INTERNATIONAL BANKING

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CHAPTER 15

• INTERNATIONAL BANKING

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American International Banking

• International banking dates back to the rise of
  international trade.
• Great Britain dominated international finance
  until after WW II.
• American banks entered international finance
  after 1914.

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The Edge Act (1919)

• Federal Reserve Act of 1913 permitted foreign
  branches.
• Agreement corporations (for state-chartered
  banks) were legalized in 1916.
• Details of the Edge Act
• Banks able to create federally chartered
  subsidiaries located in the United States
• Participate in international banking
• Could make equity investments
• U.S. banks able to compete with European banks
• Grew in number and activities after WW II

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The Reasons for Growth in U.S. International
Banking

• Increased expansion of U.S. trade and foreign
  markets.
• Growth of multinational corporations.
• U.S. government business regulation (in the past)
  limited U.S. profit opportunities.
• Need to finance petroleum-induced deficits in
  foreign countries.

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Recent Activity in U.S. International Banking

• Growth slowed in the early 1970s.
• U.S. regulations limiting the outflow of funds to
  foreign countries were eliminated.
• Smaller banks could not compete with larger
  international operations.
• International lending increased in 1974.
• OPEC increased oil prices.
• Oil producers and oil importers had
  surplus/deficit funds flow to invest or finance.

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Regulation of Overseas Banking Activity

• Domestic U.S. banking has been regulated to
  promote the following goals
• bank safety and financial soundness and
  stability.
• bank competition -- performance.
• banking business is "special" and kept separate
  (arms length) from other types of business
  activities.
• Foreign banks are not as regulated the same as
  U.S. banks, especially in their international
  banking activity.

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Allowable Banking Activities

• Traditionally more types of businesses permitted
  by U.S. banks operating in foreign countries to
  enhance competitiveness.
• Security underwriting
• Equity investments
• Restraints are kept on
• U.S. foreign bank subsidiaries owning
  nonfinancial businesses.
• control of foreign companies.

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Basle Accord of 1988

• Bank Adequacy Standards
• Mandated at least an 8 capital-to-risk-weighted
  assets ratio for all international banks
• At least 4 must be Tier 1 Capital
• Worked out under the auspices of the Bank for
  International Settlements (BIS)

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Delivery of Overseas Banking Services

• Representative offices -- assist parent bank
  customers.
• Shell branches -- limited wholesale money market
  transaction rather than retail public branches.
• Correspondent banks -- relationship with foreign
  banks to provide international banking services.
• Foreign branches -- legal branch of domestic
  parent banking providing full banking services in
  foreign country.

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Delivery of Overseas Banking Services (concluded)

• Edge Act corporations -- federally chartered
  subsidiaries of U.S. banks engaging in
  international activities not permitted domestic
  banks.
• International banking activities
• International financing activities
• Foreign Subsidiaries and Affiliates
• Subsidiaries -- separately -- (owned entirely or
  in part) by a U.S. bank, bank holding company, or
  Edge Act corporation.
• Affiliates -- small ownership interest in foreign
  bank by U.S. bank.

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Funding International Loans

• International loans can be denominated in almost
  any major currency, but the U.S. dollar is the
  most common.
• The average international loan is larger with
  large, multinational firms and sovereign
  countries as borrowers.
• Most large international loans are funded in the
  Eurocurrency market,
• International banks issue time deposits and make
  short or intermediate-term loans
• Banks often lend to each other in the interbank
  market

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Pricing International Loans

• The interbank rate in London is called the LIBOR
  or London Interbank Offered Rate.
• Nonbank borrowers pay above the LIBOR.
• The interest rate paid to time deposits and the
  rate charged borrowers will be tied to the
  interest rate levels of the country and currency
  used to denominate the deposit and loan.
• Lending rates are fixed for the stated credit
  period (usually a month) but change (float) with
  the LIBOR at the beginning of each (rollover)
  period. (Rollover Pricing)
• EURIBOR

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Current (April 11, 2005) Money Market Rates

• LIBOR
• 2.9300 for one month
• EURO LIBOR
• 2.10375 for one month
• EURIBOR (EURO Interbank Offered Rates)
• 2.105 for one month

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Characteristics of International Loans

• Most loans are intermediate-term
• Floating-rate credits
• Moderate-to-high quality borrowers
• Funded in the Eurocurrency Market
• Syndicated
• Priced above LIBOR or EURIBOR
• Unsecured (no collateral)

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Syndicated Loans

• Several banks usually participate in funding the
  loans, thus spreading the risk to banks and
  providing the large amounts of funds needed by
  the borrower.
• One or more lead bank(s) package the loan
  arrangement.

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Collateral

• Most international credits are unsecured.
• Most business borrowers have high credit ratings.
• Borrowing countries pledge their "full faith and
  credit."

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Risks in International Lending

• Credit risk -- the risk of default.
• Country (sovereign) risk -- related to the
  political stability, laws, and regulations of the
  foreign country.
• Expropriation
• Nationalization
• Change of government
• Rescheduling of sovereign loans
• Currency risk -- risk of currency value changes
  and exchange controls.

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Methods of Reducing Risk in International Lending

• Third-party help
• Guarantees by governments or central banks
• Guarantees by organizations outside the foreign
  country such as the Foreign Credit Insurance
  Association (FCIA) and Overseas Private
  Investment Corporation (OPIC)
• Pooling risk -- participation loans among banks
  to spread risk.
• Diversification of foreign loan portfolio
• Loan Sales -- selling nonperforming loans in the
  secondary market at a discount.

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Growth of Foreign Banks in the U.S. -- High
Growth after Mid-1970s Until 1990.

• Japanese banking growth dominated the world in
  the late 1980's and made significant inroads into
  west coast U.S. markets.
• The waning Japanese equity markets, increased
  international capital adequacy standards and the
  recent merger activity among large U. S. banks
  seem to have slowed the decline in U. S. banks
  relative to foreign competitors.
• However, the largest bank in the world is Mizuho
  Holdings (Toyko) with 1,135.6 billion (as of
  September 17, 2003)

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Number of Foreign Banks in the U.S. (1982-1998)
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Growth of Foreign Bank Assets in the United
States (1982-2001)
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International Banking Act of 1978

• Passed to make U.S. banks competitive with
  foreign banks operating in the United States.
• Allow federal chartering of foreign banking
  facilities.
• Limit ability of foreign banks of accepting
  interstate deposits.
• Fed may impose reserve requirements on foreign
  banks.

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International Banking Act of 1978 (concluded)

• FDIC insurance required on domestic retail
  deposits in U.S. based foreign banks.
• Foreign banks permitted to form Edge Act
  corporations.
• U.S. based foreign banks were made subject to
  nonbanking prohibitions of U.S. banking holding
  companies.

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Conclusion

• Growth of U.S. International Banking
• Edge Act Corporations
• Delivery of Overseas Banking Services
• Characteristics of International Loans
• Risks in International Lending