Overview of

International
Banking
FIN 12 MODULE 3
International lending

 • all claims of domestic banks offices on

foreign residents
 • claims of foreign bank offices on local
residents
 • claims of domestic bank offices on domestic
residents in foreign currency
 Deposits similarly classified (by residence of
bank or depositor, or currency)
Eurocurrency deposits
 placed with banks outside the country whose
currency the deposits are denominated in (not
necessarily in euros!)
Features of international
banking
 Key aspects: currency risk and complexity of credit
risk besides typical banking risks
 Competition for market share among banks
(typically spreads very narrow)
 Cyclical nature, with periodic crises
 Competition for bank loans from the international
bond market (close substitutes for loans)
 Importance of international interbank market (IIBM)
as source of liquidity and funding for banks, and risks
arising
 Role of risk management activities (swaps, options,
futures)
Historical evolution:

 Origin in Renaissance (lending to kings)

 Active international lending and bond market in the
19th century (also trade financing)
 Decline in 20s and 30s as governments restricted
international trade and financing
 Growth of trade and multinationals (MNEs) postwar
 Development of euromarkets in the 1960s (owing to
regulatory differences)
 Abolition of capital controls after breakdown of
Bretton Woods
 Waves of lending to EMEs (such as LatinAmerica in
1970s, Asia in 1990s
Reasons for international
banking
 Migration of domestic customers, notably MNEs growing
foreign activities
 Effects of regulatory differences (structural and prudential)
 Input cost differences (e.g. in cost of domestic funding) -
Japanese in the past
 Comparative advantages in retail banking (Citibank)
 Development of major financial centers offering benefits to
banks:
 Business contacts
 Location of customers
 Pool of skilled labour
 Trades and professions
 Liquidity and efficiency of markets (thick market externalities)
 Interrelation of markets (e.g.derivatives and underlying) Potential for
increasing returns to scale and self sustaining growth of centers
Main financing activities:

Syndicated lending
– credit facility offered simultaneously by
a number of banks from more than one country
.
 Eurobond issuance and trading
 bearer bonds issued in markets other than the
country of issue.
 Euronotes, international
equity,international interbank
market
 Indicators of risk in
international banking
 International trade is the exchange of
goods and services between countries. This type
of trade gives rise to a world economy, in which
prices, or supply and demand, affect and are
affected by global events. Trading globally gives
consumers and countries the opportunity to be
exposed to goods and services not available in
their own countries. As it opens up the
opportunity for specialization and therefore more
efficient use of resources, international trade has
the potential to maximize a country's capacity to
produce and acquire goods.
 Cash in advance is a term used
to describe business transactions
in which cash is tendered to settle
the cost of an order at the time that
order is placed .
 A letter of credit is a financial device
developed by merchants as a convenient
and relatively safe mode of dealing with
sales of goods to satisfy the seemingly
irreconcilable interests of the seller, who
refuses to part with his goods before he
is paid, and a buyer, who wants to have
a control of the goods before paying.
Types of Letter of Credit
a. documentary
b. non-documentary
c. revocable
d. irrevocable
e. confirmed
f. unconfirmed
f. transferable
 Draft is the term when you
ship the goods before the
payment is made and then draw
a draft on the buyer, not on the
bank.
Types of Drafts

a. sight
b. time
c. clean
d. documentary
 Consignment is placing any
material in the hand of another,
but retaining ownership until the
goods are sold or person is
transferred. This may be done
for shipping, transfer of goods to
auction, or for sale.
E. Open Account

Open account involves

delivery of your goods or
services to the buyer with an
invoice requesting payment at a
certain time after delivery.
 Bill of Lading is a document
issued by a carrier which details
a shipment of merchandise and
gives title of that shipment to a
specified party.
Type of Bills
a. Straight
b. Order
c. On-board
d. Received-for-shipment
e. Clean
f. Foul
 The commercial invoice is
the bill of sale and an
exporter’s request for payment
from a buyer.
Purposes of
Commercial Invoice
1. Lists full details of goods shipped
2. Names of importer/exporter given
3. Identifies payment terms
4. List charges for transport and
insurance.
 It allows exporters to increase
sales by offering liberal open
account terms to new and existing
customers. Insurance also provides
security for banks providing
working capital and financing
exports.
Two Categories
a. Marine - transport by sea
b. Air - transport by air
• Airway Bill is a non-
negotiable transport document
covering transport of goods from
airport to airport.
 A document certifying a
shipment of goods and shows
information such as the
consignor, consignee and value
of the shipment.
 Banker's acceptances make a
transaction between two parties
who do not know each other
safer, because they allow the
parties to substitute the bank's
credit worthiness for that who
owes the payment.
a. Converts exporters’ drafts to cash
minus interest to maturity and
commissions.
b. Low cost financing with few fees
c. May be with ( exporter still liable)
or without resource ( bank takes
liability for nonpayment)
 Factoring in international trade
is the discounting of a short- term
receivable (up to 180 days). The
exporter transfers title to its short-
term foreign accounts receivable to
a factoring house for cash at a
discount from the face value.
 Forfaiting is a method of trade
finance that allows exporters to
obtain cash by selling their
medium and long-term foreign
accounts receivable at a discount
on a “without recourse” basis.
BANK MONEY
MANAGEMENT
• A bank is a financial intermediary that accepts deposits and
channels those deposits into lending activities, either directly by
loaning or indirectly through capital markets. A bank links customers
that have capital deficits and customers with capital surpluses. Due
to their importance in the financial system and influence on national
economies, banks are highly regulated in most countries. Most
nations have institutionalized a system known as fractional reserve
banking, under which banks hold liquid assets equal to only a portion
of their current liabilities. In addition to other regulations intended to
ensure liquidity, banks are generally subject to minimum capital
requirements based on an international set of capital standards,
known as the Basel Accords. Banks act as payment agents by
conducting checking or current accounts for customers, paying
cheques drawn by customers on the bank, and collecting cheques
deposited to customers' current accounts. Banks also enable
customer payments via other payment methods such as Automated
Clearing House (ACH), Wire transfers or telegraphic transfer,
EFTPOS, and automated teller machine (ATM).
• Banks borrow money by accepting funds deposited on
current accounts, by accepting term deposits, and by issuing
debt securities such as banknotes and bonds. Banks lend
money by making advances to customers on current
accounts, by making installment loans, and by investing in
marketable debt securities and other forms of money
lending. Banks provide different payment services, and a
bank account is considered indispensable by most
businesses and individuals. Non-banks that provide payment
services such as remittance companies are normally not
considered as an adequate substitute for a bank account.
Banks can create new money when they make a loan. New
loans throughout the banking system generate new deposits
elsewhere in the system. The money supply is usually
increased by the act of lending, and reduced when loans are
repaid faster than new ones are generated.
Retail banking
•Checking account
•Savings account
•Money market account
•Certificate of deposit
(CD)
•Individual retirement
account (IRA)
•Credit card
•Debit card
•Mortgage
•Mutual fund
•Personal loan
•Time deposits
•ATM card
•Current Accounts
•Cheque books
Business (or
commercial/investment) banking
 Business loan
 Capital
raising (Equity / Debt / Hybrids)
 Mezzanine finance
 Project finance
 Revolving credit
 Risk management (FX, interest
rates, commodities, derivatives)
 Term loan
 Cash Management Services (Lock
box, Remote Deposit Capture,
Merchant Processing)
 Credit services
The economic functions of banks include:
1. Issue of money, in the form of banknotes and current accounts subject to check or payment at
the customer's order. These claims on banks can act as money because they are negotiable or repayable on
demand, and hence valued at par. They are effectively transferable by mere delivery, in the case of
banknotes, or by drawing a check that the payee may bank or cash.
2. Netting and settlement of payments – banks act as both collection and paying agents for
customers, participating in interbank clearing and settlement systems to collect, present, be presented with,
and pay payment instruments. This enables banks to economize on reserves held for settlement of
payments, since inward and outward payments offset each other. It also enables the offsetting of payment
flows between geographical areas, reducing the cost of settlement between them.
3. Credit intermediation – banks borrow and lend back-to-back on their own account as middle
men.
4. Credit quality improvement – banks lend money to ordinary commercial and personal
borrowers (ordinary credit quality), but are high quality borrowers. The improvement comes from
diversification of the bank's assets and capital which provides a buffer to absorb losses without defaulting on
its obligations. However, banknotes and deposits are generally unsecured; if the bank gets into difficulty and
pledges assets as security, to raise the funding it needs to continue to operate, this puts the note holders and
depositors in an economically subordinated position.
5. Asset liability mismatch/Maturity transformation – banks borrow more on demand debt and
short term debt, but provide more long term loans. In other words, they borrow short and lend long. With a
stronger credit quality than most other borrowers, banks can do this by aggregating issues (e.g. accepting
deposits and issuing banknotes) and redemptions (e.g. withdrawals and redemption of banknotes),
maintaining reserves of cash, investing in marketable securities that can be readily converted to cash if
needed, and raising replacement funding as needed from various sources (e.g. wholesale cash markets and
securities markets).
6. Money creation – whenever a bank gives out a loan in a fractional-reserve banking system, a
new sum of virtual money is created.
Money Management
The process of budgeting, saving, investing, spending or otherwise in
overseeing the cash usage of an individual or group. The predominant
use of the phrase in financial markets is that of an investment
professional making investment decisions for large pools of funds, such
as mutual funds or pension plans. It is also referred to as "investment
management" and/or "portfolio management”. Money management is a
strategic technique employed at making money yield the highest of
interest-yielding value for any amount of it spent. Spending money to
satisfy all cravings (regardless of whether or not they are justifiable to be
included in budget basket) is a natural human phenomenon. The idea of
money management techniques is developed to plummet the amount
which individuals, firms and institutions spend on items that add no
significant value to their living standards, long-term portfolios and asset-
basins. Warren Buffett, in one of his documentaries, admonished
prospective investors to embrace his highly esteemed "frugality"
ideology. This is the making of every financial transaction to be worth
the expense:
Bank Money Management includes
the following:

A.Asset Management
B.Liability Management
C.Liquidity Management
D.Capital Adequacy Management
E. Funds Management
F. Risk Management
 Asset Management
• The management of a client's investments by a financial
services company, usually an investment bank. The company
will invest on behalf of its clients and give them access to a
wide range of traditional and alternative product offerings
that would not be to the average investor.
• An account at a financial institution that includes checking
services, credit cards, debit cards, margin loans, the
automatic sweep of cash balances into a money market fund,
as well as brokerage services.

Also known as an "asset management account" or a "central

asset account".
 Liability Management
• Management of bank liabilities, including deposits, to support
lending activities and achieve balanced growth in earnings and
bank assets without excessive liquidity risk. Liability management
involves accepting money from depositors, and securing additional
funds from other financial institutions, for use in lending and
investing. Other tools of liability management are interest rate
hedging against unexpected market moves, and maintaining a
controlled gap between asset and liability maturities for controlled
speculation on interest rate shifts. In banking, active management
of the liability side of the balance sheet began in the early 1960s
when commercial banks began issuing negotiable certificates of
deposit, which could be sold to other holders prior to maturity, to
solicit funds from other institutions in the money market.
 Liquidity Management
• Managing liquidity is a fundamental component in the safe
and sound management of all financial institutions. Sound
liquidity management involves prudently managing assets
and liabilities (on- and off- balance sheet), both as to cash
flow and concentration, to ensure that cash inflows have an
appropriate relationship to approaching cash outflows. This
needs to be supported by a process planning which assesses
potential future liquidity needs, taking into account changes in
economic, regulatory or other operating conditions. Such
planning involves identifying known, expected and potential
cash outflows and weighing alternative asset/liability
management strategies to ensure that adequate cash inflows
will be available to the institution to meet these needs.
 Capital Adequacy Management

• Percentage ratio of a financial institution's primary

capital to its assets (loans and investments), used as
a measure of its financial strength and stability.
According to the Capital Adequacy Standard set by
Bank for International Settlements (BIS), banks must
have a primary capital base equal at least to eight
percent of their assets: a bank that lends 12 dollars
for every dollar of its capital is within the prescribed
limits.
 Risk Management
• It is the process of identification, analysis and either
acceptance or mitigation of uncertainty in investment
decision-making. Essentially, risk management occurs
anytime an investor or fund manager analyzes and
attempts to quantify the potential for losses in an
investment and then takes the appropriate action (or
inaction) given their investment objectives and risk
tolerance. Inadequate risk management can result in
severe consequences for companies as well as
individuals. For example, the recession that began in
2008 was largely caused by the loose credit risk
management of financial firms.
 Investing
Big Banks Rediscover Money Management
By Sree Vidya Bhaktavatsalam
• Money management may be dull, but it’s a coveted kind of dull. UBS (UBS) is cutting back on
investment banking as it focuses on overseeing wealthy clients’ assets. Goldman Sachs (GS),
JPMorgan Chase (JPM), and Wells Fargo (WFC), three of the five biggest U.S. banks, say they’re
considering expanding their asset-management divisions. They’re looking to grab market share from
fund companies such as Fidelity Investments. “Asset management is a terrific business,” says Ralph
Schlosstein, chief executive officer of Evercore Partners (EVR), a New York-based boutique
investment bank that last month agreed to buy wealth manager Mt. Eden Investment Advisors. “Asset
managers earn fees consistently without risking capital. Compare that to other businesses in the
financial services.”Investment banking and trading revenue at the 10 largest global investment banks
fell at least 17 percent in each of the past two years, according to data from analytics firm Coalition.
The total money overseen globally by banks has consistently hovered at about $58 trillion for the last
five years, meaning managing investor money accounted for a greater percentage of fees. The
median share of net revenue from asset and wealth management for a sample group of banks
tracked by consulting firm Johnson Associates increased to 28 percent in 2012 from 23 percent five
years ago. The share contributed by trading declined to 43 percent from 49 percent over the period,
and investment banking fell to 14 percent from 15 percent.
• Even if banks attract new wealth-management clients, they may not mitigate the impact of upcoming
Basel III capital requirements, which will cut into the profits firms make from leveraged trading. It’s
also unlikely to replace revenue lost once the Volcker Rule, which limits proprietary trading, is in
place. Money management does have advantages: Funds produce steady fees, with most of the risk
assumed by investors. “It’s not hard to see the appeal,” says Neel Kashkari, formerly a Goldman
Sachs investment banker and U.S. Treasury assistant secretary who now heads global equities at
Pimco. “But some banks have struggled in the business because of a short-term view,” he adds,
referring to banks’ tendencies to prioritize quarterly returns over long-term interests.
• To attract investors, banks will need to improve their middle-of-the-pack performance as fund
managers and overcome the perception that they push their own funds at clients’ expense.
“Culturally, asset managers have not been a good fit within banks,” says Jay Horgen, chief
financial officer of Affiliated Managers Group (AMG), a Beverly (Mass.)-based firm that holds
stakes in more than two dozen money managers. “It’s a business model that requires an
investment structure which recognizes value creation and operates across generations of existing
and future partners, and banks just don’t have that in their tool kit.”As investors have turned away
from stock funds in recent years, they’ve deposited about $1 trillion into fixed-income investments
since 2007, according to data from the Investment Company Institute. Most money is going to
passively managed funds, largely those that track indexes, and top performers. Shrinking the pool
of funds available to actively manage poses a challenge for banks seeking to expand.

• Still, it’s a tempting business. The Standard & Poor’s (MHP) index of asset managers and custody
banks has a return on equity of 13.1 percent. That compares with an average return on equity of
8.3 percent for firms in Keefe, Bruyette & Woods’s (KBW) benchmark bank index, half of what it
was in 2006 before the onset of the credit crisis, according to data compiled by Bloomberg.
JPMorgan Chase, which last year became the first bank to crack the list of the 10 largest U.S.
stock and bond mutual fund managers after more than doubling long-term assets since 2008, had
planned to spend more money on sales and marketing in 2012. In February, Mary Erdoes, CEO of
JPMorgan’s $1.4 trillion asset-management division, said at the firm’s annual investors’ day
conference that it has “heavily invested in this business in order to set ourselves up for much
future growth in the years to come.”
Depository Financial
Institutions
The Fundamentals of Bank
Management
 Banks are business firms that buy
(borrow) and sell (lend) money to make
a profit
 Money is the raw material for banks—
Repackagers of money
 Financial claims on both sides of
balance sheet
 Liabilities—Sources of funds
 Assets—Uses of funds
Bank Assets
 Total loans increased from 53% of total
assets in 1970 to 62% in 1990—most
increase coming from mortgages
 Decline in cash and investments in state and
local government securities
 Holdings of federal government securities is
fairly constant—highly marketable and liquid
 Counter-cyclical—increase during recessions and
decrease during expansions
 Banks treat federal securities as a residual use of
funds
Commercial Bank Assets
 Loans
 Securities
 Cash Assets
Loans (60.1%)
 Commercial and Industrial Loans
(14.8%)
 Consumer Loans (8.5%)
 Real Estate Loans (28%)
 Interbank Loans (Federal Funds)
(4.6%)
Securities (24.1%)
 U. S. Government Securities
 State and Municipal Bonds
Cash Assets (4.5%)
 Vault cash.
 Reserve deposits at the Federal Reserve
banks.
 Correspondent balances.
 Cash items in the process of collection.
Bank Assets
 Banks are barred by law from
owning stocks—too risky
 However, banks do buy stocks
for trusts they manage—not
shown among bank’s own
assets
Bank Liabilities
 Percentage of funds from transactions
deposits has reduced from 43% in
1970 to 10% in 2002
 Used to be major source of funds
 Generally low interest (if any) paid on
demand deposits and increase in interest
paid on other types of assets has caused
this decline
Commercial Bank Liabilities
and Equity Capital
 Transactions deposits. (9.5%)
 Savings deposits and small-
denomination time deposits. (41.3%)
 Deferred availability cash items.
 Large-denomination time deposits.
(15.6%)
 Purchased funds.
 Other borrowings.
Bank Liabilities
 Non-transaction deposits represented
47% of banks’ funds in 2002
 Passbook savings deposits—traditional form of
savings
 Time deposits—certificates of deposit with
scheduled maturity date with penalty for early
withdrawal
 Money market deposit accounts—pay money
market rates and offer limited checking functions
 Negotiable CDs—can be sold prior to maturity
Bank Liabilities
 Miscellaneous Liabilities have experienced a
significant increase during past 25 years
 Borrowing from Federal Reserve—discount borrowing
 Borrowing in the federal funds market—unsecured loans
between banks, often on an overnight basis
 Borrowing by banks from their foreign branches, parent
corporation, and their subsidiaries and affiliates
 Repurchase Agreements—sell government securities with
agreement to re-purchase at later date
 Securitization—Pooling loans into securities and
selling to raise new funds
Bank Capital (Equity)
 Individuals purchase stock in bank
 Bank pays dividends to stockholders
 Serves as a buffer against risk
 Equity capital has remained stable at 7%-8%,
but riskiness of bank assets has increased
 Bank regulators force banks to increase their
capital position to compensate for the
increased risk of assets (loans)
 Equity is most expensive source of funds so
bankers prefer to minimize the use of equity
Bank Profitability
 Bank management must balance
between liquidity and profitability
 Net Interest Income
 Difference between total interest
income (interest on loans and interest on
securities and investments) and interest
expense (amount paid to lenders)
 Closely analogous to a manufacturing
company’s gross profit
Bank Profitability
 Net interest margin—net interest income
as a percentage of total bank assets
 Factors that determine bank’s interest margin
 Better service means higher rates on loans and
lower interest on deposits
 Might have some monopoly power, but this is
becoming more unlikely due to enormous
competition from other banks and nonbank
competitors
 Also affected by a bank’s risk—interest rate and
credit
Bank Profitability
 Service charges and fees and other
operating income
 Additional source of revenue
 Become more important as banks have shifted
from traditional interest income to more
nontraditional sources on income
 Salaries and wages
 Banks are very labor-intensive
 Pressure to reduce personnel and improve
productivity
Bank Profitability
 Security gains/losses
 Results from the fact that securities held for investment are
shown at historical cost
 This may result in a gain or loss when the security is sold
 Net Income after Taxes
 Net Income less taxes
 Return on Assets (ROA)—Net Income after taxes
expressed as a percentage of total assets
 Return on Equity (ROE)—Net Income after taxes divided
by equity capital
Bank Risk
 Leverage Risk
 Leverage—Combine debt with equity to purchase assets
 Leveraging with debt increases risk because debt requires
fixed payments in the future
 The more leveraged a bank is, the less its ability to absorb a
loss in asset value
 Leverage Ratio—Ratio of bank’s equity capital to total
assets [9% in 2002]
 Regulators in US and other countries impose risk-based
requirements—riskier the asset, higher the capital
requirement
Bank Risk
 Credit Risk
 Possibility that borrower may default
 Important for bank to get as much information as
possible about borrower—asymmetric information
 Charge higher interest or require higher collateral
for riskier borrower
 Loan charge-offs is a way to measure past risk
associated with a bank’s loans
 Ratio of non-performing loans (delinquent 30
days or more) to total loans is a forward-
looking measure
Bank Risk
 Interest Rate Risk
 Mismatch in maturity of a bank’s assets and liabilities
 Traditionally banks have borrowed short and lent long
 Profitable if short-term rates are lower than long-term rates
 Due to discounting, increasing interest rates will reduce the
present value of bank’s assets
 Use of floating interest rate to reduce risk
 The one-year re-pricing GAP is the simplest and most
commonly used measure of interest rate risk
Bank Risk
 Trading Risk
 Banks act as dealers in financial instruments such
as bonds, foreign currency, and derivatives
 At risk of a drop in price of the financial
instrument if they need to sell before maturity
 Difficult to develop a good measure of trading risk
since is it hard to estimate the statistical likelihood
of adverse price changes
Bank Risk
 Liquidity Risk
 Possibility that transactions deposits and savings account
can be withdrawn at any time
 Banks may need additional cash if withdrawals significantly
exceed new deposits
 Traditionally banks provided liquidity through the holding
of liquid assets (cash and government securities)
 Historically these holdings were a measure of a bank’s
liquidity, but have declined as a percentage of total assets
during the past 30 years (41%-1970; 24%-2002)
 During past 30 years banks have used miscellaneous
liabilities to increase their liquidity
Major Trends in Bank
Management
 For most of the 20th century banks were
insulated from competition from other
financial institutions
 US banking is in a period of transition due to
recent changes in the regulations
 The Consolidation Within the Banking
Industry
 McFadden Act of 1927
McFadden Act of 1927
 Passed to prevent the formation of a few large, nationwide
banking conglomerates
 Prohibited banks branching across state lines
 Many states also had restrictions that limited or prohibited
branching within their state boundaries
 Result—many, many small banks protected from competition
from larger national banks
 Over the years a number of loopholes were exploited to reduce
effectiveness of law, primarily bank holding company—
Parent corporation that can hold one or more subsidiary banks
 Riegle-Neal Interstate Banking and Branching Efficiency
Act [1994]—Overturned the McFadden Act
Economics of Consolidation
 Is consolidation of banking industry
good or bad?
 How large should a bank be
 Large enough to offer wide menu of products
 Focus on a niche at which they are successful
 Despite dramatic decrease in number of
banks and banking organizations, number of
banking offices (including savings institutions)
has remained remarkable stable
Economics of Consolidation
 Economies of Scale—Banks become more efficient
as they get larger
 Economies of Scope—Offering a multitude of
products is more efficient [traditional and non-
traditional products]
 Little empirical evidence to support either types of
economies
 Possibly merger or expansion provided
opportunity to become more efficient—
something they should have done prior to the
merger
Nontraditional Banking
 Traditionally commercial bank accepted
demand deposits and made business loans
 Under the regulation of the Federal Reserve,
bank holding companies provide banks with
more regulatory freedom
 However, activity is limited to activities
closely related to banking
The Glass-Steagall Act (1933)
 Separated commercial banks from investment
banking—banks forced to choose
 Before 1999, commercial banks could not
underwrite corporate debt and equity
 Commercial banks challenged restrictions--
investment banks were starting to act like
commercial banks
 Circumventing Glass-Steagall—a number of
rulings by Federal Reserve eroded the distinction
between commercial and investment banks
 The Gramm-Leach-Bliley Act (1999) repealed the
Glass-Steagall Act
Globalization
 American Banks Abroad
 Rapid expansion of US banks into foreign
countries
 Growth of foreign trade
 American multinationals with operations abroad
 Edge Act (1919)
 Permitted US banks to establish special
subsidiaries to facilitate involvement in
international financing
 Exempt from the McFadden Act’s prohibition
against interstate banking
Globalization
 Foreign Banks in the United States
 Many large and well-known banks in the US are
foreign-owned
 Organizational forms of foreign banks
 Branch—integral part of foreign bank and carries bank’s
name, full service
 Subsidiary—legally separate with its own charter, full
service
 Agencies—make loans but cannot accept deposits
 Representative Offices—make contact with potential
customers of parent corporation
Foreign Banks in the United States

 Prior to 1978 foreign banks operating in

the US were largely unregulated
 International Banking Act of 1978
 Foreign banks subject to same federal
regulations as domestic banks
 Established banks were grandfathered and
not subject to the law
Eurodollars
 Foreign banks were exempt from Regulation Q and
could offer higher interest than US banks
 Eurodollar deposits made in foreign banks were
denominated in US dollars, which eliminated the
foreign exchange risk for Americans
 American banks opened foreign branches:
 Gain access to Eurodollars
 Borrow abroad during periods of tight money by the FED
 “Shell” branches are created in tax haven countries
(Bahamas and Caymans) who have almost zero
taxation and no regulation
Eurobonds
 Corporate and foreign government
bonds sold:
 Outside borrowing corporation’s home
country
 Outside country in whose money principal
and interest are denominated
 Number of tax advantages and
relatively little government regulation
Domestically Based International
Banking Facilities (IBF)
 Offers both US and foreign banks comparable
conditions as foreign countries to lure
offshore banking back to US
 IBF is a domestic branch that is regulated by
Fed as if it were located overseas.
 No reserve or deposit insurance
requirements
 Essentially bookkeeping operations with no
separate office
IBFs Cont.
 Many states exempt income from IBFs from
state and local taxes
 IBFs are not available to domestic
residents, only business that is
international in nature with respect to
sources and uses of funds
 Foreign subsidiaries of US multinationals can
use IBFs provided funds to not come from
domestic sources and not used for domestic
purposes
Nonbank Depository
Institutions—The Thrifts
 Comprised of savings and loan associations,
mutual savings banks, and credit unions
 Principal source of funds for all three thrifts is
consumer deposits
 Savings and Loans (S&L’s)
 Invest principally in residential mortgages
 This industry basically collapsed during the 1980s
 Most S&L’s have converted their charters to
commercial banks
The Thrifts
 Mutual Savings Banks
 Located mostly in the East
 Operate like S&L’s, with more power to make
consumer loans
 This industry suffered same decline as S&L’s
 Credit Unions
 Basically unaffected by the problems in the 1980s
since they did not have mortgages on their
balance sheets
 Organized around a common group and are
generally quite small
Bank Lending,
Euroloans
and
Country Risks
• Foreign loans
are raised by borrowers who are foreign to the country
where the loans are raised.

• Eurocredits or Euroloans
are financed wholly out of Eurocurrency fund,
irrespective of whether the borrower is a resident or
non-resident of the country in question, foreign loans are
domestic currency credits extended to non-residents
borrowers.
Eurocredits or Euroloans are large bank credits, usually in maturities
of three to ten years, put together by international bank syndicates
on an ad hoc basis. A loan whose denominated currency is not the
lending bank's national currency. A eurocredit loan would be made
by a U.S. bank to a lender requiring a denominated currency which
differs from the bank's local currency (USD) for specific reasons,
most likely some sort of business operations or trade requirements.
Despite the inclusion of the word "euro," a eurocredit is not
immediately derived from the euro.

Eurocredit helps the flow of capital between countries and the

financing of investments at home and abroad. These trades add
liquidity to both currencies as the U.S. bank accounts for the
incoming payments from the loans in U.S. dollar terms, and are often
large and function in a long-term basis. A U.S. bank lending a
corporation 10 million Russian rubles is an example of Eurocredit
Syndicated loans

Syndicated loans (Euro or foreign) are so large in size that it

becomes necessary to form a syndicate or a group of lending
banks to finance a loan.
• The advantage of syndication is that it enables bank to spread
the risks of large loans among themselves.
• This is important because large multinational firms need credit in
excess of what a single bank can offer.

A syndicated loan is arranged by a lead bank on behalf of a

client such as multinational firms. The lead bank seeks the
participation of a group (syndicate) of banks, each providing a
portion of a loan.
The interest paid on syndicated loans usually
computed by adding a spread to the London
interbank offer rate (LIBOR) or another reference
rate such as US prime rate or the Singapore
interbank offer rate (SIBOR). The following factors
determinate the spread:
 Whether the market is a borrower or a lender market (that is, the
availability of liquidity or loanable funds relative to demand. Spreads are
likely to be higher in a lenders’ market which is characterized by a
shortage of liquidity and excess demand for loanable funds.

 The creditworthiness of the borrower, as lower spreads are charged to

high-quality borrowers. High-quality borrowers include sovereign OECD
borrowers (that is, OECD government), multinationals and major OECD
companies, as well as international organizations such as World Bank.

 The maturity of the loan, as higher spreads are charged on long- maturity
loans.

 The fees charged- in addition to interest payments, the borrower is expected

to pay management fees, participation fees, commitment fees, and taxes.
Management fees
are charged by managing banks for their services. These are one-time
charges levied when the loan agreement is signed.

Participation fees
are divided among all banks in relation to their share of the loan.

Commitment fees
are charged to borrower as a percentage of the undrawn portion of the loan.
There is normally trade-off between fees and spread over the reference rate.

 Banks prefer a combination of high fees and low spreads because they can
advertise low spreads (which is good for business) without losing revenue.
Country risk
is taken to refer to the possibility that sovereign borrowers
of a particular country may be unable or unwilling and
other borrowers unable, to fulfil their foreign obligations for
reasons beyond the usual risks which arise in relation to all
lending.
Country risk is typically measured by giving each country a score
calculated as a weighted average of values of some indicators.
The Political
country risk
risk rating
is ofof special
Euromoney magazine,offorforeign
importance example, is
direct
based on threebecause
investment set of indicators.
it includes the possibility of confiscation,
whereby the host government assumes ownership of asset
belonging
• The first isto analytical
multinational firm without
indicators the proper
that include: (i)
compensation. If compensation is granted, then what we have is
economic indicators, which measure the country’s
the risk of expropriation. Political risk also involves the
ability to service
possibility of losses its debtsto(including
resulting changes inthe the size
rulesof debt,
governing
the balance
currency of payments
convertibility position
and remittance and the
restrictions that debt
affect
service
the cashratio); (ii) economic
flows received by therisk; (iii) firm.
parent political
Finallyrisk.
it includes
the possibility of losses resulting from such events like riots, civil
arrest and military coups.
• The second set is credit indicators, which measure the
country’s ability to reschedule payments and its past
performance in servicing its debts.

• The third set is market indicators, which measure the

risk premium that financial markets place on the bonds
and securities issued by parties belonging to
underlying country.