INTERNATIONAL BANKING
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Examination of the international department is usually conducted concurrently with
the commercial examination of the bank
- Part 347
- Requires that a bank maintain at its head office duplicate records of offshore
operations which will permit a centralized review of asset quality, funding
operations, contingent liabilities, and internal controls
International Risk
- Three types of international risk: financial (credit) risk, currency (foreign exchange)
risk, and country risk
- Financial Risk – potential economic inability of a borrower to comply with
contractual credit terms and bears the closet resemblance to domestic lending
- Currency Risk – vulnerability of international lenders to variations in rates of
currency exchange, and in every international extension of credit someone has a
currency conversion exposure
- Country Risk – encompasses an entire spectrum of risks arising from economic,
social, legal and political conditions of a foreign country that may result in
favorable or unfavorable consequences for borrowers of that country. (Primary
factor that differentiates international lending from domestic lending.)
Forms of International Lending
Trade Financing
- Two most common:
- Commercial Documentary Letter of Credit – an instrument in which a bank
(issuing bank) undertakes to pay a party (the beneficiary) named in the instrument
a sum of money on behalf of the bank’s customer (account party). The
beneficiary is paid when the beneficiary submits to the issuing bank specific
documents are required by the terms of the letter of credit
- Standby Letter of Credit – guarantees payment to the beneficiary by the issuing
bank in the event of default or nonperformance by the account party (the bank’s
customer)
- Standby letter of credit transactions involve a higher potential risk for the
issuing bank than a commercial documentary letter of credit
- Unsecured standby letters of credit are included, along with loans, within a
bank’s unsecured legal lending limit to one borrower.
Domestic Loans
- Loans to domestic customers where the proceeds are used to finance imports of
inventory are considered international credits.
Loans to Foreign Governments
- Also loans to government controlled entities
- Repayment is dependent upon the government of the country
Direct Credit to Foreign Banks
Indirect Loans to Foreign Banks
- Loans extended to a foreign borrower based primarily on the foreign bank’s guarantee
of the loan
Loans to Foreign Business or Individuals
Syndicated Project Loans
- Project loans put together by international consortia and participations in syndications
International Lending Policy
- Every bank engaged in international lending should be guided for a formal policy
approved by the Board
- Policy should address:
- Credit Standards and Information
- Banks should translate and spread foreign financial statements into English,
with the foreign currency converted to US dollars and the applicable exchange
rate indicated
- Geographic Limits
- Diversification can reduce country risk
Country Risk
- CR is the primary factor that differentiates international lending from domestic
lending
- CR analysis includes assessment of the likelihood of political or social upheaval,
nationalization or expropriation, government repudiation of external debts, and
exchange controls of foreign exchange shortfalls
- Diversification is the primary method of moderating country risk
- (REVIEW BANK OF ANYTOWN)
Classification based on Country Risk
- Other Transfer Risk Problem (OTRP)
- Country is not complying with external debt service obligations, however, the
country is taking positive actions to restore debt service (generally as part of an
IMF program)
- Country is meetings its debt obligations, but non-compliance appears imminent
- Country has been classified previously, and recent debt service performance
indicates classification is no longer warranted, but a sustained resumption of
performance needs to be demonstrated
- Substandard
- Country is not complying with external debt service obligations
- Country is not in the process of adopting an IMF or another suitable adjustment
program
- The country and its bank creditors have not negotiated a viable rescheduling and
are unlikely to do so in the near future
- Value Impaired Classification (when one or more of the following exist)
- Country has not fully paid its interest for 6 months
- Country has not complied with IMF programs
- Country has not met rescheduling terms for over one year
- Country shows no definite prospects for an orderly restoration of debt service in
the near future
- Loss Classifications
- No longer considered a bankable asset
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Assignment of adverse classifications and designation of countries as OTRP are the
responsibility of the Interagency Country Exposure Review Committee (however, the
examiner does have input)
- Committee prepares a standard narrative on the country to be used in reports of
examination
Reserve Requirements
- Part 347
- Requires banks to establish and maintain a special reserve when the value of
international loans has been impaired by a protracted inability of the borrowers in
a country to make payments on external indebtedness or not definite prospects
exist for orderly restoration of debt service
- Reserves should be established by a charge against current income and be
segregated from the bank’s general allowance
- Fees in excess of administrative cost on international loans should be amortized over
the life of the loan
Analysis of Management System of Monitoring Country Risk
- System should consist of three important components:
- Evaluation of economic trends, political development, and the country’s social
fabric
- Board and management define the level of country exposure the bank is willing to
assume
- International reporting system
- Annually (at least) a review of portfolio composition or each individual country
should be performed
- Primary Examination Objectives
- Evaluate policies, practices/procedures, and internal controls
- Conformance with operating guidelines
- Impact of country risk on the overall quality of the international loan portfolio
- Corrective action for deficient policies/practices/procedures and exceptions
- Annual report (narrative commentary) of each country
Country Risk Exposure Report
- Must be filed quarterly by banks which meet certain conditions
Foreign Exchange
Exchange of money of one country for money of another
Exchange Rates
- Trade and investment flows affect the supply and demand for currencies, which in
turn influence exchange rates.
- Banks quote different rates based upon the amount of time required to exchange
currencies
- Rates vary depending on agreed payment date (value date) of the transaction
(overnight, one week, one month, etc.)
- Banks also quote a different exchange rate for a given transaction when they are
buyers (bid) or sellers (sell/offer) of currency. The spread between bid and offered
rates represents the bank’s profit margin
Spot and Forward Exchange
- Spot Transaction – immediate delivery
- Forward Transaction – delivery at a future date
- Value Date – date on which payment is effected
- Liquidity in the market decreases beyond three months
Swaps
- Simultaneous purchase and sale of a certain amount of foreign currency for two
different value dates
- Swap permits a temporary exchange of currencies and is often used to acquire a
foreign currency, which is then used to make a short-term investment. Maturity of
the investment will coincide with the forward value date and the currency will be
returned at that time
Foreign Exchange Risk
Five types of risk
- Exchange Rate Risk - occurs when a bank takes an open position in a currency
- When a bank holds or buys more foreign currency than it sells, or agrees to sell
more than it buys, and exposure is created known as an open position
- Open position can be either long or short
- Long position – bank buys more currency than it sells
- Short position – bank sells more currency than it buys
- A long position is a depreciating currency results in exchange loss relative to
book value
- A short position in a currency that is appreciating results in an exchange loss
relative to book value
- Interest Rate Risk – mismatches or gaps in maturity
- When currency is received in advance of any scheduled offsetting payments
- Credit Risk – (two types)
- 1020% risk (exchange rates will fluctuate no more than 10-20% usually)
- Delivery or settlement risk
- Country Risk
- Operational Risk
FDIC Policy Statement
- Covers minimum standards for written bank policies, basic internal controls, and
audit documentation
Other International Department Activities
- Cash Accounts
- Due From or Nostro Accounts
- Nostro Accounts – due from accounts established in correspondent banks located
in countries where the bank conducts business
- Investments
- Typically held to meet various local laws or reserve requirements, reduce tax
liability, or as an expression of goodwill
- May be purchased strictly for investment purposes
- Should not be done for speculative purposes (can be unsuitable investment
practice)
- International investment portfolio should be reviewed by the board at least
annually
- Due From Time Deposits
- Have same risk characteristics as extensions of credit
- Borrowings
Restrictive Trade
- Prohibit exporters and banks from complying in any way with boycott request that
would cause discrimination against US citizens or companies on the basis of race,
color, religion, sex or national origin
- Also prohibit boycotts of countries friendly to the US (this is a violation of Part 369)
Foreign Corrupt Practices Act
- Crime for a US company or individuals action on behalf of a company to bribe
foreign officials or foreign political candidates or parties for the purpose of acquiring
or retaining business
- Grease payments are not prohibited
- Grease Payments – payments for expediting shipments through customs, securing
required permits, or obtaining adequate police protection are all considered grease
payments even though such payments may involve the payment of money for the
proper performance of duties
- Act does not apply directly to foreign subsidiaries, however, Congress has noted that
any entity that engages in bribery of foreign officials indirectly through any other
entity, including foreign subsidiaries, would itself be held liable under the Act.