International BankingLecture # 07

International Banking ServicesInternational 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 contractsOffer investment banking services (where allowed).Borrow or lend in Eurocurrency marketUnderwrite Eurobonds and foreign bonds

Letter of CreditIssued by a bank at the request of its customer, the Importer (Buyer), whereby the bank promises to pay the Exporter (Beneficiary) for goods or services, provided that the Exporter presents all documents

Revocable: revoked without the consent of the Exporter up to the time the documents are presentedIrrevocable: cannot be cancelled or changed without the consent of all parties, including the Exporter

Letters of CreditTypes on basis of PaymentSight Letter of Credit: payment is to be made at the time documents are presentedUsance or deferred payment Letter of Credit: payment is to be made at a future fixed time from presentation of documents (e.g. 60 days after sight)

Issuance of Letter of Credit

Payment Under a Letter of Credit

Advantages and Disadvantages of LCAdvantages to the ImporterImporter is assured that the Exporter will be paid only if all terms and conditions of the Letter of Credit have been met.Importer is able to negotiate more favorable trade terms with the Exporter when payment by Letter of Credit is offered.Disadvantages to the ImporterIt is necessary for the Importer to have a line of credit

Advantages and Disadvantages of LCAdvantages to the ExporterThe risk of payment relies upon the creditworthiness of the Issuing Bank not the creditworthiness of the ImporterExporter can further reduce foreign political and bank credit risk by requesting confirmation of the Letter of Credit by any other bankDisadvantages to the ExporterDocuments must be prepared and presented in strict compliance with the requirements stipulated in the Letter of Credit.Some Importers may not be able to open Letters of Credit due to the lack of credit facilities with their bank which consequently inhibits export growth.

Types of International Banking OfficesCorrespondent bankBanks located in different countries establish accounts in other bankProvides a means for a banks MNC clients to conduct business worldwide through his local bank or its contacts.Provides income for large banksSmaller foreign banks that want to do business ,say in the U.S., will enter into a correspondent relationship with a large U.S. bank for a fee

*Types of International Banking Offices 2. Representative officeA small service facility staffed by parent bank personnel that is designed to assist MNC clients of the parent bank in dealings with the banks correspondents.No traditional credit services providedLooks for foreign market opportunities and serves as a liaison between parent and clientsUseful in newly emerging marketsRepresentative offices also assist with information about local business customs, and credit evaluation of the MNCs local customers.It is useful when the bank has many MNC clients in a country

*Types of International Banking Offices 3. Foreign BranchA foreign branch bank operates like a local bank, but is legally part of the parent, not a separate entity.Subject to both the banking regulations of home country and foreign country.Reasons for establishing a foreign branchMore extensive range of services (faster check clearing, larger loans)Compete with host country banks at the local levelMost popular means of internationalizing bank operations

*Types of International Banking Offices4. Subsidiary and Affiliate BankA subsidiary bank is a locally incorporated bank that is either wholly owned or owned in major part by a foreign parents. An affiliate bank is 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.

*Types of International Banking Offices 5. Offshore Banking CenterA 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 bankPrimary credit services provided in currency other than host country currencyReasons for offshore banksLow or no taxes, services provided for nonresident clients, few or no FX controls, legal regime that upholds bank secrecy

*International Money MarketEurocurrency 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.

*Eurocurrency MarketThis 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.

Common reference rates includeLIBOR = London Interbank Offered RatePIBOR = Paris Interbank Offered RateSIBOR = Singapore Interbank Offered Rate

*EurocreditsShort- to medium-term loans of Eurocurrency to corporations, governments, nonprime banks or international organizations.Loans are often too large for one bank to underwrite; a syndicate of banks share the risk of the loan.

*Euronotes and Eurocommercial PapersEuronotesShort-term notes underwritten by a group of international investment banks or international commercial banks (facility). 3-6 monthsThey are sold at a discount from face value and pay back the full face value at maturity.Bank receives a small fee for underwriting.

Euro Commercial Papers

Unsecured short-term promissory notes issued by corporations and banks. 1-6 months.Placed directly with the public through a dealer.

Money, the economy, and inflation

InflationInflation is an increase in the overall price level.Sustained inflation is an increase in the overall price level that continues over a significant period.Deflation is a decrease in the overall price level.

Price IndexesPrice indexes are used to measure overall price levels. The price index that pertains to all goods and services in the economy is the GDP price index.The consumer price index (CPI) is a price index computed each month by the Bureau of Labor Statistics using a bundle that is meant to represent the market basket purchased monthly by the typical urban consumer.

Inflation

Price of basket in any given year CPI= --------------------------------------------Price of basket in the BASE year

The inflation rate is the percent change in the CPI .

Good Year 1 2 3Quantity Price Price Price Pizzas 20 $ 10 $ 11 $ 13 Rent 1 $ 600 $ 640 $ 650 Car 1 $ 100 $ 120 $ 120 Phone 1 $ 50 $ 40 $ 40

Types of InflationCost Push InflationDemand Pull inflationHyper Inflation

The Costs of InflationPeoples income increases during inflations, when most prices, including input prices, tend to rise together.Inflation changes the distribution of income. People living on fixed incomes are particularly hurt by inflation.The benefits received by many retired workers, including social security, are fully indexed to inflation. When prices rise, benefits rise.The poor have not fared so well. Welfare benefits are not indexed and have not kept pace with inflation.

The Costs of InflationUnanticipated inflationan inflation that takes people by surprisecan hurt creditors.Inflation that is higher than expected benefits debtors; inflation that is lower than expected benefits creditors.The real interest rate is the difference between the interest rate on a loan and the inflation rate.