CHAPTER
21
© 2003 South-Western/Thomson Learning
International
Banking
Chapter Objectives
Describe key regulations that reduced
competitive advantages of banks in particular
countries
 Describe the risks of international banks
 Describe bank solutions to the international
debt crisis
 Describe how banks assess country risk when
they consider lending funds to foreign
countries

International Expansion

Banks go global for several reasons
Diversify among economies to become less
dependant on a single country’s conditions
 Do business face-to-face with multinational
corporations and their subsidiaries


International expansion by U.S. banks
U.S. bank regulations limited interstate banking
 Expansion and growth via international banking

International Expansion

How U.S. banks expand overseas
Establish branches
 Must first receive approval of the Federal Reserve
Board in the U.S.
 U.S. banks’ presence largest in the U.K.
 Deposits in foreign branches are not insured
 Agencies are an alternative that can make loans
but not accept deposits or provide trust services

International Expansion

Non-U.S. banks expand into the United States
and focus on corporate rather than consumer
banking
Provide service to the subsidiaries of non-U.S.
corporations
 1913 Edge Act creates corporations that specialize
in banking and foreign transactions allowing loans
and accepting deposits only if specifically related
to international transactions

Global Bank Regulations
Countries have a system of monitoring and
regulating commercial banks
 Division of regulatory power between the
central bank and other regulators varies among
countries

Canada
 Europe
 Japan

Global Bank Regulations
Standardizing the rules with uniform
regulations helps globalize the financial
system
 Playing field leveled by three regulatory
changes

The International Banking Act requiring all banks
within the U.S. follow the same rules
 Single European Act
 Uniform capital adequacy guidelines

Global Bank Regulations

Uniform regulations for banks operating in the
U.S.
International Banking Act of 1978
 Prior to the Act, foreign banks had more flexibility
to cross state lines
 Forced foreign banks to identify one state as their
home state

Global Bank Regulations
Uniform regulations across Europe from the
Single European Act of 1987
 Capital can flow freely throughout Europe
 Banks can offer a wide variety of lending,
leasing and securities activities in Europe
 Regulations regarding competition, mergers
and taxes are similar throughout Europe
 Banks established in one European country
have the right to expand into any or all other
European countries

Global Bank Regulations
Uniform capital adequacy guidelines
 Prior to 1988 standards differed around the
world
 This difference gave some a comparative
advantage
 12 industrial countries agreed to standard
guidelines in 1988
 Risk-weighting means higher capital for
riskier assets

Global Bank Competition

U.S. bank expansion in foreign countries is
driven by several factors
Locations where U.S. multinationals are expected
to expand
 Areas benefiting from expansion due to free trade
agreements
 Goal of the banks is to offer diverse services to
meet all the banking needs of corporate customers

Global Bank Competition
Non-U.S. bank expansion in the United States
 Japanese banks developed an extensive
presence in the U.S.

Offer competitive corporate loans
 Lower fees for letters of credit
 Have a low cost of capital so can take on ventures
U.S. banks would not
 High saving rate in Japan provides deposit funds
for global expansion

Global Bank Competition
Impact of the Euro on bank expansion
 Introduction of a single currency stimulated
bank expansion

Simplifies transactions to deal in one, rather than
several currencies
 Customers can more easily compare service costs
 Expansion via acquisition to capture economies of
scale

Global Bank Competition
Competition for investment banking services
 Banks compete to provide a variety of services

Swaps
 Foreign exchange
 Investment banking

Underwriting
Brokerage

Banks expand both geographically and their
product and service lines to capture economies
Impact of Eastern European Reform on
Global Competition

Banks helped facilitate the trend toward
privatization
Provide direct loans to businesses
 Act as underwriters on bonds and stocks
 Provide letters of credit
 Provide consulting services

International
trade
Mergers
Other
corporate activities
Risks of Multinational Banks
Credit Risk
Settlement Risk
Combining All
Types of Risk
Interest Rate Risk
Exchange Rate Risk
Risks of Multinational Banks

Credit risk exists for U.S. banks making
foreign loans because they may have less
information than for domestic loans
Regulations for the disclosure of financial
information differ among countries and are not as
strict as in the U.S.
 Ratios and industry norms differ among countries
so benchmarking is difficult

Risks of Multinational Banks

Managing credit risk
May solve the problem by lending to large
corporations or government
 Performance of each branch in a particular country
linked to the performance to that country’s
economy

Diversify
within a country across industries
Diversify throughout the bank across countries
Risks of Multinational Banks
Exchange rate risk
 Banks may agree to accept payment in a
currency other than the currency in which the
loan is denominated
 Convert funds received into the currency
customers want to borrow
 Assets and liabilities denominated in different
currencies
 Net out exposure

Risks of Multinational Banks
Risk exists because banks may suffer losses as
they settle their transactions
 If one participant can not meet their
obligations, counterparties will also be unable
to meet their obligations
 Central banks around the world are examining
ways to stop the ripple effect

Risks of Multinational Banks
Interest rate risk is even more challenging for
the international bank because of its foreign
currency balances
 Risk depends on the currency denomination
and the interest rates of loans and securities in
various currencies
 Minimize the risk by matching rate
sensitivities of assets and liabilities for each
currency

Risks of Multinational Banks



Combining all types of risk means managing risk is
complex
Tradeoffs exist because trying to minimize one of the
risks may affect exposure in another area
Risks occur as the bank does daily business with
multinationals and meets their needs


Trying to control bank risks means they would not meet
customer needs
Customers have many choices in this competitive market
International Debt Crisis
Reducing bank exposure to Lesser Developed
Countries (LDC) debt is more difficult in an
integrated global economy
 Stagnant U.S. and European economies hurt
LDCs in the early 1980s because the LDC’s
dependence on export earnings
 Strong dollar also hurt LDCs in the early
1980s because their loans were denominated
in dollars
 Countries simultaneously defaulted

International Debt Crisis

Commercial banks with LDC debt in the
1980s faced a crisis and had to decide between
two alternatives
Provide additional loans and incur the risk of
default of new as well as older loans
 Reject the request for additional funds and cause
default


Banks and countries formed groups to
negotiate
International Debt Crisis
Exposure to LDC debt was concentrated in 9
money center banks which, if even one failed,
would have caused a panic
 Banks reduced their exposure by

Selling LDC loans
 Using debt-for-equity swaps
 Boosting loan loss reserves

International Debt Crisis
The Brady plan developed between 1985 and
1988 was used to reduce LDC debt problems
 The only chance Lesser Developed Countries
had as a group to pay off loans was to improve
their economic conditions
 The plan allowed LDCs the chance to reform
their economies
 Banks were given the option of trading their
loans to the World Bank and IMF

Asian Crisis

Impact of bank lending on the Asian crisis
The Asian crisis was caused in part by banks’
willingness to extend credit in Thailand
 Commercial developers in Thailand borrowed
without having to show projects were feasible
 Debt was at high interest rates and expensive
 Economic growth slowed and cash flows could
not cover local loans or foreign currency-based
loans

Asian Crisis
Spread of loan defaults throughout Asia
 Problems caused by a weak economy spread
throughout Asia
 Currencies weakened and investors withdrew
funds
 South Korean loans made without adequate
credit analysis resulted in defaults

Asian Crisis

Impact on U.S. and European banks
U.S. and European banks had exposure because
they made loans in Asia
 Bank stocks declined as a result of the losses

Country Risk Assessment

Several factors of country risk including:

Economic indicators
Changes
in the consumer price index
Real growth in gross domestic product
Current account balances divided by exports
Country Risk Assessment

Debt management
Debt service and short-term debt divided by total
exports
 Ratio of total debt to GDP
 Short-term debt divided by total debt

Country Risk Assessment

Political factors are measured subjectively and
include a probability for each
Destabilizing riots or civil unrest
 Increased terrorist activities
 Civil war
 Foreign war
 Government overthrow

Country Risk Assessment

Structural factors are also measured
subjectively
Natural resource base
 Human resource base
 Leadership


Overall rating
Assigns a score between 0 and 100
 Grade assigned for both short and long term

Exhibit 21.2 Determining Country Risk
Ratings
Short-Term Horizon
Medium-Term Horizon
Weighted
Grade
Weight
Grade
Weighted
Grade
.3
70
21
27
.2
70
14
60
12
.3
50
15
75
15
.2
60
12
Weight
Grade
Debt management model
.3
80
24
Economic Indicator model
.3
90
Political rating model
.2
Structural rating model
.2
78
62
Exhibit 21.3 Converting Grade Into
Country Rating
Overall
Grade Rating
Rating
9 1–1 0 0
AAA
8 1–9 0
AA
7 1–8 0
A
6 1–7 0
BBB
5 1–6 0
BB
4 1–5 0
B
3 1–4 0
CCC
2 1–3 0
CC
11–2 0
C
0 –1 0
D
Excellent
Satisfactory quality, average risk
Low quality, high risk
Excessive risk
Country Risk Assessment

Discriminant analysis is used to examine
country risk
Discriminant analysis is a statistical technique
used to identify factors that are distinctly different
between two groups
 Used to try to identify factors that distinguish
between countries with and without debt
repayment problems
