International Finance

Chapter 6

International Banking and the International Money Markets

International Banks

• Can be distinguished from domestic banks by the:

• Services they offer

• The deposits they attract

• The loans they make

International Banks: Services

• Financing cross border trade (exports)– Letters of credit; bankers’ acceptances

• Offering foreign exchange services– Buying and selling foreign exchange for clients– Offering hedging contracts

• Offering interest rate and currency swap financing.

• Consulting services to global firms– Hedging strategies; international cash management.

• Underwriting eurobonds, foreign bonds, equity issues for global firms.

International Banking: Deposits

• May or may not be involved in accepting domestic deposits.– China will currently not allow foreign banks to

engage in this activity.

• Participate in eurocurrency deposit market.– Accepting “offshore” deposits

International Banking: Loans

• Lenders of “eurocurrency” deposits

• Participation in syndicated loans to large multinational firms and sovereign entities.– Allows for the pooling of resources and the

sharing of risk!

Who are these International Banks: Ranked by Asset Size, 2002

• 1 Mizuho Holdings (Japan)*• 2 Citigroup (United States)• 3 Deutsche Bank (Germany)• 4 Sumitomo Mitsui Banking Corp (Japan)• 5 UBS (Switzerland)

*formed by the 2002 merger of Dai-Ichi Kangyo, Fuji Bank and The Industrial Bank of Japan.

Who are these International Banks: Ranked by Asset Size, 2002

• 6 BNP (France)• 7 JP Morgan Chase (United States)• 8 HSBC (United Kingdom)• 9 Bayerische Hypo-und Vereinsbank- (Germany)• 10 Bank of America (United States)• 11 ING (Netherlands)• 12 Credit Suisse (Switzerland)• 13 Bank of Tokyo – Mitsubishi (Japan)• 14 ABN AMRO (Netherlands)

Who are these International Banks: Ranked by Asset Size, 2002

• 15 Industrial & Commercial Bank of China (China)

• 16 Royal Bank of Scotland (United Kingdom)• 17 Barclays Bank (United Kingdom)• 18 Crédit Agricole (France)• 19 Norinchukin Bank (Japan)• 20 Morgan Stanley Dean Witter (United States)• 21 Société Générale (France)

Who are these International Banks: Ranked by Asset Size, 2002

• Of the largest 50 commercial banks:

• 9 are American

• 6 are Japanese and United Kingdom

• 5 are French and German

• 4 are Chinese

• 3 are Dutch

Why do Banks Establish International Operations?

• Low Marginal Costs in doing so– Apply home knowledge to foreign market

• Knowledge Advantage– Overseas operations can utilize the parent’s

knowledge to compete in foreign market

• Home Information Source– Providing local (foreign) firms with information about

parent’s home market

• Prestige– Global banks can attract clients abroad

Why do Banks Establish International Operations?

• Regulation Advantage– Global banks may not face the same

regulations as domestic banks (e.g., reserve requirements on eurocurrency deposits).

• Wholesale and Retail Defensive Strategy– Following corporate clients overseas– Providing retail customer overseas services

• Circumventing Government Restrictions– Wanting to do business in RMB

Why do Banks Establish International Operations?

• Growth– Home market may be saturated

• Risk Reduction– Greater stability of consolidated earnings.

Citigroup

• Financial services firm combining banking, insurance, and investments under one global organization.– “Universal or full service bank”

• Located in over 100 countries

• Go to home page and view countries and product lines– http://www.citigroup.com/citigroup/homepage/

Services Offered by International Banks

• The services offered by global banks are a function of:– The regulatory environment.

• What will governments allow?• Developing countries still somewhat restrictive

regarding foreign banks.

– The type of banking office established.

Types of International Banking Offices

• Correspondent Bank– No physical presence overseas– Correspondent relationships with banks in

foreign markets– Allows bank to service core clients with little

cost.• Reciprocal deposit accounts• Facilities foreign exchange conversion• Facilities trade financing (clearing bankers

acceptances)

Types of International Banking Offices

• Representative Office– Small service facility staffed by parent bank

personnel– Cannot make loans or accept deposits– Useful strategy if bank has many important

clients in foreign country– There to assist core clients with

• Country and economic information• Credit evaluations on local firms

Types of International Banking Offices

• Foreign Branch Office– Most popular form of U.S. bank expansion abroad.– Legally part of the parent bank– Subject to regulations at home and in foreign market.– Branch lending limits are based on parent capital (not

branch office)• Can provide larger loans

– Allows for fast clearing of checks within the bank

Types of International Banking Offices

• Subsidiary Bank– Locally incorporated (in foreign country) bank.

• Either wholly owned by parent, or joint venture• Non-controlling subsidiary is referred to as an

“affiliate bank.”

– Operate under the banking laws of the country in which they are incorporated.

– Desirable before the abolition of Glass Steagell Act!

Types of International Banking Offices

• Offshore Banking Centers– Organized branches or subsidiaries in recognized

offshore countries.– A country whose banking system allows for “external”

banking activity.• Accepting deposits and making loans in currencies other

than the home currency of the offshore country.– IMF recognizes the following as offshore countries:

• Bahamas, Bahrain, the Cayman Islands, Hong Kong, the Netherlands Antilles, Panama, and Singapore.

– Minimal host country regulations, low taxes, favorable time zone, banking secrecy laws all promoting external banking transactions!

The International Money Market

• The core of the international money market is the eurocurrency market.– A time deposit in a particular currency with is

other than the national currency of the country in which it is deposited.

– For Example, a U.S. dollar deposit in banks in Hong Kong or Singapore!!!

• Banks accepting deposits can be host (offshore) banks, or foreign banks (including U.S. banks).

Euro Prefix

• The term “euro” is used to denote an offshore currency deposit, e.g.,– Eurodollars, euroyen, europounds, euroeuros!

• Does not mean the currencies are being deposited in Europe.– Sub-set in Asia, called the Asian dollar market.

• Do not confuse with the single European currency, the “Euro.”

• Banks accepting these deposits are commonly referred to as Eurobanks.

Eurocurrency Market

• The eurocurrency market is a external market than runs alongside a country’s domestic banking market.

• The market is two tiered:– Wholesale (interbank) market where global banks

trade among themselves.• Interbank Offer Rate: The rate charged by banks with excess

currency deposits to lend to other banks.• Interbank Bid Rate: The rate at which a bank will accept

deposits from another bank.• Offer rates higher than bid rates by about 1/8%• Major rates come out of London, thus London Interbank Offer

and Bid rates are important to the market.

Interbank LIBOR Rates

• LIBOR Rates, Jun 14 2004  Country Over night

• US$ Libor 1.05875%• Euro Libor 2.04625% • £ Libor 4.50000%• Yen Libor 0.03125%• Source: The FT

– http://www.marketprices.ft.com/markets/currencies/money

Importance of LIBOR Rates

• Used to calculate forward rates on currencies.

• Used by global banks in “scaling” lending rates to corporate and sovereign entity borrowers:

Lending rate = LIBOR + X (basis points)

Where X basis points is an estimation of the particular risk associated with the borrower.

Libor Loans

• Libor loans are generally negotiated on a “roll-over” basis:– Every three to six months the loan is rolled

over at the new LIBOR rate– Avoids Eurobanks paying more for their

deposits than the returns on their loans.– Maintains a positive margin on euroloans.

26

Roll Over Loan Example

11 22 33 44 55 66TodayToday

Loan is re-rated at Loan is re-rated at LIBORLIBOR every six months, with every six months, withinterest payments made on those Roll-over datesinterest payments made on those Roll-over dates

Six months periodsSix months periods

yearsyears

etc.etc. etc.etc. etc.etc.