INTERNATIONAL BANKING CHAPTER 14 INTERNATIONAL BANKING Copyright© 2012 John Wiley & Sons, Inc.

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© 2012 John Wiley & Sons, Inc.

The Edge Act (1919) Federal Reserve Act of 1913 permitted foreign branches. Agreement corporations were legalized in 1916. The Edge Act of 1919: Allowed banks to create subsidiaries that could engage in international banking (Edge Act corporations (EAC)) EACs could make equity investments Through EACs, U.S. banks were able to compete with European banks EACs grew in number and activities after WW II Copyright© 2012 John Wiley & Sons, Inc.

Reasons for U.S. Banks’ Global Expansion Increased expansion of U.S. trade and foreign markets. Growth of multinational corporations. Banks followed their U.S. customers who expanded internationally. Regulations limited capital transfers from U.S. Banks raised funds abroad to circumvent these regulations. Copyright© 2012 John Wiley & Sons, Inc.

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 1974. OPEC increased oil prices. Oil producers and importers had surplus/deficit funds flow to invest or finance. Copyright© 2012 John Wiley & Sons, Inc.

Recent Activity in U.S. International Banking Due to mergers, fewer U.S. banks with larger networks of global affiliates: branches, overseas offices, correspondent banks By 2010, JP Morgan Chase became the 8th largest bank in the world. Copyright© 2012 John Wiley & Sons, Inc.

Regulation of Overseas Banking Activities Goals of domestic U.S. bank regulation: bank safety, financial soundness, and stability bank competition - performance banking business is "special" and kept separate (arms length) from other types of business activities Foreign banks do not have as many regulatory limits, especially in their international banking activities. Copyright© 2012 John Wiley & Sons, Inc.

The Regulatory Framework Federal Reserve Act of 1913 - 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© 2012 John Wiley & Sons, Inc.

The Regulatory Framework (continued) Bank Holding Company Act Amendments of 1970 - regulated international activities of bank holding companies. International Banking Act of 1978 - extended federal regulation to foreign banks in the U.S. The DIDMCA of 1980: expanded Fed control over foreign banks; permitted U.S. banks to establish international banking facilities. Foreign Bank Supervision Enhancement Act (1991) gave the Fed greater authority over foreign banks. Copyright© 2012 John Wiley & Sons, Inc.

Allowable Banking Activities U.S. banks operating in foreign countries are allowed to engage in: security underwriting; equity investments. Restraints are kept on: U.S. foreign bank subsidiaries owning nonfinancial businesses; control of foreign companies. Copyright© 2012 John Wiley & Sons, Inc.

Delivery of Overseas Banking Services Representative offices - assist parent bank customers. Shell branches - limited wholesale services rather than retail public branches. Correspondent banks - relationship with foreign banks to provide international banking services. Foreign branches - provide full banking services in foreign country. Copyright© 2012 John Wiley & Sons, Inc.

Delivery of Overseas Banking Services Edge Act corporations - subsidiaries of U.S. banks engaging in international activities not permitted to domestic banks. International banking activities International financing activities Foreign subsidiaries and affiliates Subsidiaries - 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© 2012 John Wiley & Sons, Inc.

A U. S. Multinational Bank Structure Copyright© 2012 John Wiley & Sons, Inc.

International Banking Facilities (IBFs) Fed permitted IBFs beginning December 1981. May be established by a U.S. depository institution, a U.S. branch or agency of a foreign bank, or a U.S. office of an Edge Act Corporation. IBFs represent the balance sheet of the aggregated foreign assets and liabilities. 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© 2012 John Wiley & Sons, Inc.

Characteristics of International Loans Funding Denominated in major world currencies International loans are large Multinational firms and sovereign countries are 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© 2012 John Wiley & Sons, Inc.

Characteristics of International Loans Pricing Rates are based on LIBOR (London Interbank Offer Rate) for a given currency. Nonbank borrowers pay above LIBOR. Lending rates change (float) with the LIBOR at the beginning of each (rollover) period (a month, 6 months, or a year). Copyright© 2012 John Wiley & Sons, Inc.

Characteristics of International Loans Syndicated Loans Syndicates of banks fund large international loans, which: spreads credit risk banks take on; provides large amounts of funds needed by the borrower. One or more lead bank(s) package the loan. Copyright© 2012 John Wiley & Sons, Inc.

Characteristics of International Loans Collateral Most international loans are unsecured. Most business borrowers have high credit ratings. Borrowing countries pledge their "full faith and credit." Copyright© 2012 John Wiley & Sons, Inc.

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© 2012 John Wiley & Sons, Inc.

Risk Evaluation Analysis of the country’s political and economic risks Financial analysis of the borrower 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. Copyright© 2012 John Wiley & Sons, Inc.

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© 2012 John Wiley & Sons, Inc.

Growth of Foreign Banks in the U.S. Japanese banking dominated the world in the late 1980's and made significant inroads into west coast U.S. markets. The decline in U.S. banks relative to foreign competitors has slowed due to: Waning Japanese equity markets, Increased international capital adequacy standards, Recent merger activity among large U.S. banks. Copyright© 2012 John Wiley & Sons, Inc.

Number of Foreign Banks in the U.S. (1982-2010) Copyright© 2012 John Wiley & Sons, Inc.

Growth in Foreign Bank Assets in the U.S. (1985-2010) Copyright© 2012 John Wiley & Sons, Inc.

Top Foreign Banks in the U.S. (2010) Copyright© 2012 John Wiley & Sons, Inc.

Regulation of Foreign Banks’ U.S. Operations International Banking Act of 1978 Leveled the playing field for U.S. and foreign banks in the U.S. Allowed federal chartering of foreign banking facilities. Limited ability of foreign banks of accepting interstate deposits. Allowed the Fed to impose reserve requirements on foreign banks. Required FDIC insurance on domestic retail deposits in U.S. based foreign banks. Permitted foreign banks to form Edge Act corporations. Copyright© 2012 John Wiley & Sons, Inc.

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. Copyright© 2012 John Wiley & Sons, Inc.