1. Chapter Twenty International Banking and the Future of Banking and Financial Services Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

2. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Key Topics Types of International Banking Organizations Regulation of International Banking Foreign Banking Activity in the United States U.S. Banks Operating Abroad Services Provided by International Banks Managing Currency Risk Exposure Challenges for International Banks in Foreign Markets The Future of Banking and Financial Services 20-2 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

3. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Types of International Banking Organizations Representative Offices ▫ Limited-service facility: markets home-office services; does not take deposits or book loans Agency Offices ▫ Does not take deposits from the public but extends commitments to make or purchase loans Branch Offices ▫ The most common organizational form for most international banks: a local office that represents a single large financial-service corporation 20-3 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

4. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Types of International Banking Organizations (continued) Subsidiaries ▫ Foreign subsidiary possesses its own charter and capital stock; may not necessarily close down if its principal owner fails Joint Ventures ▫ Bank concerned about risk exposure in entering a foreign market alone may choose to enter into a joint venture with a foreign financial firm, sharing both profits and expenses 20-4 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

5. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Types of International Banking Organizations (continued) Edge Act Corporations ▫ Domestic US companies owned by the US or foreign bank but located outside of he home state of the bank that owns them; limited to international transactions Agreement Corporations ▫ Subsidiaries of a bank organized under Section 25 of the Federal Reserve Act; devote the bulk of their activities to serving international customers 20-5 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

6. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Types of International Banking Organizations (continued) International Banking Facilities (IBF) ▫ Computerized account records that are not part of the domestic US accounts of the bank that operates them Shell Branches ▫ Offshore locations established in order to escape the burden of regulation 20-6 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

7. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Types of International Banking Organizations (continued) Export Trading Companies (ETCs) ▫ The Export Trading Company Act (ETCA) allowed U.S. banking firms and Edge Act corporations to create ETCs; these specialized firms must receive over half their income from activities associated with exporting goods and services from the United States 20-7 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

8. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Regulation of International Banking International banking activities are closely regulated by both home and host countries A strong trend toward deregulation of banking and the related fields of securities brokerage and underwriting took place from the 1960s to the 1990s Changing regulatory rules have contributed to a more volatile international economy 20-8 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

9. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Regulation of International Banking (continued) Harmonization ▫ The coordination of various nations in their regulatory activities so that all financial firms serving international markets will operate under similar rules 20-9 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

10. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Goals of International Banking Regulation Protecting the Safety of Depositor Funds Promote Stable Growth in Money and Credit Foreign Exchange Controls Restrict the Outflow of Scarce Capital Protect Domestic Financial Institutions and Markets from Foreign Competition 20-10 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

11. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Regulation of Foreign Bank Activity in the U.S. International Banking Act of 1978 ▫ Branches and agency offices of foreign banks must secure federal licenses for the US operations ▫ Foreign branching in the US is regulated, with a designated home state ▫ Larger foreign branches and agencies (>$1 billion) are subject to legal reserve requirements 20-11 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

12. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Regulation of Foreign Bank Activity in the U.S. (continued) Foreign Bank Supervision Act of 1991 ▫ Tighter control of foreign bank operations in the US. Empowered the Fed to examine the US offices and affiliates International Lending and Supervision Act of 1983 ▫ Federal regulatory agencies should prepare capital and lending rules for US-supervised banks Basel Agreement ▫ Calls for all banks to achieve a minimum total- capital-to-total risk-adjusted assets ratio 20-12 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

13. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Services Supplied By Banks in International Markets The variety of services international banks and their strongest competitors offer has expanded in response to evolving customer needs and intense international competition 20-13 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

14. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. TABLE 20–1 Key Customer Services Offered by International Banks 20-14 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

15. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Services Supplied By Banks in International Markets (continued) Making Foreign Currency (FOREX) Available to Customers ▫ Customers require sizable quantities of currencies to pay for imported goods and raw materials, to purchase foreign securities, and to complete mergers and acquisitions ▫ Other customers may receive foreign-currency or foreign-currency–denominated deposits from businesses and individuals abroad who purchase their products or securities ▫ These foreign funds must be exchanged for domestic currency and deposits 20-15 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

16. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Services Supplied By Banks in International Markets (continued) Making Foreign Currency (FOREX) Available to Customers ▫ FOREX trading activity among commercial and investment bank dealers has sharply increased due to volatility among leading currencies ▫ Trading volume often exceeds a trillion dollars a day and is climbing ▫ Proprietary Trading ▫ When dealers speculate on the prices of selected currencies 20-16 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

17. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Services Supplied By Banks in International Markets (continued) Hedging Against Foreign Currency Risk Exposure ▫ Currency risk is the potential for loss due to fluctuations in currency exchange rates ▫ Customers are not the only ones who face currency risk; international banks themselves must deal with exchange rate risk exposure 20-17 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

18. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Services Supplied By Banks in International Markets (continued) Hedging Against Foreign Currency Risk Exposure ▫ Currency risks arise most often in international banking when ▫ Making foreign currency–denominated loans to customers ▫ Issuing foreign-currency–denominated IOUs (such as deposits) to raise new funds ▫ Purchasing foreign-issued securities ▫ Trading in foreign currencies for a bank’s own currency position as well as for the needs of its customers 20-18 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

19. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Services Supplied By Banks in International Markets (continued) Hedging Against Foreign Currency Risk Exposure ▫ The net exposure of a bank or its customers to fluctuations in currency values can be determined from the following equation ▫ If Net Exposure > 0, the bank is long on currency i and if Net Exposure < 0, the bank is short currency i. 20-19 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

20. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Services Supplied By Banks in International Markets (continued) Hedging Against Foreign Currency Risk Exposure ▫ International banks typically employ a wide variety of currency-hedging techniques to help shelter their own and their customers’ risk exposure ▫ The most widely used of these currency-risk management techniques include ▫ Forward Contracts A customer works through a bank to negotiate a contract calling for the delivery of a particular currency at a stipulated price on a specific future date ▫ Currency Futures Contracts Contracts promise delivery of stipulated currencies at a specified price on or before a terminal date (long hedges and short hedges) 20-20 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

21. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Services Supplied By Banks in International Markets (continued) Hedging Against Foreign Currency Risk Exposure ▫ Currency Options Right but not an obligation to deliver of take delivery of a designated FOREX futures contracts at a set price any time before the option expires ▫ Currency Swaps Contract between two parties to exchange one currency for another and help reduce the risk of loss as currency prices change 20-21 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

22. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. EXHIBIT 20–3 A Straight Currency 20-22 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

23. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Services Supplied By Banks in International Markets (continued) Additional Services Provided to Customers ▫ Supplying Customers with Short and Long Term Credit or Credit Guarantees ▫ Supplying Payment and Thrift Instruments ▫ Underwriting Customer Note and Bond Issues in the Eurobond Market ▫ Protecting Customers Against Interest Rate Risk ▫ Helping Customers Market Their Products Through Export Trading Companies (ETCs) 20-23 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

24. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Services Supplied By Banks in International Markets (continued) Ways of Supplying Customers with Credit ▫ Note Issuance Facilities (NIFs) ▫ Eurocommercial Paper (ECP) ▫ Depository Receipts (DRs) 20-24 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

25. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Services Supplied By Banks in International Markets (continued) Payment Instruments ▫ Payment Services ▫ Sight Drafts ▫ Time Drafts Thrift Instruments ▫ Thrift services ▫ Tap CDs ▫ Tranche CDs ▫ Floating Rate CDs ▫ Floating Rate Notes 20-25 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

26. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Challenges for International Banks in Foreign Market Growing customer use of securities markets to raise funds in a more volatile and risky world Developing better methods for assessing risk in international lending Adjusting to new market opportunities created by deregulation and new international agreements 20-26 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

27. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Challenges for International Banks in Foreign Market Solutions to Troubled International Loans ▫ They may be restructured ▫ They can be sold in the secondary market ▫ They can be written off ▫ Either a portion or in its entirety 20-27 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

28. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Challenges for International Banks in Foreign Market International Loan Risk Evaluation Systems ▫ The Checklist Approach ▫ The Delphi Method ▫ Advanced Statistical Methods ▫ Published Country-Risk Indicators ▫ Euromoney Magazine ▫ Institutional Investor Index ▫ International Country Risk Guide 20-28 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

29. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Challenges for International Banks in Foreign Market New Opportunities ▫ Opportunities created by the North American Free Trade Agreement (NAFTA) and the Central American Free Trade Agreement (CAFTA) ▫ Opportunities in the expanding European community ▫ Opportunities in Asia as barriers erode 20-29 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

30. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. The Future of Banking and Financial Services Convergence Consolidation Survival of Community Financial-Service Institutions Reaching the Mass Media Invasion by Industrial and Retailing Companies The Wal-Mart Challenge Fighting for Ultimate Survival in a Global Financial System 20-30 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

31. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Quick Quiz What organizational forms do international banks use to reach their customers? What are the principal goals of international banking regulation? Describe the principal customer services supplied by international banks serving foreign markets. What types of risk exposure do international banks strive to control? What types of tools have these banks developed to help protect themselves and their customers against various risks? 20-31 Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.