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International Banking and Money Market

Chapter Objective:

INTERNATIONAL FINANCIAL MANAGEMENT
Third Edition EUN / RESNICK

Chapter Six

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This chapter serves to begin our discussion of world financial markets and institutions.

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Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Six Outline

International Banking Services

The World’s Largest Banks

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Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Six Outline
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International Banking Services Reasons for International Banking

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Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Six Outline
  

International Banking Services Reasons for International Banking Types of International Banking Offices

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Correspondent Bank Representative Offices Foreign Branches Subsidiary and Affiliate Banks Edge Act Banks Offshore Banking centers International Banking Facilities
Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Six Outline
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International Banking Services Reasons for International Banking Types of International Banking Offices Capital Adequacy Standards

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Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved.

. All rights reserved.Chapter Six Outline      International Banking Services Reasons for International Banking Types of International Banking Offices Capital Adequacy Standards International Money Market       6-5 Eurocurrency Markets Eurocredits Forward Rate Agreements Euronotes Euro-Medium-Term Notes Eurocommercial Paper Copyright © 2003 by The McGraw-Hill Companies. Inc.

. All rights reserved.Chapter Six Outline       International Banking Services Reasons for International Banking Types of International Banking Offices Capital Adequacy Standards International Money Market International Debt Crisis    6-6 History Debt-for-Equity Swaps The Solution: Brady Bonds Copyright © 2003 by The McGraw-Hill Companies. Inc.

All rights reserved. Inc. .Chapter Six Outline        International Banking Services Reasons for International Banking Types of International Banking Offices Capital Adequacy Standards International Money Market International Debt Crisis Japanese Banking Crisis 6-7 Copyright © 2003 by The McGraw-Hill Companies.

. Inc. All rights reserved.Chapter Six Outline         International Banking Services Reasons for International Banking Types of International Banking Offices Capital Adequacy Standards International Money Market International Debt Crisis Japanese Banking Crisis The Asian Crisis 6-8 Copyright © 2003 by The McGraw-Hill Companies.

6-9 Copyright © 2003 by The McGraw-Hill Companies. All rights reserved. Offer hedging services for foreign currency receivables and payables through forward and option contracts. .International Banking Services  International Banks do everything domestic banks do and:     Arrange trade financing. Arrange foreign exchange. Inc. Offer investment banking services (where allowed).

Inc.S. Japan Germany UFJ Bank Ltd. All rights reserved.S. France U.K. 6-10 Japan Copyright © 2003 by The McGraw-Hill Companies.The World’s 10 Largest Banks Citigroup Mizuho Bank/ Mizuho Corp Bank HSBC Holdings Bank of America JP Morgan Chase Deutsche Bank U. Germany Royal Bank of Scotland Group Sumitomo Mitsui Banking Group HypoVereinsbank U. Japan U. .K.

Inc. All rights reserved.Reasons for International Banking  Low Marginal Costs  Managerial and marketing knowledge developed at home can be used abroad with low marginal costs. 6-11 Copyright © 2003 by The McGraw-Hill Companies. .

All rights reserved. 6-12 Copyright © 2003 by The McGraw-Hill Companies.Reasons for International Banking   Low Marginal Costs Knowledge Advantage  The foreign bank subsidiary can draw on the parent bank’s knowledge of personal contacts and credit investigations for use in that foreign market. Inc. .

All rights reserved. . 6-13 Copyright © 2003 by The McGraw-Hill Companies. Inc.Reasons for International Banking    Low Marginal Costs Knowledge Advantage Home Nation Information Services  Local firms in a foreign market may be able to obtain more complete information on trade and financial markets in the multinational bank’s home nation than is obtainable from foreign domestic banks.

All rights reserved. Inc. 6-14 Copyright © 2003 by The McGraw-Hill Companies. which can be attractive to new clients. .Reasons for International Banking     Low Marginal Costs Knowledge Advantage Home Nation Information Services Prestige  Very large multinational banks have high perceived prestige.

Reasons for International Banking      Low Marginal Costs Knowledge Advantage Home Nation Information Services Prestige Regulatory Advantage  Multinational banks are often not subject to the same regulations as domestic banks. 6-15 Copyright © 2003 by The McGraw-Hill Companies. . All rights reserved. Inc.

All rights reserved. 6-16 . Inc.Reasons for International Banking       Low Marginal Costs Knowledge Advantage Home Nation Information Services Prestige Regulatory Advantage Wholesale Defensive Strategy  Banks follow their multinational customers abroad to avoid losing their business at home and abroad. Copyright © 2003 by The McGraw-Hill Companies.

Reasons for International Banking        Low Marginal Costs Knowledge Advantage Home Nation Information Services Prestige Regulatory Advantage Wholesale Defensive Strategy Retail Defensive Strategy  Multinational banks also compete for retail services such as travelers checks. Copyright © 2003 by The McGraw-Hill Companies. Inc. All rights reserved. tourist and foreign business market. 6-17 .

All rights reserved. Inc.Reasons for International Banking        Knowledge Advantage Home Nation Information Services Prestige Regulatory Advantage Wholesale Defensive Strategy Retail Defensive Strategy Transactions Costs  Multinational banks may be able to circumvent government currency controls. 6-18 . Copyright © 2003 by The McGraw-Hill Companies.

Inc. All rights reserved.Reasons for International Banking        Home Nation Information Services Prestige Regulatory Advantage Wholesale Defensive Strategy Retail Defensive Strategy Transactions Costs Growth  Foreign markets may offer opportunities to growth not found domestically Copyright © 2003 by The McGraw-Hill Companies. 6-19 .

. All rights reserved. Inc.Reasons for International Banking        Prestige Regulatory Advantage Wholesale Defensive Strategy Retail Defensive Strategy Transactions Costs Growth Risk Reduction  6-20 Greater stability of earnings due to diversification Copyright © 2003 by The McGraw-Hill Companies.

. All rights reserved. Inc.Types of International Banking Offices        Correspondent Bank Representative Offices Foreign Branches Subsidiary and Affiliate Banks Edge Act Banks Offshore Banking Centers International Banking Facilities 6-21 Copyright © 2003 by The McGraw-Hill Companies.

. Correspondent banking allows a bank’s MNC client to conduct business worldwide through his local bank or its correspondents. All rights reserved.Correspondent Bank   A correspondent banking relationship exists when two banks maintain deposits with each other. 6-22 Copyright © 2003 by The McGraw-Hill Companies. Inc.

Inc. 6-23 . Representative offices also assist with information about local business customs.Representative Offices   A representative office is a small service facility staffed by parent bank personnel that is designed to assist MNC clients of the parent bank in dealings with the bank’s correspondents. Copyright © 2003 by The McGraw-Hill Companies. and credit evaluation of the MNC’s local customers. All rights reserved.

Can provide a much fuller range of services than a representative office.   Subject to both the banking regulations of home country and foreign country. but is legally part of the the parent. All rights reserved.Foreign Branches  A foreign branch bank operates like a local bank. banks to expand overseas. Inc. 6-24 Copyright © 2003 by The McGraw-Hill Companies.  Branch Banks are the most popular way for U. .S.

U.S. . Inc. An affiliate bank is one that is partly owned but not controlled by the parent. parent banks like foreign subsidiaries because they allow U.Subsidiary and Affiliate Banks    A subsidiary bank is a locally incorporated bank wholly or partly owned by a foreign parent. All rights reserved. banks to underwrite securities. 6-25 Copyright © 2003 by The McGraw-Hill Companies.S.

that are allowed to engage in a full range of international banking activities. All rights reserved.S. The Edge Act was a 1919 amendment to Section 25 of the 1914 Federal Reserve Act.S. banks that are physically located in the U. . 6-26 Copyright © 2003 by The McGraw-Hill Companies.Edge Act Banks   Edge Act banks are federally chartered subsidiaries of U. Inc.

6-27 Copyright © 2003 by The McGraw-Hill Companies. All rights reserved. The host country usually grants complete freedom from host-country governmental banking regulations.Offshore Banking Centers   An offshore banking center is a country whose banking system is organized to permit external accounts beyond the normal scope of local economic activity. Inc. .

Offshore Banking Centers  The IMF recognizes        the Bahamas Bahrain the Cayman Islands Hong Kong the Netherlands Antilles Panama Singapore Copyright © 2003 by The McGraw-Hill Companies. Inc. All rights reserved.  as major offshore banking centers 6-28 .

. 6-29 Copyright © 2003 by The McGraw-Hill Companies. The purpose was to allow U. All rights reserved. The actual business is done by the parent bank at the parent bank. banks to compete internationally without the expense of setting up operations ―for real‖.―Shell‖ Branches    Shell branches need to be nothing more than a post office box. Inc.S.

Any U. Inc.International Banking Facilities     An international banking facility is a separate set of accounts that are segregated on the parents books. bank can have one.S. International banking facilities have captured a lot of the Eurodollar business that was previously handled offshore. 6-30 Copyright © 2003 by The McGraw-Hill Companies. All rights reserved. An international banking facility is not a unique physical or legal identity. .

All rights reserved. 6-31 Copyright © 2003 by The McGraw-Hill Companies. . There are various standards and international agreements regarding how much bank capital is ―enough‖ to ensure the safety and soundness of the banking system.Capital Adequacy Standards   Bank capital adequacy refers to the amount of equity capital and other securities a bank holds as reserves. Inc.

looked good on paper relative to capital adequacy standards. For example. they may not be sufficient protection from derivative risk.Capital Adequacy Standards   While traditional bank capital standards may be enough to protect depositors from traditional credit risk. . Inc. which collapsed in 1995 from derivative losses. All rights reserved. 6-32 Copyright © 2003 by The McGraw-Hill Companies. Barings Bank.

. Euroyen are yen-denominated time deposits in banks located outside of Japan.International Money Market  Eurocurrency is a time deposit in an international bank located in a country different than the country that issued the currency.S. dollar-denominated time deposits in banks located abroad. Eurodollars are U.    For example. 6-33 Copyright © 2003 by The McGraw-Hill Companies. All rights reserved. Inc. The foreign bank doesn’t have to be located in Europe.

000. Copyright © 2003 by The McGraw-Hill Companies.Eurocurrency Market   Most Eurocurrency transactions are interbank transactions in the amount of $1. Inc. Common reference rates include    LIBOR the London Interbank Offered Rate PIBOR the Paris Interbank Offered Rate SIBOR the Singapore Interbank Offered Rate EURIBOR the rate at which interbank time deposits of € are offered by one prime bank to another. All rights reserved.  A new reference rate for the new euro currency  6-34 .000 and up.

Often the loans are too large for one bank to underwrite. Inc. Eurocredits feature an adjustable rate. 6-35 Copyright © 2003 by The McGraw-Hill Companies. All rights reserved. The loans are denominated in currencies other than the home currency of the Eurobank. On Eurocredits originating in London the base rate is LIBOR.to medium-term loans of Eurocurrency.Eurocredits     Eurocredits are short. a number of banks form a syndicate to share the risk of the loan. .

a buyer and a seller. The seller agrees to pay the buyer the increased interest cost if interest rates increase above the agreed rate. . 6-36 Copyright © 2003 by The McGraw-Hill Companies. All rights reserved. Inc.Forward Rate Agreements    An interbank contract that involves two parties. The buyer agrees to pay the seller the increased interest cost on a notational amount if interest rates fall below an agreed rate.

Inc. . Speculate on the future course of interest rates. 6-37 Copyright © 2003 by The McGraw-Hill Companies.Forward Rate Agreements: Uses  Forward Rate Agreements can be used to:   Hedge assets that a bank currently owns against interest rate risk. All rights reserved.

Inc.Euronotes    Euronotes are short-term notes underwritten by a group of international investment banks or international commercial banks. They are sold at a discount from face value and pay back the full face value at maturity. Maturity is typically three to six months. 6-38 Copyright © 2003 by The McGraw-Hill Companies. All rights reserved. .

. All rights reserved. 6-39 Copyright © 2003 by The McGraw-Hill Companies.Euro-Medium-Term Notes    Typically fixed rate notes issued by a corporation. Maturities range from less than a year to about ten years. Euro-MTNs is partially sold on a continuous basis –this allows the borrower to raise funds as they are needed. Inc.

S. dollar denominated.S. Maturities typically range from one month to six months. Placed directly with the public through a dealer. commercial paper—as a result yields are higher. is often of lower quality than U. Inc.Eurocommercial Paper     Unsecured short-term promissory notes issued by corporations and banks. while typically U. . All rights reserved. 6-40 Copyright © 2003 by The McGraw-Hill Companies. Eurocommercial paper.

All rights reserved. 6-41 Copyright © 2003 by The McGraw-Hill Companies. .International Debt Crisis   Some of the largest banks in the world were endangered when loans to sovereign governments of some less-developed countries.2 trillion. At the height of the crisis. Inc. third world countries owed $1.

6-42 Copyright © 2003 by The McGraw-Hill Companies. especially if: You don’t know much about that basket. Inc. . All rights reserved.International Debt Crisis    Like a great many calamities. it is easy to see in retrospect that: It’s a bad idea to put too many eggs in one basket.

Inc. but in local currency. creditor banks would sell their loans for U. The MNC would use the local currency to make preapproved new investment in the LDC that was economically or socially beneficial to the LDC. 6-43 Copyright © 2003 by The McGraw-Hill Companies. . All rights reserved. A LDC central bank would buy the bank debt from a MNC at a smaller discount than the MNC paid.S.Debt-for-Equity Swaps    As part of debt rescheduling agreements among the bank lending syndicates and the debtor nations. dollars at discounts from face value to MNCs desiring to make equity investment in subsidiaries or local firms in the LDCs.

. Inc. All rights reserved.Debt-for-Equity Swap Illustration International Bank LDC firm or MNC subsidiary $60m $80m in Equity local currency Investor or MNC Sell $100m LDC debt at 60% of face $80m in local currency LDC Central Bank 6-44 Redeem LDC debt at 80% of face in local currency Copyright © 2003 by The McGraw-Hill Companies.

All rights reserved. 6-45 Copyright © 2003 by The McGraw-Hill Companies. Keiretsu members have cross-holdings of an another’s equity and ties of trade and credit. .Japanese Banking Crisis    The history of the Japanese banking crisis is a result of a complex combination of events and the structure of the Japanese financial system. Inc. Japanese commercial banks have historically served as the financing arm and center of a collaborative group know as keiretsu.

All rights reserved.Japanese Banking Crisis    The collapse of the Japanese stock market set in motion a downward spiral for the entire Japanese economy and in particular Japanese banks.   The Japanese financial system does not have a legal infrastructure that allows for restructuring of bad bank loans. Inc. It is unlikely that the Japanese banking crisis will be rectified anytime soon. Copyright © 2003 by The McGraw-Hill Companies. 6-46 . Japanese bank managers have little incentive to change because of the Keiretsu structure. This put in jeopardy massive amounts of bank loans to corporations.

Inc.The Asian Crisis    This crisis followed a period of economic expansion in the region financed by record private capital inflows. . 6-47 Copyright © 2003 by The McGraw-Hill Companies. particularly in real estate. Bankers from the G-10 countries actively sought to finance the growth opportunities in Asia by providing businesses with a full range of products and services. All rights reserved. This led to domestic price bubbles in East Asia.

Inc. All rights reserved. 6-48 Copyright © 2003 by The McGraw-Hill Companies. The Asian crisis is only the latest example of banks making a multitude of poor loans—spurred on no doubt by competition from other banks to make loans in the ―hot‖ region.The Asian Crisis    Additionally. . the close interrelationships common among commercial firms and financial institutions in Asia resulted in poor investment decision making. It is doubtful if the international debt crisis or the Asian crisis has taught banks a lasting lesson.

Inc.End Chapter Six 6-49 Copyright © 2003 by The McGraw-Hill Companies. . All rights reserved.