostro accounts will have to be maintained by IBUs with
correspondent banks. IBUs will not be permitted to participate in domestic call,
notice, term, forex, money and other onshore markets and domestic payment
systems.
Page 32
CONCLUSION
As we have learnt, finance and macroeconomics are inextricably linked.
And what is true domestically is also true internationally. In the current historical
phase, both real and financial markets are highly integrated globally, just as they
Page 33
were almost uninterruptedly for many decades until the Great Depression. The
need to develop new analytical frameworks to think about the interaction
between finance and macroeconomics in a domestic context inevitably extends to
the global stage. This calls for a reversal in the prevailing perspective. One
should not ask what the real side of the equation means for its financial
counterpart, but what the financial side means for its real counterpart. The
starting point should be what happens in financial asset markets rather than in the
goods markets, domestically and internationally. Otherwise, there is a risk that
the financial side will be neglected. This is precisely what has happened for far
too long. There is a need to redress the balance.
In both cases, financial surges and collapses within and across national
borders were at the root of the historic financial crises. Current account positions
did not provide a useful pointer: surges occurred in both surplus and deficit
countries. And in both cases, understanding the build-up of vulnerabilities
requires looking beyond the capital account to what decision-making units
operating in multiple jurisdictions were doing banks and non-financial
corporates in the interwar years, and, above all, the nexus between European
banks and US money market funds in the US sub-prime crisis. This analysis has
major implications for central banks. Given their primary responsibility for
monetary and financial stability, central banks inevitably end up under the
spotlight once the focus shifts to asset prices, balance sheets and financial crises.
As long as the focus is on current accounts, central banks role is necessarily
more peripheral. There is little doubt, however, that policy frameworks should be
strengthened to incorporate more systematically financial surges and collapses.
And in a highly globalised world, ways should also be found to take proper
account of policy spillovers, both on other countries and on aggregate conditions.
Despite an abundance of cross-section, panel, and studies, there is
strikingly little convincing documentation of direct positive impacts of financial
opening on the economic welfare levels or growth rates of developing countries.
The econometric difficulties are similar to those that bedevil the literature on
Page 34
trade. Openness and growth, though if anything, they are more severe in the
context of finance. There is also little systematic evidence that financial opening
raises welfare indirectly by promoting collateral reforms of economic institutions
or policies. At the same time, opening the financial account does appear to raise
the frequency and severity of economic crises. Nonetheless, developing countries
have moved over time in the direction of further financial openness. A plausible
explanation is that financial development is a concomitant of economic growth,
and a growing financial sector in an economy open to trade cannot long be
insulated from cross-border financial flows. This survey discusses the policy
framework in which financial globalization is most likely to prove beneficial. The
reforms developing countries need to institute to make their economies safe for
international asset trade are the same ones they need so as to curtail the power of
entrenched economic interests and liberate the economy's productive potential.
BIBLIOGRAPHY
Ericsmore.wordpress.com
www.managementjournals.com
www.bis.org
www.armeconomist.com
Page 35
willembuiter.com
pib.nic.in
www.oecd.org
www.bis.org
www.isu.edu
object.cato.org
Page 36

International Finance

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International Finance

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REGULATORY FRAMEWORK OF

INTERNATIONAL FINANCE: ROLE OF FEMA

NEED & IMORTANCE

Knowledge of international finance can help a financial manager decide

Other asset prices are negatively affected, such as stock prices of

Only by studying international finance can a manager understand matters

There are other reasons to study international finance beyond learning

Analysis is relevant to more than the giant multinational corporations

Specifically, if governments increase interest rates to defend their

It is difficult to think of any firm or individual that is not affected in some

THE GROWING IMPORTANCE OF INTERNATIONAL FINANCE

The managerial issues of international finance, it is important to

A strong currency, for example, ceteris paribus, improves a countrys

OBJECTIVES OF THE STUDY

1. To study an international perspective, necessary in order to become an

Overall objective: to enable the Board to discharge those functions in the

States as the economic and political leader of the free world.

effects of domestic monetary policy) upon economic developments abroad.

THE DILEMMAS OF INTERNATIONAL FINANCIAL REGULATION

REGULATORY FRAMEWORK OF INTERNATIONAL FINANCE

Support to exporters especially, in times of stress, to such sectors such as

Textiles, Leather & Handicrafts.

Advance Authorized Scheme.

offset by appropriate policy Instruments.

Assistance Scheme & Market Access Initiative Scheme.

catalyze the next phase of export growth.

Capital Goods under the EPCG at Zero Percent Duty.

exports in the previous year, of specified product group.

added focussed support & incentives.

Role of RBI with reference to International Finance

Role of Foreign Exchange Dealers Association of India (FEDAI) :

Foreign Exchange Management Act, 1999

subject to certain provisions, nothing contained in any other regulations shall

apply to a unit located in IFSC.

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