Global Financing Decisions

International Banks
• International banks are the banks that facilitate
international trade by arranging their financing, borrow
and lend in the foreign currency market and provide
some consulting services to their clients on issues of
international finance
• Two major features that distinguish international banks
from domestic banks are
• The types of deposits they accept and loans and
investments they make
• The underwriting of Eurobonds and foreign bonds
 Reasons and Needs for International Bank
• The main reason why international banks are needed is
to perform many important tasks to help the
international transactions of the multinational
companies
• These include
• To finance foreign trade and investment
• To underwrite international bonds
• To lend and borrow in the Eurodollar market
• To organize syndicated loans
• To manage international cash management
 Organizational Set up for international Banking
A Representative Office
• Is as small service facility staffed by parent bank
personnel, to assist MNC clients in its dealing with the
bank’s correspondent
A Foreign Branch Bank
• Is a branch that operates like a local bank, but legally it
is a part of the parent bank
• It is therefore subject to the banking regulation of its
home country and the country in which it operates
• It offer fuller range of services to its customers than RO
 Organizational Set up for international Banking
A Subsidiary Bank
• Is as a locally incorporated bank that is either wholly
owned or owned in major part by a foreign subsidiary
An Affiliate Bank
• Is one that is only partially owned, but not controlled
by its foreign parent
Both the subsidiary and affiliate banks operate under the
banking laws of the country in which they are
incorporated
 Organizational Set up for international Banking
Offshore Banking Centre (London, New York and Tokyo)
• Is a country whose banking system is organized to
permit external accounts beyond normal economic
activities of the country
• Offshore banks operate as branches or subsidiaries of
the parent bank
• The primary activities of the offshore banks are to seek
deposits and grant loans in currencies other than the
currency of the host government
 Organizational Set up for international Banking
Correspondent Bank
• Correspondent banking relationship is established when two
banks maintain a correspondent bank account with one
another
• A correspondent bank account is an account opened by one
bank at a bank in another country for the purpose of
facilitating payments of its clients from and to that country
• Correspondent banking system provides a means for a bank’s
MNC clients to conduct business worldwide through its local
bank or its contacts
 International Money Market
• The international money market is a market where
international currency transactions between numerous
central banks of countries are carried on.
• The transactions are mainly carried out using gold or in US
dollar as a base.
• The basic operations of the international money market
include the money borrowed or lent by the governments or
the large financial institutions.
• The international money market is governed by the
transnational monetary transaction policies of various
nations’ currencies.
 International Money Market
• The international money market’s major responsibility is to
handle the currency trading between the countries.
• This process of trading a country’s currency with another one
is also known as forex trading.
• Unlike share markets, the international money market sees
very large funds transfer.
• The players of the market are not individuals; they are very
big financial institutions.
• The international money market investments are less risky
and consequently, the returns obtained from the investments
are less too.
 International Money Market
• The best and most popular investment method in the
international money market is via money market mutual
funds or treasury bills.
 Internal vs External Financing
• Most countries base their planning for national development
on the domestic capital
• However, to some extent they have to use the opportunity of
the available foreign capital
• Developing countries have to depend on foreign capital for
financing their development programs because of low level
of income and low level of capital accumulation
• The degree of dependence, however, varies from country to
country depending upon:
1. Its level of mobilization of domestic capital
2. Level of technology and the attitude of the government
 Why Foreign Currency Financing?
The need for foreign capital in a developing country like Tanzania
arises on account of the following
1. Inadequacy of Domestic Capital
Foreign capital is needed to meet the big requirements of
development projects to develop and industrialize.
2. Due to technology gap, it is necessary to import foreign
technology. Such technology usually comes along with
foreign capital in the form of private foreign investments or
foreign collaboration
3. Development of Basic infrastructure
• Foreign capital helps to finance infrastructural facilities
 Implication of International Parity Conditions
• Two parity conditions are important to explain the advantage
of foreign currency financing
• The international fisher effect and the purchasing power
parity
The International Fisher Effect
• With the international Fisher Effect, the effect of the
differences in the interest rates in two countries to the
exchange rate are considered
• Normally interest rates are lower in countries whose
economies are stronger, and hence it is cheaper to borrow
from them
 Implication of International Parity Conditions
• However, the advantages obtained by cheaper financing will
be eroded by the loss in the domestic exchange rate at the
time of repatriation of funds
• Thus, at the end of the transaction, the cost of borrowing will
be the same as the domestic cost of borrowing
 Implication of International Parity Conditions
The Purchasing Power Parity combined with Fisher Effect
• The PPP shows the relationship between the inflation differentials in
the two countries and the exchange rates
• But also, the fisher effect shows the relationship between inflation
and the nominal interest rates.
• When we combine these two parity conditions, we observe that
countries with weaker economies have higher inflation in most of the
cases
• The higher inflation results into higher nominal interest rates in the
weaker economies
• Hence, it is cheaper for developing countries to borrow from
developed countries
 Implication of International Parity Conditions
• However, the advantages obtained by cheaper
financing will be eroded by the loss in the domestic
exchange rate at the time of repatriation of funds
• Thus, at the end of the transaction, the cost of
borrowing will be the same as the domestic cost of
borrowing
 Eurocurrency Market
• All the world currencies banked outside their countries
of origin are called Eurocurrency and trade on the
Eurocurrency market
• e.g. US dollars in Tokyo are called Eurodollars, British
pounds in New York are called Europounds, Euros in
New York are Euroeuros etc
• The Eurocurrency market is characterized by large
transactions, involving only the largest companies,
banks and governments
 Origin of Eurocurrency Market
• The Eurocurrency market began to develop in the 1950s,
when the Eastern Bloc countries were afraid the United
States might seize their holdings of dollars
• It means that instead of depositing their dollars in the
United States, they deposited them in Europe
• Additional dollar deposits came from Western European
central banks and companies that exported to the United
States
• The Eurocurrency market has grown rapidly mainly due to
the existence of various US regulations that have raised costs
and lowered returns on domestic banking transactions
 Origin of Eurocurrency Market
• The origin of the Eurocurrency market can be traced back to the
1920s when the US dollars were deposited in the European banks
which converted them into their local currencies for lending
purposes.
• But the real growth of the Eurocurrency market began after the
Second World War.
• The following factors led to its growth:
1. Flow of US Aid:
• After WW2 US emerged as the most powerful nation
• It spent huge sums of money on the rehabilitation of Europe both in
terms of economic and military aid.
• Thus the transfer of a large amounts of dollars in Euro-banks
 Origin of Eurocurrency Market
2. Cold War:
• The cold war started in the 1950s led the Soviet Union and
the East European governments to transfer their dollar
deposits from America to European banks for fear that they
might be blocked by the American Government.
3. Decline in the Importance of the Pound Sterling:
• In the post-war period Britain emerged as a debtor country.
• Consequently, the British sterling which had dominated the
international financial market in the pre-war era gave place
to the dollar in the post-war period.
 Origin of Eurocurrency Market
4. BOP Deficits in US:
• There have been large and persistent BOP deficits in the
US thereby leading to the outflow of the US dollars to
the Euro-banks in countries having surplus with it

• Eurobank: is any bank that accepts deposits in currency

other than its domestic currency
 Origin of Eurocurrency Market
• The market developed first in London as banks needed a
market for dollar deposits outside the United States
• Dollars held outside the United States are referred to as
eurodollars, even if they are held in Asian markets such
as Singapore or Caribbean markets
• The eurocurrency market has expanded to include other
currencies such as the yen and the British pound
whenever they trade outside of their home market
• However, the eurodollar market remains the largest
 Features of Eurocurrency Market
• The Euro-currency market is an international market which accepts
deposits and gives credit in currencies from throughout the world
• It is a free and independent market which does not function under the
control of any monetary authority
• It is a wholesale market in which different currencies are bought and
sold usually above $ 1 million
• It is a highly competitive market in which the supply and demand for
currencies depends on interest rate changes of Eurobanks
• It is a short-term money market in which deposits in different currencies
are usually accepted for a period ranging from a few days to a year and
interest is paid on them.
• It is an inter-bank market in which the Euro-banks borrow and lend
dollars and other Euro-currencies from each other.
 Eurocurrency Market
Sources of Eurocurrency Deposits
• Governments with excess funds from prolonged trade
surplus
• Commercial banks with excess currency
• International companies with excess cash
• Extremely rich individuals
Value
• Eurocurrency market is valued at around $6 trillion,
and London accounts for 20% of all deposits
 Interbank Eurocurrency Interest Rates
Interbank interest rates are interest rates that the world’s
largest banks charge one another for loans
• London Interbank Offer Rate (LIBOR) is the interest rate
charged by London banks to other large banks borrowing
Eurocurrency
• London Interbank Bid Rate (LIBID) is the interest rate
offered by London banks to large investors for
Eurocurrency deposits
 Eurocurrency Market
Why is Eurocurrency market found to be attractive
1. Complete absence of regulation lowers the costs
• Banks charge borrowers less and pays investors more
and still obtain profit
2. Low transaction costs because transactions are large
 The Positive Economic Consequences of Eurocurrency Market
• The expansion of the Euro-currency market has greatly
increased international capital mobility and has helped in
reducing the global liquidity problem
• It has helped in integrating international capital markets
• It has played an effective role in recycling funds from
countries having surplus balance of payments to those having
deficit balance of payments
• International flows of Eurocurrencies have improved
economic efficiency by reducing interest differential among
nations
 Eurocurrency Market
Disadvantage of Eurocurrency Market
• There is greater risk because of the lack of
government regulation

However, Eurocurrency transactions are fairly safe

because of the size of banks invovled
 Financing with a Portfolio of Currencies
• If a firm borrows a single foreign currency, it is especially
vulnerable to that currency’s exchange rate
• The firm can lower its vulnerability to any single currency by
borrowing a portfolio
• Currencies which are volatile and highly correlated with each
other could cause the effective financing rate of the portfolio
to be very volatile over time.
• Ideally, the currencies comprising the portfolio would have a
low degree of volatility or negative correlations.
• This would reduce the exchange rate risk of the portfolio.
 International Capital Market
• A capital market is a system that allocates financial resources
in the form of debt and equity according to their most
efficient uses.
• Its main purpose is to provide a mechanism to borrow or
invest money efficiently
• The international Capital market is a network of individuals,
companies, financial institutions and governments that invest
and borrow across national boundaries
• Large international banks gather excess cash of investors and
savers around the world and then channel it to global
borrowers
 International Capital Market
Purposes of International Capital Market
1. Expand money supply to borrowers
• Companies unable to obtain funds from investors in the domestic
market seek financing in the international market
• Essential for firms in countries with small or developing capital
markets or emerging stock market
• An expanded supply of money benefits small companies
2. Reducing the cost of money for borrowers
• An expanded money supply reduces the cost of borrowing
• Projects regarded as infeasible because of low expected returns
might be viable at a lower financing cost
3. Reduce risk for Lenders
 International Capital Market
International Bond Financing
• International bonds are all bond sold by companies,
governments etc. outside their own countries
• Tanzanian companies can also sell bonds outside the country
to obtain the capital they need for their business
• Buyers include medium to large size banks, pension funds etc
Types of International Bonds
1. Eurobonds
• These are bonds issued outside the country in whose currency it
is denominated - about 75-80% of all international bonds
• The cost is low due to absence of regulation but risk is high
 International Capital Market
International Bond Financing
2. Foreign Bonds
• These are bonds sold outside borrower’s country and
denominated in currency of the country in which it is sold
(e.g. Yen denominated bond issued by a German
Company in Japan’s bond market)
• It accounts for 20-25% of all international bonds
• There are regulations to be followed, including the
disclosure of the details of the company activity
 International Capital Market
International Bank Loan Financing
• These are loans from international banks. Tanzanian
corporate sector is permitted to raise finance through
international loans within the framework of policies and
procedures prescribed by the government.
• The government keeps prudential limits for total external
borrowings
• The interest of the government is to keep the maturity of the
loans long and costs low, while encouraging export sector
financing
• The guidelines change from time to time
 International Capital Market
International Equity Financing
• This is a way of financing which involves the shares bought
and sold outside the issuer’s home country
• Companies and governments issue equity shares which are
bought by other companies, banks, pension funds and
individuals
Increase of Int. Equity Financing in Developing countries
1. Spread of privatization
2. Economic Growth
3. Activity of Investment Banks
4. Advent of Cybermarkets
 International Capital Market
International Equity Financing
1. Spread of Privatization
• A single privatization often places millions of dollars of new
shares on stock markets
• Increasing privatization in developing countries is expanding
international equity
2. Economic Growth in Developing countries
• Growth in developing countries contributes to growth in the
international equity market
• Because of limited supply of funds in developing countries
the international equity market is a major source of funds
 International Capital Market
International Equity Financing
3. Activity of Investment Banks
• Investment banks facilitate the sale of shares worldwide by
bringing together sellers and large potential buyers
• Investment banks prefer international equity than listing a
company’s share on another country’s stock exchange
4. Advent of Cyber markets
• Stock markets that have no central geographic location, but
consists of online global trading activities that allow listing of
stocks worldwide for electronic 24-hour trading