Overview Although many FIs can diversify domestically, the benefits to global diversification are available only to large firms. This chapter explores the potential risk-return advantages and disadvantages of international expansion and the trends toward globalization of FI franchises. As countries such as the U.S. expand, some countries, Japan in particular, are contracting their overseas operations.

Global & International Expansions Three ways to establish global presence Sell financial services from domestic offices to foreign customers Sell financial services through a branch, agency, or representative office in foreign customer’s country Sell financial services through subsidiary company in foreign customer’s country.

Global Expansion of FIs U.S. insurance companies and securities firms recent expansion 12 banks in the world with over 50 percent of assets in foreign countries No single country dominates the top 30 Canada had 5 in the top 30, Ireland, Netherlands, U.S. all had 3. Japanese banks absent in spite of their size

Top Global Banks (2003)

J.P. Morgan/Chase have had offices abroad since beginning of century. U.S. Banks Abroad J.P. Morgan/Chase have had offices abroad since beginning of century. Major growth began in 1960s Overseas Direct Investment Control Act, 1964. Offshore funding and lending in dollars forged beginnings of the Eurodollar market. Assets of U.S. bank activities abroad increased from $353.8 billion in 1980, to $854.4 billion in 2003. Declined in percentage terms.

Factors Encouraging U.S. Bank Expansions Abroad Dollar as international medium of exchange Effects of Euro Political risk Encouraged flows to U.S. branches and subsidiaries in Cayman Islands and Bahamas. USA Patriot Act of 2001 prohibited services to shell banks and increased efforts to control money laundering Know your customer rules

Factors Encouraging U.S. Bank Expansions Abroad Domestic activity restrictions Fed regulations permitting banks to engage in activities permitted by foreign host. Diversification benefits. Technology and communications improvements CHIPS Decreasing operating costs

Factors Deterring Expansion Capital constraints Proposed BIS 2006 reforms raise capital requirements for loans to non-OECD sovereigns rated below B- raise capital requirements for loans to OECD countries rated below AA- zero risk weights for OECD countries rated above AA-

Factors Deterring Expansion Emerging markets problems Increased caution due to Korea, Thailand, Indonesia and Argentina despite improved regulatory environment (NAFTA, for example allowing greater expansion into Mexico). WTO reduction of barriers to global expansion China as a recent noteworthy example

Factors Deterring Expansion Competition During 1990s, extensive competition from Japanese banks Japan had 9 of the 10 largest banks Effects of recession and bad debts European Community Second Banking Directive resulted in significant consolidation of European banks.

Foreign Banks in the U.S. Choice of organizational form affected by regulations in home country as well as risk management strategies Subsidiary Branch Agency Edge Act Corporation Representative Office

Rapid expansion of foreign banks in U.S. Trends and Growth Rapid expansion of foreign banks in U.S. In 1980, foreign banks had assets of $166.7 billion (10.8 percent of total U.S. bank assets) 1992, $514.3 billion (16.4 percent) 1994, $471.1 billion (13.8 percent) Retrenchments due to several factors including competitive and regulatory effects. 16.1 percent, 2000 Global recession effects 14.5 percent in 2003

Regulation of Foreign Banks in U.S. Prior to 1978, foreign branches and agencies were licensed mostly at state level. No access to discount window No direct access to Fedwire/fed funds markets No FDIC coverage

Regulation of Foreign Banks in U.S. (post 1978) Passage of International Banking Act, 1978 National treatment to level the playing field Accelerated expansion of foreign banks in U.S. Japanese bank entry into California, and subsequent sales notable

Regulation of Foreign Banks Foreign Bank Supervision Enhancement Act 1991, increased federal control. Triggered by three events: collapse of BCCI issuance of $1 billion in unauthorized letters of credit to Iraq by Atlanta agency of Banca Nazionale del Lavoro unauthorized taking of deposit funds by U.S. representative of Greek National Mortgage Bank of New York.

Features of FBSEA Fed’s approval required for entry Closure under control of Federal Reserve Daiwa Bank ordered to cease operations. Examination by Fed Deposits: Only foreign subsidiaries with FDIC coverage can take deposits under $100,000. Activity powers: restricted to activities permitted to federal branch.

Web Resources Visit Federal Reserve www.federalreserve.gov FDIC www.fdic.gov

Advantages to International Expansion Revenue and Risk diversification Economies of scale Innovations generate extra returns from selling new products abroad. Funds source Customer relationships Regulatory avoidance

Information/monitoring costs Nationalization/expropriation. Disadvantages Information/monitoring costs Example: differences in accounting standards Nationalization/expropriation. Fixed costs may be high Tokyo real estate prices for example. Uncertainty about volume of business from foreign entry versus entry costs

Pertinent websites Federal Reserve www.federalreserve.gov The Banker www.thebanker.com FDIC www.fdic.gov