International Banking and 6

Money Market Chapter six

Chapter Objective:
• Differentiate between international bank and domestic
bank operations and examine the differences of various
international banking offices.
Chapter Outline
 International Banking Services
 Types of International Banking Offices
 Capital Adequacy Standards
 International Money Market
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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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 World’s 10 Largest Banks

Citigroup U.S.
Mizuho Bank/ Mizuho Corp Bank Japan
HSBC 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 accounts
in other bank
 Provides a means for a bank’s MNC clients to conduct
business worldwide through his local bank or its
contacts.
 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 a
large 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 in
dealings with the bank’s correspondents.
 No traditional credit services provided
 Reps looks for foreign market opportunities and serves as a liaison
between parent and clients
 Useful in newly emerging markets
 Representative offices also assist with information about
local business customs, and credit evaluation of the MNC’s
local customers.

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 Types of International
Banking Offices
3. Foreign Branch
 A foreign branch bank operates 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 requirements
or 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 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.

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 Types of International
Banking Offices
5. 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 country
currency
 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 other

securities a bank holds as reserves.
 How much bank capital is “enough” to ensure the
safety and soundness of the banking system?
 Basle Accord 1 (1988): Rules-based approach + VAR
 Basle Accord 2 (2003 - ?) - 3 pillars
-min. cap. Requirements
-supervisory review process
-market discipline

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 Basle Accord I: minimum bank capital
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
 Asset Weights:
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 probability

over a specified time period.

1% chance: maximum loss over 10 days > bank’s capital

VAR = (PV)()(Z.01)(D1/2)
PV = portfolio value;
 = 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 doesn’t 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 - NO
Deposit 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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 Eurocredits

 Short- 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.
 Adjustable rate - Rollover 3-6 mo. Example 6.1
 On Eurocredits originating in London, the base rate
is LIBOR + X% based on the creditworthiness of
the borrower.
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 Forward Rate Agreements

 An interbank contract that involves two parties, a buyer and a

seller.
 The buyer agrees to pay the seller the increased interest cost on a
notional 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.
 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.
Notionalam ount * ( SR  AR) * days / 360
FRApayment 
1  ( SR * days / 360)
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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 Eurobank
loans. 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 paper—as a result yields are higher.
 Eurocommercial paper 2001 = $243.1billion

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 International Debt Crisis

 Some of the largest banks in the world were

endangered 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:
 It’s a bad idea to put too many eggs in one basket,
especially if:
 You don’t know much about that basket.

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 Debt-for-Equity Swaps

 As part of debt rescheduling agreements among the bank

lending syndicates and the debtor nations, creditor banks
would sell their loans for U.S. dollars at discounts from face
value to MNCs desiring to make equity investment in
subsidiaries or local firms in the LDCs.
 A LDC central bank would buy the bank debt from a MNC
at 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 economically
or socially beneficial to the LDC.

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 Debt-for-Equity Swap
Illustration
International
Bank
Sell $100m
$60m LDC debt at
$80m in
LDC firm or Equity 60% of face
local
MNC currency Investor or
subsidiary MNC
Redeem LDC
$80m in local
debt at 80% of
currency
LDC Central face in local
Bank 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 another’s equity and ties of
trade and credit.
 The collapse of the Japanese stock market set in motion a downward spiral
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 anytime soon.
 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 the Keiretsu
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 the
growth opportunities in Asia by providing businesses with a full
range of products and services.
 This led to domestic price bubbles in East Asia, particularly in
real estate.
 Additionally, the close interrelationships common among
commercial firms and financial institutions in Asia resulted in
poor investment decision making.
 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.
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