CH 11: International Banking and Money Market

International Banking Services

Do everything domestic banks do, and:

• Trade financing

• Foreign exchange

• Offer hedging services for foreign currency receivables and payables through forward and option contracts

• Offer investment banking services

Reasons for International Banking:

Low Marginal cost

• Managerial and marketing knowledge is developed at the home country and can be used abroad.

Knowledge advantage

• Foreign bank subsidiaries can draw on the parent banks knowledge of personal contacts and credit investigations for use in the foreign market

Home nation information services

• Local firms in a foreign market may be able to obtain more complete information on trade and financial marks in the MN bank’s home nation.

Prestige

• Very large MN banks have high prestige, which can be attractive to new clients

Regulatory advantage

• MN banks are often not subject to the same regulations as domestic banks.

Wholesale defensive strategy

• Banks follow their multinational customers abroad to avoid losing their business at home and abroad

Retail defensive strategy

• MN banks also compete for retail services such as travelers checks and the tourist and foreign business market

Transactional costs

• Mn banks may be able to circumvent government currency controls.

Growth

• Foreign markets may offer opportunities for growth not found domestically

Risk reduction

• Greater stability of earnings with diversification

Types of International Banking Offices

Correspondent Bank

Exists when two banks maintain deposits with each other.

Correspondent banking allows a bank’s MNC client to conduct business worldwide through his local bank or its correspondents.

Representative Offices

Small service facility staffed by parent bank personnel that is designed to assist MNC clients of the parent bank in dealings with the banks correspondents.

Also assist with information about local business customs and credit evaluation of the MNC’s local customers.

Foreign Branches

Operates like a local bank, but is legally part of the parent.

• Subject to both the banking regulations of home country and foreign country.

• Can provide a much fuller range of services than a representative office.

Branch banks are the most popular way for U.S banks to expand overseas.

Subsidary and Affiliate Banks

A Subsidary bank is a locally incorporated bank wholly or partly owned by a foreign parent.

An Affiliate bank is one that is partly owned but not controlled by the parent.

U.S parent banks like foreign subsidiaries because they allow U.S banks to underwrite securities.

Edge Act Banks

Federally chartered subsidiaries of U.S banks that are physically located in the U.S and are allowed to engage in a full range of international banking activities.

Offshore Banking Centers

Country whose banking system is organized to permit external accounts beyond the normal scope of local economic activity.

Host country usually grants complete freedom from host-country governmental banking regulations

“Shell” Branches

Need to be nothing more than a post office box.

Actual business is done by the parent bank at the parent bank.

Purpose: Allow U.S banks to compete internationally without the expense of setting up operations “for real”.

International Banking Facilities

Separate set of accounts that are segregated on the parent’s books.

Captured a lot of the Eurodollar business that was previously handled offshore.

Any U.S bank can have one.

Capital Adequacy Standards

Refers to the amount of equity capital and other securities a bank holds as reserves.

3 pillars of capital adequacy:

• Minimum capital requirements

• Supervisory review process

• Effective use of market discipline.

Traditional bank capital standards protect depositors from traditional credit risk, but they may not be sufficient protection from derivative risk.

The Basel II Accords has been endorsed by central bank governors and bank supervisors in the G10 countries.

** The key variables the bank must estimate are the probability of default and the loss given default for each asset on their books.

International Money Market

Eurocurrency is a time deposit in an international bank located in a country different than the country that issued the currency.

Example: Eurodollars are U.S dollar-denominated time deposits in banks located abroad.

Euroyen are yen-denominated time deposits in banks located outside of Japan.

The foreign bank doesn’t have to be located in Europe.

Eurocredits

Short to medium term loans of Eurocurrency.

Loans are denominated in currencies other than the home currency of the Eurobank.

Often the loans are too large for one bank to underwrite; a number of banks form a syndicate to share the risk of the loan.

Feature an adjustable rate

Forward Rate Agreements

An interbank contract that involves 2 parties, a buyer and a seller.

• Buyer agrees to pay the sellers the increased interest cost on a notational amount if interest rates fall below an agreed rate.

• Seller agrees to pay the buyer the increased interest cost if interest rates increase above the agreed rate.

Uses:

Hedge assets that a bank currently owns against interest rate risk.

Speculate on the future course of interest rates.