Journal of Financial Regulation and Compliance

Emerald Group Publishing Limited
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Latest documents

  • Editorial
  • Unbundling interest rate and bank credit nexus on income inequality: structural break analysis from Nigeria

    Purpose: Income inequality stalls economic growth with undesirable socio-economic consequences. Despite various measures targeted towards reducing the inequality gap, disparities in income distribution persist in Nigeria. Therefore, this study aims to explore a new line of argument to the finance mechanism in reducing income inequality. Design/methodology/approach: The study uses time-series data on Nigeria from 1980 to 2015 with analysis conducted using the autoregressive distributed lag-error correction model approach of Pesaran et al. (2001). Findings: The results show amongst others that the channel of real interest rate on income inequality is through bank credit, real interest rate has an indirect relationship to income inequality and bank credit has an equalising impact on income inequality when the model is augmented for a structural break. The results show amongst others, that, on average, ceteris paribus, a 1% point increase in the real lending interest rate is associated with a 0.45% decline in the volume of bank credit. Originality/value: This paper engages a new line of argument by unbundling how financial intermediation impacts on income inequality. The extant literature submits that finance directly impacts income inequality, whereas this study investigates further to show that interest rate impacts income inequality through bank credit. That is, the transmission mechanism by which finance affects income inequality is modelled and analysed.

  • Money laundering via underground currency exchange networks

    Purpose: This paper aims to demonstrate how illicit funds are being laundered through underground currency exchange networks. Design/methodology/approach: Sixty interviews with money launderers and compliance officers were conducted to identify methods relevant to current money laundering issues. Further, a quantitative survey of 200 compliance officers was administered. Findings: The currency exchange method is highly suitable for money launderers with access to a criminal network. It may be used for placement or pre-placement. Evidently, the vast majority of compliance officers fail to recognize the utilization of this method in their daily business. Research limitations/implications: Implications are based on the statements of 60 interviewees, comprising both alleged money launderers and compliance officers. Practical implications: The study identified gaps in anti-money laundering mechanisms. The documentation of said inconsistencies aims to provide compliance officers, law enforcement agencies and legislators with useful insights into the minds of money launderers. Originality/value: Whereas most prior literature focuses on money laundering prevention methods, how money launderers operate is not illustrated. This study comprehensively overviews the issue by interviewing not only compliance officers but also money launderers. Understanding how money launderers operate is essential to effectively prevent money laundering. In particular, compliance officers must be able to view money laundering from the criminal’s perspective to sufficiently combat the issue.

  • Impact of activity restrictions on risk taking of banks: does competition matter during crisis?

    Purpose: This study aims to examine the impact of activity restrictions in shaping the risk-taking behaviour of banks through the channel of competition in different economic conditions. Design/methodology/approach: The authors use a dynamic panel regression method, particularly a two-step system generalised method of moments to address the risk-taking persistence of banks and endogeneity of activity restrictions and competition with banks’ risk-taking using financial freedom and property rights as instrumental variables. Activity restrictions are computed by constructing an index based on the survey results of Barth et al. (2001, 2006, 2008 and 2013a). Competition is measured by the Panzar–Rosse H-statistic and risk-taking behaviour are measured by non-performing loan ratio and lnZ-score. In the investigation process, the authors control bank characteristics – size, efficiency, ownership and loan composition and macroeconomic factors – gross domestic product growth and inflation, and use 2,527 bank-year observations from 180 commercial banks of Association of the Southeast Asian Nations-five countries over the 1990–2014 period. Findings: This study finds that activity restrictions exacerbate the risk-taking behaviour of the banks leading to changes in the channel of competition because of the “risk-shifting effect” of competition. The finding is robust by considering the financial crisis and alternative specifications. Research limitations/implications: This study contributes to bank literature and policy formulation regarding the effect of activity restrictions on the risk-taking behaviour of banks, which is an issue of concern amongst bank regulators, policymakers and academics, especially in the aftermath of the 2008–2009 global financial crisis. Practical implications: Understanding how the competition plays a role in the relationship between activity restrictions and the risk-taking of banks in different economic situations. Originality/value: This study provides new insight into the bank literature by investigating the moderating role of competition on activity restrictions and the risk-taking behaviour of banks in a different economic environment.

  • Demystifying gaps and testing for convergence in bank regulations impacting the competitive environment: a case of India and its peers in BRICS

    Purpose: This study aims to demystify how the critical regulations affecting the bank competition have instituted, amended and fine-tuned over the years in India and its peers in Brazil, Russia, India, China and South Africa (BRICS). The gaps in the regulatory practices influencing bank contestability and competition in BRICS nations are identified. Also, the regulatory convergence is tested by comparing the policies embraced in India vis-à-vis its peer nations. Design/methodology/approach: A methodological framework by Barth, Caprio and Levine (2013) is adopted to construct various regulatory indices. The empirical analysis is based on information available in five rounds of the bank regulation and supervision survey conducted in 2000, 2003, 2007, 2011 and 2017 by the World Bank. Findings: The empirical findings elucidate that although bank entry regulations have been liberalized over time, the bank contestability seems to be low in the BRICS countries, especially in India. This might be due to the substantial government ownership and the presence of notional powers that are conferred to bank supervisors. On comparing the bank regulations in India vis-à-vis its peers, the author find a strong convergence in licensing requirements for entry into the banking business, foreign bank entry mode, restrictions on conglomerate formation and adoption of prompt corrective action framework. Practical implications: The study suggests that future policy initiatives in India need to focus on redesigning the banking structure by reducing the share of state ownership, permitting joint ventures and liberally allowing the entry of new domestic and foreign banks in the industry. In the years to come, regulators in India will continuously face the challenge of fostering bank contestability without jeopardizing bank efficiency and overall stability. Originality/value: This study is perhaps first of its kind, which analyzes the inter-temporal changes in regulatory indicators to examine the variations in the competitive environment of the banking markets of BRICS economies in general and India in particular.

  • Securitization and earnings management: evidence from the Sarbanes–Oxley act

    Purpose: This paper aims to examine whether the opportunistic use of assets securitization for earnings management is systematically widespread. It is hypothesized that with the passage of the Sarbanes–Oxley (SOX) Act of 2002, which imposed more stringent governance over the financial reporting process, there should be a decrease in the opportunistic use of securitization among firms that were not compliant prior to the passage. Design/methodology/approach: The author use the SOX Act as an exogenous shock to determine whether the act had the intended effect of mitigating opportunistic securitization. Findings: The empirical results show that there was a significant decrease in securitization among the non-compliant firms relative to the compliant firms and this reduction is related to firms using securitization opportunistically. This evidence suggests that securitization for earnings management was a systematic phenomenon and that SOX was effective in mitigating such behavior. Originality/value: The contribution of this paper to the literature is twofold. It will identify changes in the use of asset securitization for earnings management purpose by using the exogenous variation in the strength of external governance. Furthermore, it will provide additional evidence of the effectiveness of financial regulations and have potential implications at the policy maker level.

  • Establishing an EU internal market for depositaries

    Purpose: This paper aims to examine the rationale for the establishment of a depositary passport as the next logical step in building an internal market for investment funds in the European Union (EU). It makes the point that the de facto prohibition of depositary passporting poses risks to financial stability and has an adverse impact on investor protection in EU member states, which do not have a fully developed funds industry. Design/methodology/approach: This paper analyses both the arguments in favour and against the adoption of a depositary passport. Moreover, it examines this proposal in the context of different approaches to fostering the internal market such as mutual recognition, harmonisation of regulation, reflexive governance of financial supervision and centralised supervision. Findings: Based on the review of the current EU legal framework, this paper, subsequently, puts forward possible solutions for the establishment of an internal market for depositary business, which solutions have been discussed with various experts in the field to assess their feasibility in practice. Originality/value: The paper contributes to the debate on the EU internal market in the field of asset management, which is topical in view of the upcoming review of the EU’s Alternative Investment Fund Managers Directive.

  • What is good and bad with the regulation supporting the SME’s credit access

    Purpose: This analysis asks whether regulatory capital requirements capture differences in systematic risk for large firms and micro-, small- and medium-sized enterprises (MSMEs). The authors explore whether bank capital regulations intended to support SMEs’ access to borrowing are effective. The purpose of this paper is to find out whether the regulatory design (particularly the estimate of asset correlations) positively affects the lending process to small and medium enterprises, compared to large corporates. Design/methodology/approach: The authors investigate the appropriateness of bank capital requirements considering default risk of loans to MSMEs and distortions in capital charges between MSMEs and large firms under the Basel III framework. The authors compiled firm-level data to capture the proportions of MSMEs and large firms in Italy during 2000–2014. The data set is drawn from financial reports of 708,041 firms over 15 years. Unlike most empirical studies that correlate assets and defaults, this study assesses a firm’s creditworthiness not by agency ratings or by sampling banks but by a specific model to estimate one-year probabilities of default. Findings: The authors found that asset correlations increase with firms’ size and that large firms face considerably greater systematic risk than MSMEs. However, the empirical values are much lower than regulatory values. Moreover, when the authors focused on the MSME segment, systematic risk is rather stable and varies significantly with turnover. This analysis showed that the regulatory supporting factor represents a valuable attempt to treat MSME loans more fairly with respect to banks’ capital requirements. Basel III-internal ratings-based approach results show that when the supporting factor is applied, the Risk-Weighted-Assets (RWA) differences between MSMEs and large firms increase. Research limitations/implications: The implications of this research is that banking regulators to make MSMEs support more effective should review asset correlation estimation criteria, refining the fitting with empirical evidence. Practical implications: The asset correlation parameter stipulated by the Basel framework is invariant with economic cycles, decreases with borrowers’ probability of default and increases with borrowers’ assets. The authors found that those relations do not hold. This way, asset correlations fall below parameters defined by regulatory formula, and SMEs’ credit risk could be overstated, resulting in a capital crunch. Originality/value: The original contribution of this paper is to demonstrate that the gap between empirical and regulatory capital charge remains high. When the authors examined the Basel III-IRBA, results showed that when the supporting factor is applied, the RWA differences between MSMEs and large firms increase. This is particularly strong for loans to small- and medium-sized companies. Correctly calibrating asset correlations associated with the supporting factor eliminates regulatory distortions, reducing the gap in capital charges between loans to large corporate and MSMEs.

  • Does interest rate liberalisation affect the constancy of mean interest rates in China?

    Purpose: This paper aims to examine the impact of interest rate liberalisation on the constancy of mean interest rates in China to test the effect of financial reforms and provide strategies for future practices. Design/methodology/approach: Bai and Perron’s (1998, 2003) methodology is used to test for structural breaks in the mean of different interest rates using Chinese data, and break dates are measured against the exact dates of the interest rate liberalisation. The performance of mean interest rates across the regimes defined by liberalisation dates is also investigated. Findings: The main results show that interest rates generally increase (decrease) after deregulations on lending (deposit) rates, but these changes are not significant to induce a negative impact on the domestic economy. Instead, the infrequent but important shifts (structural breaks) in mean interest rates are caused by factors other than liberalisation such as economic shocks, inflationary expectation and liquidity crunch in China. Originality/value: To the best of the author’s knowledge, this paper provides unprecedented evidence on significant changes in interest rates attributable to the liberalisation within the Chinese context.

  • The establishment of the OECD Asia-Pacific academy for tax and financial crime investigation

    Purpose: This viewpoint paper has two purposes: One is to argue that the Academy activities should increasingly be promoted and used for disseminating the practical and useful skills for the related law enforcement people who fight against financial crime, while the other is to contribute to the basis of discussions and further academy research. Design/methodology/approach: This study summarizes and indicates potential usefulness of the new academy, specializing in the related social and political contexts in qualitative and descriptive ways. Findings: This study indicates that the new academy activities in Japan would continue for a long time, thus providing immediately useful skillsets for the investigators and officers at the very frontline who face against various financial crimes. Originality/value: While little research has been done about the series of related academy activities by OECD, this study describes the historical background and usefulness of the academy of the OECD in a specialized manner, thus showing its linkage with FATF.

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