INTERNATIONAL BANKING
OBJECTIVES
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Demonstrate understanding of International
Banking
INTERNATIONAL BANKING
INTERNATIONAL BANKING
International banking refers to business
undertaken by banks across national borders
and/or activities that involve the use of different
currencies
 International banking is like any other banking
service, but it takes place across different nations
or internationally. To put it another way, it is an
arrangement of financial services by a residential
bank of one country to the residents of another
country. Most multinational companies and
individuals use this banking facility for
transacting. International banking forms a major
part of the international financial market
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WHY DO BANKS GO OVERSEAS?
- The main theories describing the motives for overseas
expansion relate to:
1) Factor price differentials and trade barriers
- Determinants of Foreign Direct Investment (FDI) focuses
on two main motives for overseas expansion – [factor
price differentials and trade barriers]. The former, known
as vertical FDI, suggests that overseas activity occurs so
that firms can take advantage of international factor
price differences (taking advantage of lower costs e.g.,
cheap labour, cheap materials)
- The alternative motivation for the existence of
multinationals relates to trade barriers that make
exporting costly. Where trade costs are high the firm
establishes (physical presence) in countries to access
markets and this is referred to as horizontal FDI
- In the case of banking, evidence would seem to suggest
that horizontal FDI is likely to be a much more important
motive for cross-border activity than vertical FDI
FACTOR PRICE DIFFERENTIALS AND TRADE
BARRIERS
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For instance, the strategic reasons for banks to establish
multinational operations are most likely to be based on
advantages associated with 'internalising’ informational
advantages as opposed to trading at arm’s length. Because it is
difficult to find efficient markets for long-distance transactions in
some areas of banking (such as retail banking, lending to small
firms, specific credits to companies operating in different
regulatory and economic environments)
Regulations governing many areas of business are also countryspecific and act as substantial trade barriers. This means that in
many areas of business (and particularly in banking) it may be
difficult to undertake cross-border activity without a physical
presence within a country. For example, differences in tax
treatments, consumer protection legislation, marketing rules,
definition of products and so on, mean that the cross-border
selling of many financial services products and services is
problematic unless the bank has a physical presence in the
market in which it wishes to sell its products.
ARBITRAGE
2) Arbitrage (taking advantage of a difference in prices in two or
more markets) and the cost of capital (cost of raising funds
either debt/equity)
- One of the main theories explaining the overseas investment
decision of firms relates to the arbitrage activities of firms, in
that companies that raise their finance in strong currency
markets can borrow relatively cheaply and they can invest
their proceeds in markets where currencies are weak and
firms can be acquired relatively cheaply.
- firms that issue securities in strong currencies require a lower
cost of capital (it is cheaper for them to borrow via the issue
of equity or debt instruments). Subsequently, these firms can
acquire overseas assets at higher prices than local firms who
issue securities in local currencies. E.g., if the Euro is strong
compared with the dollar, Euro-based firms can raise funds
for acquisition more cheaply than their US counterparts, and
therefore can acquire stakes or outbid them to make
purchases, say in the US market.
ARBITRAGE
- While cost of capital arguments have been put
forward as the main reason for the acquisition of
weaker currencies by strong currencies, this
theory cannot really explain the following:
 why some firms invest overseas in markets which
have the same currency
 why there is cross-investment between firms
from the same currency
 why firms incur substantial costs in setting up
new operations overseas instead of just making
an acquisition
- Various other theories have been proposed to
explain overseas expansion of banks (and other
firms)
OWNERSHIP ADVANTAGES/DIVERSIFICATION OF
EARNINGS
3) Ownership advantages
- These may be related to technological expertise, marketing
know-how, production efficiency, managerial expertise,
innovative product capability, and so on, must be easily
transferable within the bank and the skills and other
‘ownership advantages’ diffused effectively throughout the
organisation
4) Diversification of earnings
- Driven by the aim of management to diversify business
activity. This theory states that the investment decisions of
banks stem from a conscious effort by managers to
diversify earnings and therefore reduce risk. If a Botswana
bank believes the prospects for retail banking in South
Africa are more attractive than retail banking in its home
market then it makes sense to consider expansion in South
Africa. This will diversify earnings and make the Botswana
bank less exposed to its home market
DIVERSIFICATION OF EARNING
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Diversification of bank earnings and risk
reduction can be brought about by expansion into
foreign markets and risk will be reduced the less
correlated earnings in the foreign country are to
those in the home market.
Banks can diversify by doing similar business
activity in different countries and also by
expanding into new areas (such as insurance,
mutual funds, investment management,
investment banking, and so on) both at home and
abroad.
EXCESS MANAGERIAL CAPACITY
5) Excess managerial capacity
- Driven by the desire of companies to use up
excess managerial capacity. A bank may require
the use of certain managerial and other resources
that can be only fully utilised when they achieve
a certain size
- For instance, if a firm has a highly specialised
management team it may not get the best use of
this team if it only focuses on business in one
particular geographical market. Companies can
extend their scale of operations by expanding
overseas and into new markets and these
managerial resources will be more efficiently
utilised
LOCATION AND THE PRODUCT LIFECYCLE
6) Location and the product lifecycle
- The focus is on the nature of the product (or
services) produced and the changing demand and
production cost features of the product in
different markets. The product lifecycle has three
main stages:
a) innovative or new product;
b) maturing product;
c) standardised product.
LOCATION AND THE PRODUCT LIFECYCLE
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The innovative (or new product) stage is when a good
or service is produced to meet a new consumer
demand or when a new technology enables the
creation of innovative goods. In the first instance, the
product may not be standardised and seeks to
establish a market presence. The product is first sold
in the home market before any international
expansion is considered
As the bank gains from ‘learning by doing’ and the
most efficient forms of production, distribution and
selling are identified, the product becomes more
standardised. This is known as the mature product
stage. Customers are more aware of the product’s
features and demand for the product in the home
market becomes more elastic. As the market expands,
the producer is likely to benefit from scale economies
so production costs fall.
LOCATION AND THE PRODUCT LIFECYCLE
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The final stage of the product lifecycle is that of
the standardised product where the product is
uniform and undifferentiated and competition
between producers is based solely on price. In
this case knowledge about foreign markets is not
important and the main issue for the producer is
to find the lowest cost of production. In this stage
of the product lifecycle, production is transferred
to the lowest cost country so the firm can
maintain competitive advantage.
OTHER THEORIES ON THE RATIONALE FOR
INTERNATIONAL BANKING
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Firm-specific advantages
Some banks have advantages (whether financial, based on
distribution and production expertise, selling experience, etc.)
that make foreign expansion more amenable. Size often confers
such advantages as large banks typically have a wide array of
financing sources, may benefit from scale and scope economies
and have more expert management and systems that make
foreign expansion easier. They also are more likely to have the
relevant financial resources to undertake large-scale overseas
activity
Location advantages
Location benefits may relate to a variety of production,
distribution and selling attributes of the product or service in
question. For instance, banks like to group together in financial
centres (as in London, New York and Tokyo) to benefit from the
close proximity of the foreign exchange market and other
Eurocurrency activities. The liquidity of London’s foreign
exchange market (the largest in the world) attracts foreign
banks
TYPES OF BANK ENTRY INTO FOREIGN
MARKET
When undertaking business in foreign markets,
banks have a number of choices regarding the
structure of their activities. The choice of structure
depends on a broad range of considerations including
the amount of investment the bank wishes to
undertake, tax issues, and other factors
- The five main types of structure that banks can
choose include:
1) correspondent banking;
2) representative office;
3) branch office;
4) agency;
5) subsidiary
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TYPES OF BANK ENTRY INTO FOREIGN
MARKET
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Correspondent banking The lowest level of
exposure to the foreign market can be achieved
through a correspondent banking relationship.
This simply involves using a bank located in the
overseas market to provide services to a foreign
bank. Typically banks will use correspondent
banks to do business in markets where they have
no physical presence and as such these types of
services are widely used by smaller banks
INTERNATIONAL BANKING SERVICES
Banks can offer a wide range of different types of banking and
financial services via their international operations
Products and services to international business:
1) money transmission and cash management;
2) credit facilities – loans, overdrafts, standby lines of credit and
other facilities;
3) syndicated loans (only available to large companies and
multinational firms);
4) debt finance via bond issuance (only available to large companies
and multinational firms);
5) other debt finance including asset-backed financing;
6) domestic and international equity (the latter typically only
available to large companies and multinational firms);
7) securities underwriting and fund management services;
8) risk management and information management services; and
9) foreign exchange transactions and trade finance.
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