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International Banking and
Money Market
Chapter Objective: Differentiate between international bank and domestic
bank operations and examine the differences of variousinternational banking offices.
Chapter Outline
International Banking Services Types of International Banking Offices
Capital Adequacy Standards
International Money Market
6Chapter six
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International Banking Services
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).
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W
orlds 10 Largest Banks
Citigroup U.S.
Mizuho Bank/ Mizuho Corp Bank JapanHSBC Holdings U.K.
Bank of America U.S.
JP Morgan Chase U.S.
Deutsche Bank Germany
Royal Bank of Scotland Group U.K.
Sumitomo Mitsui Banking Group Japan
HypoVereinsbank Germany
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Types of International
Banking Offices
1. Correspondent bank
Banks located in different countries establish accountsin other bank
Provides a means for a banks MNC clients to conductbusiness worldwide through his local bank or itscontacts.
Provides income for large banks Smaller foreign banks that want to do business ,say in the
U.S., will enter into a correspondent relationship with alarge U.S. bank for a fee
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Types of International
Banking Offices
2. Representative office
A small service facility staffed by parent bank personnel
that is designed to assist MNC clients of the parent bank indealings with the banks correspondents.
No traditional credit services provided
Reps looks for foreign market opportunities and serves as a liaisonbetween parent and clients
Useful in newly emerging markets Representative offices also assist with information about
local business customs, and credit evaluation of the MNCslocal customers.
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Types of International
Banking Offices
3. Foreign Branch
Aforeign branch bankoperates like a local bank, but is
legally part of the parent. Subject to both the banking regulations of home country
and foreign country.
Reasons for establishing a foreign branch More extensive range of services
Foreign branches are not subject to Canadian reserve requirementsor deposit insurance
Compete with host country banks at the local level
Most popular means of internationalizing bank operations
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Types of International
Banking Offices
4. Subsidiary and Affiliate Bank
A subsidiary bankis a locally incorporated bank that iseither wholly owned or owned in major part by a foreign
parents.
An affiliate bankis one that is only partially owned, but not
controlled by its foreign parent.
Both subsidiary and affiliate banks operate under the
banking laws of the country in which they are incorporated.
They are allowed to underwrite securities.
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Types of International
Banking Offices5. Offshore Banking Center 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. Banks operate as branches or subsidiaries of the parent bank
Primary credit services provided in currency other than host countrycurrency
Reasons for offshore banks Low or no taxes, services provided for nonresident clients, few or no FX
controls, legal regime that upholds bank secrecy
The IMF recognizes the Bahamas, Bahrain, the Cayman Islands,Hong Kong, the Netherlands Antilles, Panama, Singapore as
major offshore banking centers
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Capital Adequacy Standards
Bank capital adequacy = equity capital and othersecurities a bank holds as reserves.
How much bank capital is enough to ensure thesafety and soundness of the banking system?
Basle Accord 1 (1988): Rules-basedapproach + VAR
Basle Accord2
(2
003
- ?) -3
pillars-min. cap. Requirements-supervisory review process-market discipline
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Basle Accord I: minimum bankcapital
adequacy ratio (rules-based)
Banks involved in cross-border transactions.
Min. Cap. Adequacy = 8% [risk weighted assets]Tier I Core capital = shareholder equity + retained earnings
Tier II Supplemental capital = internationally recognized
non-equity items
Tier II < 50% total bank capital
AssetWeights:Government obligations = 0%; short-term interbank assets =20%
Residential mortgages =50%; other assets = 100%
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Basle Accord I:
Risk-focused Cap. adequacy
1996 amendment allows banks to use modern portfolio models to
specify adequate Cap. Adequacy.
VAR(value-at-risk) = loss exceeded with a specified probabilityover a specified time period.
1% chance: maximum loss over 10 days > banks capital
VAR = (PV)(W)(Z.01)(D1/2)
PV = portfolio value;
W = standard deviation of return(daily);
Z.01 = standard normal value for 1-tail confidence interval;
D = days
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International Money Market
Eurocurrency is a time deposit in an international
bank located in a country different than the country
that issued the currency.
Eurodollars are U.S. dollar-denominated time deposits in
banks located outside the United States.
Euroyen are yen-denominated time deposits in banks
located outside of Japan.
The foreign bank doesnt have to be located in Europe.
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Eurocurrency Market
This is an external banking system that runs parallel to the
domestic banking system.Banks seek deposits and make loans to other Eurobanks.
- loan interest rate is the interbank offered rate.
- interbank deposit interest rate is the interbank bid rate.
Lower cost structure:
Reserve requirement - NODeposit insurance - NO
Rapid growth, especially in the Eurodollar market.
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Eurocurrency Market
Most Eurocurrency transactions are interbank
transactions in the amount of$1,000,000 and up.
Common reference rates include
LIBOR= London Interbank Offered Rate
PIBOR= Paris Interbank Offered Rate
SIBOR= Singapore Interbank Offered Rate
New reference rate for the euro
EURIBOR= rate at which interbank time deposits of
are offered by one prime bank to another.
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Forward Rate Agreements
An interbank contract that involves two parties, a buyer and aseller.
The buyer agrees to pay the seller the increased interest cost on anotional amount if interest rates fall below an agreed rate.
The seller agrees to pay the buyer the increased interest cost ifinterest rates increase above the agreed rate.
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.
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360/*)(*
daysSR
daysARSRountNotionalamFRApayment
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Euronotes
Short-term notes underwritten by a group of
international investment banks or international
commercial banks (facility). 3-6 months
They are sold at a discount from face value and pay
back the full face value at maturity.
Interest rate usually less than syndicated Eurobankloans. LIBOR + 1/8%, for example.
Bank receives a small fee for underwriting.
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Eurocommercial Paper
Unsecured short-term promissory notes issued by
corporations and banks. 1-6 months.
Placed directly with the public through a dealer.
Eurocommercial paper, while typically U.S. dollar
denominated, is often of lower quality than U.S.
commercial paperas a result yields are higher. Eurocommercial paper2001 = $243.1billion
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International Debt Crisis
Some of the largest banks in the world wereendangered when loans to sovereign governments
of some less-developed countries. At the height of the crisis, third world countries
owed $1.2 trillion.
Like a great many calamities, it is easy to see in
retrospect that: Its a bad idea to put too many eggs in one basket,especially if: You dont know much about that basket.
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Debt-for-Equity Swaps
As part of debt rescheduling agreements among the banklending syndicates and the debtor nations, creditor banks
would sell their loans for U.S. dollars at discounts from facevalue to MNCs desiring to make equity investment insubsidiaries or local firms in the LDCs.
A LDC central bank would buy the bank debt from a MNCat a smaller discount than the MNC paid, but in local
currency. The MNC would use the local currency to make pre-
approved new investment in the LDC that was economicallyor socially beneficial to the LDC.
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Debt-for-Equity Swap
IllustrationInternational
Bank
Equity
Investor or
MNC
LDC Central
Bank
LDC firm or
MNC
subsidiary
$60m Sell $100mLDC debt at
60% of face
Redeem LDC
debt at 80% of
face in local
currency
$80m in local
currency
$80m in
local
currency
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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.
Japanese commercial banks have historically served as the financing arm
and center of a collaborative group know as keiretsu. Keiretsu members have cross-holdings of an anothers equity and ties of
trade and credit.
The collapse of the Japanese stock market set in motion a downwardspiral for the entire Japanese economy and in particular Japanese banks.
This put in jeopardy massive amounts of bank loans to corporations.
It is unlikely that the Japanese banking crisis will be rectified anytimesoon. The Japanese financial system does not have a legal infrastructure that
allows for restructuring of bad bank loans.
Japanese bank managers have little incentive to change because of theKeiretsu structure.
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The Asian Crisis This crisis followed a period of economic expansion in the region
financed by record private capital inflows.
Bankers from the G-10 countries actively sought to finance thegrowth opportunities in Asia by providing businesses with a fullrange of products and services.
This led to domestic price bubbles in East Asia, particularly inreal estate.
Additionally, the close interrelationships common amongcommercial firms and financial institutions in Asia resulted in
poor investment decision making.
The Asian crisis is only the latest example of banks making amultitude of poor loansspurred on no doubt by competitionfrom other banks to make loans in the hot region.