chapter 6 banking and money markets management 3460 institutions and practices in international...
TRANSCRIPT
Chapter 6 Banking and Money Markets
Management 3460 Institutions and Practices in
International Finance
Fall 2003Greg Flanagan
Oct 23, 2003 2
Chapter Objectives The student will be able to:
Describe the banking systemThe IMFCentral banksThe Bank of International Settlements
(BIS)Commercial banks—domestic International banking services
Oct 23, 2003 3
The student will be able to:
List and discuss the different international banking services.
List and discuss the reasons for international banking services.
Explain capital adequacy and the reasons for it.Explain the calculation of Value at Risk
(VAR)
Oct 23, 2003 4
The student will be able to:
Explain the international money marketDescribe the creation of eurocurency.
Explain the supply and demand of loanable funds.
Differentiate theInterbank offered rates: LIBOR; SIBOR; PIBOR; EURIBOR.
Eurocredits, Euronotes, Euro commercial paper.
Oct 23, 2003 5
Banking System The World Bank
“Not a bank, but rather a specialized agency.” The IMF
promoting international monetary cooperation; facilitating the expansion and balanced growth of
international trade; promoting exchange stability; assisting in the establishment of a multilateral system of
payments; and making its resources available (under adequate
safeguards) to members experiencing balance of payments difficulties
Oct 23, 2003 6
Banking System More generally, the IMF is responsible for
ensuring the stability of the international monetary and financial system—the system of international payments and exchange rates among national currenciesIMF Videos
Oct 23, 2003 7
Banking System Bank of International Settlements BIS Central Banks
Bank of Canada• FX market intervention• Foreign exchange reserves stood at US$37.2 billion
at the end of 2002,
• up from US$34.2 billion at the end of 2001, primarily owing to a revaluation resulting from the appreciation of the euro against the U.S. dollar.
Commercial banks—domestic
Oct 23, 2003 8
Banking System
Domestic commercial bankssupervised by central bankprovide retail services and productsinvesthold depositsmake loans
Oct 23, 2003 9
Banking System
Assets Liabilities
Deposits:
Loans:
+$1000
Cash:
+$1000
+$900 +$900
$1000$1000Balance
10% reserves
$1900$1900Balance
$100
-$900
Bank A
A single bank only lends out its excess reserves.
Oct 23, 2003 10
Banking System
+$900
Assets Liabilities
Deposits:
Loans:
Cash:
+$900
+$810 +$810
$900$900Balance
10% reserves
$1710$1710Balance
$90
-$810
And so on to Bank C and Bank D….
Bank B
Oct 23, 2003 11
Banking System
+$1000
Assets Liabilities
Deposits:
Loans:
Cash:
+$1000
+$9,000 +$9,000
$10,000$10,000Balance
10% reservesAll Commercial Banks
Money has been created!
Oct 23, 2003 12
Banking System
International Banks do everything domestic banks do and:Arrange trade financing.Arrange foreign exchange.Offer hedging services for foreign currency
receivables and payables through forward and option contracts.
Offer investment banking services (where allowed).
Oct 23, 2003 13
The World’s 50 Largest Banks Bank Country Equity Assets Net Income
Oct 23, 2003 14
The World’s 50 Largest Banks Bank Country Equity Assets Net Income
Oct 23, 2003 15
The World’s 50 Largest Banks Bank Country Equity Assets Net Income
Oct 23, 2003 16
Reasons for International Banking
PrestigeRegulatory AdvantageWholesale Defensive StrategyRetail Defensive StrategyTransactions CostsGrowthRisk Reduction
Greater stability of earnings due to diversification
Oct 23, 2003 17
Types of International Banking Offices
Correspondent BankRepresentative OfficesForeign BranchesSubsidiary and Affiliate BanksEdge Act BanksOffshore Banking Centers International Banking Facilities
Oct 23, 2003 18
Correspondent Bank
A correspondent banking relationship exists when two banks maintain deposits with each other.
Correspondent banking allows a bank’s MNC client to conduct business worldwide through his local bank or its correspondents.
Oct 23, 2003 19
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.
Representative offices also assist with information about local business customs, and credit evaluation of the MNC’s local customers.
Oct 23, 2003 20
Foreign Branches
A foreign branch bank operates like a local bank, but is legally part of the the parent.Subject to both the banking regulations of
home country and foreign country.Can provide a much fuller range of
services than a representative office.Branch Banks are the most popular way for
domestic banks to expand overseas.
Oct 23, 2003 21
Subsidiary and Affiliate Banks
A subsidiary bank is a locally incorporated bank wholly or partly owned by a foreign parent.
An affiliate bank is one that is partly owned but not controlled by the parent.
U.S. parent banks like foreign subsidiaries because they allow U.S. banks to underwrite securities.
Oct 23, 2003 22
Edge Act Banks
Edge Act banks are federally chartered subsidiaries of U.S. banks that are physically located in the U.S. that are allowed to engage in a full range of international banking activities.
The Edge Act was a 1919 amendment to Section 25 of the 1914 Federal Reserve Act.
Oct 23, 2003 23
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.
The host country usually grants complete freedom from host-country governmental banking regulations.
Oct 23, 2003 24
Offshore Banking Centers
The IMF recognizes as major offshore banking centersthe BahamasBahrainthe Cayman IslandsHong Kongthe Netherlands AntillesPanamaSingapore
Oct 23, 2003 25
“Shell” Branches
Shell branches need to be nothing more than a post office box.
The actual business is done by the parent bank at the parent bank.
The purpose was to allow U.S. banks to compete internationally without the expense of setting up operations “for real”.
Oct 23, 2003 26
International Banking Facilities
An international banking facility is a separate set of accounts that are segregated on the parents books.
An international banking facility is not a unique physical or legal identity.
Any U.S. bank can have one. International banking facilities have
captured a lot of the Eurodollar business that was previously handled offshore.
Oct 23, 2003 27
Capital Adequacy Standards
Bank capital adequacy refers to the amount of equity capital and other securities a bank holds as reserves.
There are various standards and international agreements regarding how much bank capital is “enough” to ensure the safety and soundness of the banking system.
Oct 23, 2003 28
Capital Adequacy Standards Traditional bank capital standards may be
enough to protect depositors from traditional credit risk, they may not be sufficient protection from derivative risk.i.e. Barings Bank, collapsed in 1995 from
derivative losses, but looked OK on paper relative to capital adequacy standards.
Value-at-Risk (VAR)
Oct 23, 2003 29
Value-at-Risk (VAR) BIS Basle Accord
VAR = Portfolio Value X Daily Standard Deviation of return X Confidence Interval factor X SQRT(time horizon)
Portfolio Value is known 99% Confidence Interval factor = 2.326 SQRT 10 day horizon =3.1622 Daily Standard Deviation of return needs to
be estimated
Oct 23, 2003 30
Value-at-Risk (VAR) Example: Portfolio value = $500M Daily Standard Deviation of return
estimated at .67% $500M X .0067 X 2.326 X 3.1622
= $24.64M
The probability of loss greater than this is1%
Oct 23, 2003 31
Money Markets
Q*
Interestrate
Loanable funds (Eurocurrency)
Demand
Supply
i*
S2
i**
Q**
Oct 23, 2003 32
International Money MarketEurocurrency is a time deposit in an
international bank located in a country different than the country that issued the currency.i.e. Eurodollars are US$-denominated time
deposits in banks located abroad.Euroyen are yen-denominated time deposits
in banks located outside of Japan.The foreign bank doesn’t have to be located
in Europe.
Oct 23, 2003 33
Eurocurrency MarketMost Eurocurrency transactions are
interbank transactions in the amount of $1,000,000 and up.
Common reference rates includeLIBOR the London Interbank Offered
RatePIBOR the Paris Interbank Offered RateSIBOR the Singapore Interbank Offered
Rate
Oct 23, 2003 34
Eurocurrency Market
A new reference rate for the new euro currency
EURIBOR the rate at which interbank time deposits of € are offered by one prime bank to another.
Oct 23, 2003 35
EurocreditsEurocredits are short- to medium-term loans
of Eurocurrency.The loans are denominated in currencies
other than the home currency of the Eurobank.
Often the loans are too large for one bank to underwrite; a number of banks form a syndicate to share the risk of the loan.
Eurocredits feature an adjustable rate. On Eurocredits originating in London the base rate is LIBOR.
Oct 23, 2003 36
Forward Rate AgreementsAn interbank contract that involves two
parties, a buyer and a seller.The buyer agrees to pay the seller the
increased interest cost on a notational amount if interest rates fall below an agreed rate.
The seller agrees to pay the buyer the increased interest cost if interest rates increase above the agreed rate.
Oct 23, 2003 37
Forward Rate Agreements: Uses
Forward Rate Agreements can be used to: Hedge assets that a bank currently owns
against interest rate risk.Speculate on the future course of interest
rates.
Oct 23, 2003 38
Forward Rate AgreementsBank wishes to hedge a deposit cost over a
time period against a loan return over a different time period.
The Bank will sell a forward rate agreement.Settlement rate–SR Agreement rate–AR The payment equals
Note Amount X (SR-AR) X days/360
1+ (SR X days/360)
Oct 23, 2003 39
Forward Rate AgreementsExample: A bank has a loan out at 4.5% and is
paying deposits at a lower rate—the spread.Note = $1,000,000 Agreement rate = 4.5%;
Settlement rate = 5%; the forward rate period = 91days (three months)
$1,000,000 X (.05-.045) X 91/360 1+ (.05 X 91/360)$1,000,000 X .005 X .25 1.0125
= $1,234.57
Bank pays this as the SR > AR
Oct 23, 2003 40
EuronotesEuronotes 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.
Oct 23, 2003 41
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.
Oct 23, 2003 42
Eurocommercial PaperUnsecured short-term promissory notes issued
by corporations and banks.Placed directly with the public through a dealer.Maturities typically range from one month to six
months.Eurocommercial paper, while typically U.S.
dollar denominated, is often of lower quality than U.S. commercial paper—as a result yields are higher.