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International Banking. 21. Chapter Objectives. Describe key regulations that reduced competitive advantages of banks in particular countries Describe the risks of international banks Describe bank solutions to the international debt crisis

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chapter objectives
Chapter Objectives
  • Describe key regulations that reduced competitive advantages of banks in particular countries
  • Describe the risks of international banks
  • Describe bank solutions to the international debt crisis
  • Describe how banks assess country risk when they consider lending funds to foreign countries
international expansion
International Expansion
  • Banks go global for several reasons
    • Diversify among economies to become less dependant on a single country’s conditions
    • Do business face-to-face with multinational corporations and their subsidiaries
  • International expansion by U.S. banks
    • U.S. bank regulations limited interstate banking
    • Expansion and growth via international banking
international expansion1
International Expansion
  • How U.S. banks expand overseas
    • Establish branches
    • Must first receive approval of the Federal Reserve Board in the U.S.
    • U.S. banks’ presence largest in the U.K.
    • Deposits in foreign branches are not insured
    • Agencies are an alternative that can make loans but not accept deposits or provide trust services
international expansion2
International Expansion
  • Non-U.S. banks expand into the United States and focus on corporate rather than consumer banking
    • Provide service to the subsidiaries of non-U.S. corporations
    • 1913 Edge Act creates corporations that specialize in banking and foreign transactions allowing loans and accepting deposits only if specifically related to international transactions
global bank regulations
Global Bank Regulations
  • Countries have a system of monitoring and regulating commercial banks
  • Division of regulatory power between the central bank and other regulators varies among countries
    • Canada
    • Europe
    • Japan
global bank regulations1
Global Bank Regulations
  • Standardizing the rules with uniform regulations helps globalize the financial system
  • Playing field leveled by three regulatory changes
    • The International Banking Act requiring all banks within the U.S. follow the same rules
    • Single European Act
    • Uniform capital adequacy guidelines
global bank regulations2
Global Bank Regulations
  • Uniform regulations for banks operating in the U.S.
    • International Banking Act of 1978
    • Prior to the Act, foreign banks had more flexibility to cross state lines
    • Forced foreign banks to identify one state as their home state
global bank regulations3
Global Bank Regulations
  • Uniform regulations across Europe from the Single European Act of 1987
  • Capital can flow freely throughout Europe
  • Banks can offer a wide variety of lending, leasing and securities activities in Europe
  • Regulations regarding competition, mergers and taxes are similar throughout Europe
  • Banks established in one European country have the right to expand into any or all other European countries
global bank regulations4
Global Bank Regulations
  • Uniform capital adequacy guidelines
  • Prior to 1988 standards differed around the world
  • This difference gave some a comparative advantage
  • 12 industrial countries agreed to standard guidelines in 1988
  • Risk-weighting means higher capital for riskier assets
global bank competition
Global Bank Competition
  • U.S. bank expansion in foreign countries is driven by several factors
    • Locations where U.S. multinationals are expected to expand
    • Areas benefiting from expansion due to free trade agreements
    • Goal of the banks is to offer diverse services to meet all the banking needs of corporate customers
global bank competition1
Global Bank Competition
  • Non-U.S. bank expansion in the United States
  • Japanese banks developed an extensive presence in the U.S.
    • Offer competitive corporate loans
    • Lower fees for letters of credit
    • Have a low cost of capital so can take on ventures U.S. banks would not
    • High saving rate in Japan provides deposit funds for global expansion
global bank competition2
Global Bank Competition
  • Impact of the Euro on bank expansion
  • Introduction of a single currency stimulated bank expansion
    • Simplifies transactions to deal in one, rather than several currencies
    • Customers can more easily compare service costs
    • Expansion via acquisition to capture economies of scale
global bank competition3
Global Bank Competition
  • Competition for investment banking services
  • Banks compete to provide a variety of services
    • Swaps
    • Foreign exchange
    • Investment banking
      • Underwriting
      • Brokerage
  • Banks expand both geographically and their product and service lines to capture economies
impact of eastern european reform on global competition
Impact of Eastern European Reform on Global Competition
  • Banks helped facilitate the trend toward privatization
    • Provide direct loans to businesses
    • Act as underwriters on bonds and stocks
    • Provide letters of credit
    • Provide consulting services
      • International trade
      • Mergers
      • Other corporate activities
risks of multinational banks
Risks of Multinational Banks

Credit Risk

Settlement Risk

Exchange Rate Risk

Combining All

Types of Risk

Interest Rate Risk

risks of multinational banks1
Risks of Multinational Banks
  • Credit risk exists for U.S. banks making foreign loans because they may have less information than for domestic loans
    • Regulations for the disclosure of financial information differ among countries and are not as strict as in the U.S.
    • Ratios and industry norms differ among countries so benchmarking is difficult
risks of multinational banks2
Risks of Multinational Banks
  • Managing credit risk
    • May solve the problem by lending to large corporations or government
    • Performance of each branch in a particular country linked to the performance to that country’s economy
      • Diversify within a country across industries
      • Diversify throughout the bank across countries
risks of multinational banks3
Risks of Multinational Banks
  • Exchange rate risk
  • Banks may agree to accept payment in a currency other than the currency in which the loan is denominated
  • Convert funds received into the currency customers want to borrow
  • Assets and liabilities denominated in different currencies
  • Net out exposure
risks of multinational banks4
Risks of Multinational Banks
  • Risk exists because banks may suffer losses as they settle their transactions
  • If one participant can not meet their obligations, counterparties will also be unable to meet their obligations
  • Central banks around the world are examining ways to stop the ripple effect
risks of multinational banks5
Risks of Multinational Banks
  • Interest rate risk is even more challenging for the international bank because of its foreign currency balances
  • Risk depends on the currency denomination and the interest rates of loans and securities in various currencies
  • Minimize the risk by matching rate sensitivities of assets and liabilities for each currency
risks of multinational banks6
Risks of Multinational Banks
  • Combining all types of risk means managing risk is complex
  • Tradeoffs exist because trying to minimize one of the risks may affect exposure in another area
  • Risks occur as the bank does daily business with multinationals and meets their needs
    • Trying to control bank risks means they would not meet customer needs
    • Customers have many choices in this competitive market
international debt crisis
International Debt Crisis
  • Reducing bank exposure to Lesser Developed Countries (LDC) debt is more difficult in an integrated global economy
  • Stagnant U.S. and European economies hurt LDCs in the early 1980s because the LDC’s dependence on export earnings
  • Strong dollar also hurt LDCs in the early 1980s because their loans were denominated in dollars
  • Countries simultaneously defaulted
international debt crisis1
International Debt Crisis
  • Commercial banks with LDC debt in the 1980s faced a crisis and had to decide between two alternatives
    • Provide additional loans and incur the risk of default of new as well as older loans
    • Reject the request for additional funds and cause default
  • Banks and countries formed groups to negotiate
international debt crisis2
International Debt Crisis
  • Exposure to LDC debt was concentrated in 9 money center banks which, if even one failed, would have caused a panic
  • Banks reduced their exposure by
    • Selling LDC loans
    • Using debt-for-equity swaps
    • Boosting loan loss reserves
international debt crisis3
International Debt Crisis
  • The Brady plan developed between 1985 and 1988 was used to reduce LDC debt problems
  • The only chance Lesser Developed Countries had as a group to pay off loans was to improve their economic conditions
  • The plan allowed LDCs the chance to reform their economies
  • Banks were given the option of trading their loans to the World Bank and IMF
asian crisis
Asian Crisis
  • Impact of bank lending on the Asian crisis
    • The Asian crisis was caused in part by banks’ willingness to extend credit in Thailand
    • Commercial developers in Thailand borrowed without having to show projects were feasible
    • Debt was at high interest rates and expensive
    • Economic growth slowed and cash flows could not cover local loans or foreign currency-based loans
asian crisis1
Asian Crisis
  • Spread of loan defaults throughout Asia
  • Problems caused by a weak economy spread throughout Asia
  • Currencies weakened and investors withdrew funds
  • South Korean loans made without adequate credit analysis resulted in defaults
asian crisis2
Asian Crisis
  • Impact on U.S. and European banks
    • U.S. and European banks had exposure because they made loans in Asia
    • Bank stocks declined as a result of the losses
country risk assessment
Country Risk Assessment
  • Several factors of country risk including:
    • Economic indicators
      • Changes in the consumer price index
      • Real growth in gross domestic product
      • Current account balances divided by exports
country risk assessment1
Country Risk Assessment
  • Debt management
    • Debt service and short-term debt divided by total exports
    • Ratio of total debt to GDP
    • Short-term debt divided by total debt
country risk assessment2
Country Risk Assessment
  • Political factors are measured subjectively and include a probability for each
    • Destabilizing riots or civil unrest
    • Increased terrorist activities
    • Civil war
    • Foreign war
    • Government overthrow
country risk assessment3
Country Risk Assessment
  • Structural factors are also measured subjectively
    • Natural resource base
    • Human resource base
    • Leadership
  • Overall rating
    • Assigns a score between 0 and 100
    • Grade assigned for both short and long term
exhibit 21 2 determining country risk ratings

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Exhibit 21.2 Determining Country Risk Ratings
exhibit 21 3 converting grade into country rating

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Exhibit 21.3 Converting Grade Into Country Rating
country risk assessment4
Country Risk Assessment
  • Discriminant analysis is used to examine country risk
    • Discriminant analysis is a statistical technique used to identify factors that are distinctly different between two groups
    • Used to try to identify factors that distinguish between countries with and without debt repayment problems
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