Power Point Slides for:
Financial Institutions, Markets, and
Money, 9th Edition
Authors: Kidwell, Blackwell, Whidbee &
Peterson
Prepared by: Babu G. Baradwaj, Towson University
and
Lanny R. Martindale, Texas A&M University
Copyright© 2006 John Wiley & Sons, Inc.
1
CHAPTER 15
INTERNATIONAL
BANKING
Development of 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.
Copyright© 2006 John Wiley & Sons, Inc.
3
The Edge Act (1919)
Federal Reserve Act of 1913 permitted foreign
branches.
Agreement corporations were legalized in 1916.
Details of the Edge Act
Banks able to create federally chartered subsidiaries
located in the United States
Participated in international banking
Could make equity investments
U.S. banks able to compete with European banks
Grew in number and activities after WW II
Copyright© 2006 John Wiley & Sons, Inc.
4
Reasons U.S. Banks’ Global Expansion
Increased expansion of U.S. trade and
foreign markets.
Growth of multinational corporations.
U.S. government business regulation
limited U.S. profit opportunities.
Need to finance petroleum induced deficits
in foreign countries.
Copyright© 2006 John Wiley & Sons, Inc.
5
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.
Copyright© 2006 John Wiley & Sons, Inc.
6
Recent Activity in U.S. International Banking
While fewer U.S. banks operate overseas,
they have a larger network of global
affiliates in the form of branches, overseas
offices, and most importantly through
correspondent banks.
Since the 1990s, fewer, but larger U.S.
banks are operating globally. Two of the
largest banks in the world are U.S. banks –
Citigroup & J. P. Morgan.
Copyright© 2006 John Wiley & Sons, Inc.
7
World’s Largest Banks (2002)
Copyright© 2006 John Wiley & Sons, Inc.
8
World’s Largest Banks (1990)
Copyright© 2006 John Wiley & Sons, Inc.
9
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.
Copyright© 2006 John Wiley & Sons, Inc.
10
The Regulatory Framework
Federal Reserve Act of 1913 - allowed
federally chartered branches outside the
U.S.
Amendment to Federal Reserve Act
(1916) - agreement corporations permitted.
Edge Act (1919) - federally chartered
corporations for international banking.
National banks permitted equity
investments in foreign bank stock (1966).
Copyright© 2006 John Wiley & Sons, Inc.
11
The Regulatory Framework
Bank Holding Company Act Amendments of 1970 regulated international activities of bank holding
companies.
International Banking Act of 1978 - extended
federal regulation to foreign banks operating in the
United States.
The DIDMCA of 1980:
expanded Fed control over foreign banks.
permitted U.S. banks to establish international
banking facilities.
In July, 1988, the Bank for International Standards
(BIS) worked out enhanced bank capital adequacy
standards (effective in 1992) between leading
economic nations.
Copyright© 2006 John Wiley & Sons, Inc.
12
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.
Copyright© 2006 John Wiley & Sons, Inc.
13
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.
Copyright© 2006 John Wiley & Sons, Inc.
14
Delivery of Overseas Banking Services
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.
Copyright© 2006 John Wiley & Sons, Inc.
15
International Banking Facilities (IBFs)
Fed permitted the IBFs beginning December 1981.
May be established by a U. S chartered depository
institution, a U. S. branch or agency of a foreign
bank or the U. S. office of an Edge Act
Corporation.
They represent the balance sheet of the aggregated
foreign assets and liabilities by the IBF.
They are not subject to U.S. banking regulations.
Deposits over $100,000 can be accepted from non U. S.
residents or other IBFs.
Deposits generated can be used to make foreign loans
only.
Copyright© 2006 John Wiley & Sons, Inc.
16
A U. S. Multinational Bank Structure
Copyright© 2006 John Wiley & Sons, Inc.
17
Characteristics of International Loans
Funding
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
Copyright© 2006 John Wiley & Sons, Inc.
18
Characteristics of International Loans
Pricing
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.
Copyright© 2006 John Wiley & Sons, Inc.
19
Characteristics of International Loans
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.
Copyright© 2006 John Wiley & Sons, Inc.
20
Characteristics of International Loans
Collateral
Most international credits are unsecured.
Most business borrowers have high credit
ratings.
Borrowing countries pledge their "full faith and
credit."
Copyright© 2006 John Wiley & Sons, Inc.
21
Risks in International Lending
Credit risk - the risk of default.
Country risk - related to the political stability,
laws, and regulations of the foreign country.
Expropriation
Nationalization
Change of government
Currency risk - risk of currency value changes and
exchange controls.
Copyright© 2006 John Wiley & Sons, Inc.
22
Risk Evaluation
An analysis of both the borrower and borrower's
country is done by the bank’s foreign lending and
economic departments.
Evaluation involves a statistical analysis of the
country’s political and economic risks.
A financial analysis of the borrower is also conducted.
If the cost of doing the analysis internally is
prohibitive, outside sources exist but they tend not to
be as reliable.
The higher the cost of gathering information, the
higher the loan rate, reflecting the increased risk due
to unreliable information or lack of information.
Copyright© 2006 John Wiley & Sons, Inc.
23
Risk Management in International Lending
Third-party help
Guarantees by governments or central banks
Guarantees by organizations outside the foreign
country
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.
Copyright© 2006 John Wiley & Sons, Inc.
24
Growth of Foreign Banks in the U.S.
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.
Copyright© 2006 John Wiley & Sons, Inc.
25
Number of Foreign Banks in the U.S. (1982-2003)
Copyright© 2006 John Wiley & Sons, Inc.
26
Growth of Foreign Bank Assets in the U.S. (1982-2003)
Copyright© 2006 John Wiley & Sons, Inc.
27
Top Foreign Banks in the U. S. (2003)
Copyright© 2006 John Wiley & Sons, Inc.
28
Regulation of Foreign Banks’ U.S. Operations
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.
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.
Copyright© 2006 John Wiley & Sons, Inc.
29
Regulation of Foreign Banks’ U.S. Operations
In addition, the Foreign Bank Supervision
Enhancement Act (FBSEA) was passed in
1991 to give the Federal Reserve Bank the
authority to oversee the activities of foreign
institutions in the U.S.
Copyright© 2006 John Wiley & Sons, Inc.
30