Chapter 6 International Banking and Money Market 4017

8/6/2019 Chapter 6 International Banking and Money Market 4017

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International Banking and

Money Market

Chapter Objective: Differentiate between international bank and domestic

bank operations and examine the differences of variousinternational banking offices.

Chapter Outline

International Banking Services Types of International Banking Offices

Capital Adequacy Standards

International Money Market

6Chapter six


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International Banking Services

International Banks do everything domestic banks

do and: Arrange trade financing.

Arrange foreign exchange.

Offer hedging services for foreign currency receivables

and payables through forward and option contracts. Offer investment banking services (where allowed).


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W

orlds 10 Largest Banks

Citigroup U.S.

Mizuho Bank/ Mizuho Corp Bank JapanHSBC Holdings U.K.

Bank of America U.S.

JP Morgan Chase U.S.

Deutsche Bank Germany

Royal Bank of Scotland Group U.K.

Sumitomo Mitsui Banking Group Japan

HypoVereinsbank Germany


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Types of International

Banking Offices

1. Correspondent bank

Banks located in different countries establish accountsin other bank

Provides a means for a banks MNC clients to conductbusiness worldwide through his local bank or itscontacts.

Provides income for large banks Smaller foreign banks that want to do business ,say in the

U.S., will enter into a correspondent relationship with alarge U.S. bank for a fee


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Banking Offices

2. Representative office

A small service facility staffed by parent bank personnel

that is designed to assist MNC clients of the parent bank indealings with the banks correspondents.

No traditional credit services provided

Reps looks for foreign market opportunities and serves as a liaisonbetween parent and clients

Useful in newly emerging markets Representative offices also assist with information about

local business customs, and credit evaluation of the MNCslocal customers.


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Banking Offices

3. Foreign Branch

Aforeign branch bankoperates like a local bank, but is

legally part of the parent. Subject to both the banking regulations of home country

and foreign country.

Reasons for establishing a foreign branch More extensive range of services

Foreign branches are not subject to Canadian reserve requirementsor deposit insurance

Compete with host country banks at the local level

Most popular means of internationalizing bank operations


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Banking Offices

4. Subsidiary and Affiliate Bank

A subsidiary bankis a locally incorporated bank that iseither wholly owned or owned in major part by a foreign

parents.

An affiliate bankis one that is only partially owned, but not

controlled by its foreign parent.

Both subsidiary and affiliate banks operate under the

banking laws of the country in which they are incorporated.

They are allowed to underwrite securities.


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Banking Offices5. Offshore Banking Center A country whose banking system is organized to permit external

accounts beyond the normal scope of local economic activity.

The host country usually grants complete freedom from host-country governmental banking regulations. Banks operate as branches or subsidiaries of the parent bank

Primary credit services provided in currency other than host countrycurrency

Reasons for offshore banks Low or no taxes, services provided for nonresident clients, few or no FX

controls, legal regime that upholds bank secrecy

The IMF recognizes the Bahamas, Bahrain, the Cayman Islands,Hong Kong, the Netherlands Antilles, Panama, Singapore as

major offshore banking centers


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Capital Adequacy Standards

Bank capital adequacy = equity capital and othersecurities a bank holds as reserves.

How much bank capital is enough to ensure thesafety and soundness of the banking system?

Basle Accord 1 (1988): Rules-basedapproach + VAR

Basle Accord2

(2

003

- ?) -3

pillars-min. cap. Requirements-supervisory review process-market discipline


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Basle Accord I: minimum bankcapital

adequacy ratio (rules-based)

Banks involved in cross-border transactions.

Min. Cap. Adequacy = 8% [risk weighted assets]Tier I Core capital = shareholder equity + retained earnings

Tier II Supplemental capital = internationally recognized

non-equity items

Tier II < 50% total bank capital

AssetWeights:Government obligations = 0%; short-term interbank assets =20%

Residential mortgages =50%; other assets = 100%


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Basle Accord I:

Risk-focused Cap. adequacy

1996 amendment allows banks to use modern portfolio models to

specify adequate Cap. Adequacy.

VAR(value-at-risk) = loss exceeded with a specified probabilityover a specified time period.

1% chance: maximum loss over 10 days > banks capital

VAR = (PV)(W)(Z.01)(D1/2)

PV = portfolio value;

W = standard deviation of return(daily);

Z.01 = standard normal value for 1-tail confidence interval;

D = days


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International Money Market

Eurocurrency is a time deposit in an international

bank located in a country different than the country

that issued the currency.

Eurodollars are U.S. dollar-denominated time deposits in

banks located outside the United States.

Euroyen are yen-denominated time deposits in banks

located outside of Japan.

The foreign bank doesnt have to be located in Europe.


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Eurocurrency Market

This is an external banking system that runs parallel to the

domestic banking system.Banks seek deposits and make loans to other Eurobanks.

- loan interest rate is the interbank offered rate.

- interbank deposit interest rate is the interbank bid rate.

Lower cost structure:

Reserve requirement - NODeposit insurance - NO

Rapid growth, especially in the Eurodollar market.


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Eurocurrency Market

Most Eurocurrency transactions are interbank

transactions in the amount of$1,000,000 and up.

Common reference rates include

LIBOR= London Interbank Offered Rate

PIBOR= Paris Interbank Offered Rate

SIBOR= Singapore Interbank Offered Rate

New reference rate for the euro

EURIBOR= rate at which interbank time deposits of

are offered by one prime bank to another.


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Forward Rate Agreements

An interbank contract that involves two parties, a buyer and aseller.

The buyer agrees to pay the seller the increased interest cost on anotional amount if interest rates fall below an agreed rate.

The seller agrees to pay the buyer the increased interest cost ifinterest rates increase above the agreed rate.

Forward Rate Agreements can be used to:

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

Speculate on the future course of interest rates.

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360/*)(*

daysSR

daysARSRountNotionalamFRApayment

!


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Euronotes

Short-term notes underwritten by a group of

international investment banks or international

commercial banks (facility). 3-6 months

They are sold at a discount from face value and pay

back the full face value at maturity.

Interest rate usually less than syndicated Eurobankloans. LIBOR + 1/8%, for example.

Bank receives a small fee for underwriting.


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Eurocommercial Paper

Unsecured short-term promissory notes issued by

corporations and banks. 1-6 months.

Placed directly with the public through a dealer.

Eurocommercial paper, while typically U.S. dollar

denominated, is often of lower quality than U.S.

commercial paperas a result yields are higher. Eurocommercial paper2001 = $243.1billion


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International Debt Crisis

Some of the largest banks in the world wereendangered when loans to sovereign governments

of some less-developed countries. At the height of the crisis, third world countries

owed $1.2 trillion.

Like a great many calamities, it is easy to see in

retrospect that: Its a bad idea to put too many eggs in one basket,especially if: You dont know much about that basket.


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Debt-for-Equity Swaps

As part of debt rescheduling agreements among the banklending syndicates and the debtor nations, creditor banks

would sell their loans for U.S. dollars at discounts from facevalue to MNCs desiring to make equity investment insubsidiaries or local firms in the LDCs.

A LDC central bank would buy the bank debt from a MNCat a smaller discount than the MNC paid, but in local

currency. The MNC would use the local currency to make pre-

approved new investment in the LDC that was economicallyor socially beneficial to the LDC.


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Debt-for-Equity Swap

IllustrationInternational

Bank

Equity

Investor or

MNC

LDC Central

Bank

LDC firm or

MNC

subsidiary

$60m Sell $100mLDC debt at

60% of face

Redeem LDC

debt at 80% of

face in local

currency

$80m in local

currency

$80m in

local

currency


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Japanese Banking Crisis The history of the Japanese banking crisis is a result of a complex

combination of events and the structure of the Japanese financial system.

Japanese commercial banks have historically served as the financing arm

and center of a collaborative group know as keiretsu. Keiretsu members have cross-holdings of an anothers equity and ties of

trade and credit.

The collapse of the Japanese stock market set in motion a downwardspiral for the entire Japanese economy and in particular Japanese banks.

This put in jeopardy massive amounts of bank loans to corporations.

It is unlikely that the Japanese banking crisis will be rectified anytimesoon. The Japanese financial system does not have a legal infrastructure that

allows for restructuring of bad bank loans.

Japanese bank managers have little incentive to change because of theKeiretsu structure.


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The Asian Crisis This crisis followed a period of economic expansion in the region

financed by record private capital inflows.

Bankers from the G-10 countries actively sought to finance thegrowth opportunities in Asia by providing businesses with a fullrange of products and services.

This led to domestic price bubbles in East Asia, particularly inreal estate.

Additionally, the close interrelationships common amongcommercial firms and financial institutions in Asia resulted in

poor investment decision making.

The Asian crisis is only the latest example of banks making amultitude of poor loansspurred on no doubt by competitionfrom other banks to make loans in the hot region.

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Chapter 6 International Banking and Money Market 4017