Copyright© 2006 John Wiley & Sons, Inc.1 Power Point Slides for: Financial Institutions, Markets, and Money, 9th Edition Authors: Kidwell, Blackwell, Whidbee & Peterson Prepared by: Babu G. Baradwaj, Towson University and Lanny R. Martindale, Texas A&M University

CHAPTER 15 INTERNATIONAL BANKING

Copyright© 2006 John Wiley & Sons, Inc.3 Development of International Banking International banking dates back to the rise of international trade. Great Britain dominated international finance until after WW II. American banks entered international finance after 1914.

Copyright© 2006 John Wiley & Sons, Inc.4 The Edge Act (1919) Federal Reserve Act of 1913 permitted foreign branches. Agreement corporations were legalized in Details of the Edge Act Banks able to create federally chartered subsidiaries located in the United States Participated in international banking Could make equity investments U.S. banks able to compete with European banks Grew in number and activities after WW II

Copyright© 2006 John Wiley & Sons, Inc.5 Reasons U.S. Banks’ Global Expansion Increased expansion of U.S. trade and foreign markets. Growth of multinational corporations. U.S. government business regulation limited U.S. profit opportunities. Need to finance petroleum induced deficits in foreign countries.

Copyright© 2006 John Wiley & Sons, Inc.6 Recent Activity in U.S. International Banking Growth slowed in the early 1970s. U.S. regulations limiting the outflow of funds to foreign countries were eliminated. Smaller banks could not compete with larger international operations. International lending increased in OPEC increased oil prices. Oil producers and oil importers had surplus/deficit funds flow to invest or finance.

Copyright© 2006 John Wiley & Sons, Inc.7 Recent Activity in U.S. International Banking While fewer U.S. banks operate overseas, they have a larger network of global affiliates in the form of branches, overseas offices, and most importantly through correspondent banks. Since the 1990s, fewer, but larger U.S. banks are operating globally. Two of the largest banks in the world are U.S. banks – Citigroup & J. P. Morgan.

Copyright© 2006 John Wiley & Sons, Inc.8 World’s Largest Banks (2002)

Copyright© 2006 John Wiley & Sons, Inc.9 World’s Largest Banks (1990)

Copyright© 2006 John Wiley & Sons, Inc.10 Regulation of Overseas Banking Activity Domestic U.S. banking has been regulated to promote the following goals: bank safety and financial soundness and stability. bank competition - performance. banking business is "special" and kept separate (arms length) from other types of business activities. Foreign banks are not as regulated the same as U.S. banks, especially in their international banking activity.

Copyright© 2006 John Wiley & Sons, Inc.11 The Regulatory Framework Federal Reserve Act of allowed federally chartered branches outside the U.S. Amendment to Federal Reserve Act (1916) - agreement corporations permitted. Edge Act (1919) - federally chartered corporations for international banking. National banks permitted equity investments in foreign bank stock (1966).

Copyright© 2006 John Wiley & Sons, Inc.12 The Regulatory Framework Bank Holding Company Act Amendments of regulated international activities of bank holding companies. International Banking Act of extended federal regulation to foreign banks operating in the United States. The DIDMCA of 1980: expanded Fed control over foreign banks. permitted U.S. banks to establish international banking facilities. In July, 1988, the Bank for International Standards (BIS) worked out enhanced bank capital adequacy standards (effective in 1992) between leading economic nations.

Copyright© 2006 John Wiley & Sons, Inc.13 Allowable Banking Activities Traditionally more types of businesses permitted by U.S. banks operating in foreign countries to enhance competitiveness. Security underwriting Equity investments Restraints are kept on: U.S. foreign bank subsidiaries owning nonfinancial businesses. control of foreign companies.

Copyright© 2006 John Wiley & Sons, Inc.14 Delivery of Overseas Banking Services Representative offices - assist parent bank customers. Shell branches - limited wholesale money market transaction rather than retail public branches. Correspondent banks - relationship with foreign banks to provide international banking services. Foreign branches - legal branch of domestic parent banking providing full banking services in foreign country.

Copyright© 2006 John Wiley & Sons, Inc.15 Delivery of Overseas Banking Services Edge Act corporations - federally chartered subsidiaries of U.S. banks engaging in international activities not permitted domestic banks. International banking activities International financing activities Foreign Subsidiaries and Affiliates Subsidiaries - separately - (owned entirely or in part) by a U.S. bank, bank holding company, or Edge Act corporation. Affiliates - small ownership interest in foreign bank by U.S. bank.

Copyright© 2006 John Wiley & Sons, Inc.16 International Banking Facilities (IBFs) Fed permitted the IBFs beginning December May be established by a U. S chartered depository institution, a U. S. branch or agency of a foreign bank or the U. S. office of an Edge Act Corporation. They represent the balance sheet of the aggregated foreign assets and liabilities by the IBF. They are not subject to U.S. banking regulations. Deposits over $100,000 can be accepted from non U. S. residents or other IBFs. Deposits generated can be used to make foreign loans only.

Copyright© 2006 John Wiley & Sons, Inc.17 A U. S. Multinational Bank Structure

Copyright© 2006 John Wiley & Sons, Inc.18 Characteristics of International Loans Funding International loans can be denominated in almost any major currency, but the U.S. dollar is the most common. The average international loan is larger with large, multinational firms and sovereign countries as borrowers. Most large international loans are funded in the Eurocurrency market, International banks issue time deposits and make short or intermediate-term loans Banks often lend to each other in the interbank market

Copyright© 2006 John Wiley & Sons, Inc.19 Characteristics of International Loans Pricing The interbank rate in London is called the LIBOR or London Interbank Offered Rate. Nonbank borrowers pay above the LIBOR. The interest rate paid to time deposits and the rate charged borrowers will be tied to the interest rate levels of the country and currency used to denominate the deposit and loan. Lending rates are fixed for the stated credit period (usually a month) but change (float) with the LIBOR at the beginning of each (rollover) period.

Copyright© 2006 John Wiley & Sons, Inc.20 Characteristics of International Loans Syndicated Loans Several banks usually participate in funding the loans, thus spreading the risk to banks and providing the large amounts of funds needed by the borrower. One or more lead bank(s) package the loan arrangement.

Copyright© 2006 John Wiley & Sons, Inc.21 Characteristics of International Loans Collateral Most international credits are unsecured. Most business borrowers have high credit ratings. Borrowing countries pledge their "full faith and credit."

Copyright© 2006 John Wiley & Sons, Inc.22 Risks in International Lending Credit risk - the risk of default. Country risk - related to the political stability, laws, and regulations of the foreign country. Expropriation Nationalization Change of government Currency risk - risk of currency value changes and exchange controls.

Copyright© 2006 John Wiley & Sons, Inc.23 Risk Evaluation An analysis of both the borrower and borrower's country is done by the bank’s foreign lending and economic departments. Evaluation involves a statistical analysis of the country’s political and economic risks. A financial analysis of the borrower is also conducted. If the cost of doing the analysis internally is prohibitive, outside sources exist but they tend not to be as reliable. The higher the cost of gathering information, the higher the loan rate, reflecting the increased risk due to unreliable information or lack of information.

Copyright© 2006 John Wiley & Sons, Inc.24 Risk Management in International Lending Third-party help Guarantees by governments or central banks Guarantees by organizations outside the foreign country Pooling risk - participation loans among banks to spread risk. Diversification of foreign loan portfolio Loan Sales - selling nonperforming loans in the secondary market at a discount.

Copyright© 2006 John Wiley & Sons, Inc.25 Growth of Foreign Banks in the U.S. Japanese banking growth dominated the world in the late 1980's and made significant inroads into west coast U.S. markets. The waning Japanese equity markets, increased international capital adequacy standards and the recent merger activity among large U. S. banks seem to have slowed the decline in U. S. banks relative to foreign competitors.

Copyright© 2006 John Wiley & Sons, Inc.26 Number of Foreign Banks in the U.S. ( )

Copyright© 2006 John Wiley & Sons, Inc.27 Growth of Foreign Bank Assets in the U.S. ( )

Copyright© 2006 John Wiley & Sons, Inc.28 Top Foreign Banks in the U. S. (2003)

Copyright© 2006 John Wiley & Sons, Inc.29 Regulation of Foreign Banks’ U.S. Operations International Banking Act of 1978 Passed to make U.S. banks competitive with foreign banks operating in the United States. Allow federal chartering of foreign banking facilities. Limit ability of foreign banks of accepting interstate deposits. Fed may impose reserve requirements on foreign banks. FDIC insurance required on domestic retail deposits in U.S. based foreign banks. Foreign banks permitted to form Edge Act corporations. U.S. based foreign banks were made subject to non- banking prohibitions of U.S. banking holding companies.

Copyright© 2006 John Wiley & Sons, Inc.30 Regulation of Foreign Banks’ U.S. Operations In addition, the Foreign Bank Supervision Enhancement Act (FBSEA) was passed in 1991 to give the Federal Reserve Bank the authority to oversee the activities of foreign institutions in the U.S.