International

1
21

• International
• Banking

2
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

3
International Expansion

• Banks go global for several reasons
• Diversify among economies to become less
  dependant on a single countrys 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

4
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

5
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

6
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

7
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

8
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

9
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

10
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

11
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

12
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

13
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

14
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

15
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

16
Risks of Multinational Banks
Credit Risk
Settlement Risk
Exchange Rate Risk
Combining All Types of Risk
Interest Rate Risk
17
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

18
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
  countrys economy
• Diversify within a country across industries
• Diversify throughout the bank across countries

19
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

20
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

21
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

22
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

23
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 LDCs dependence on
  export earnings
• Strong dollar also hurt LDCs in the early 1980s
  because their loans were denominated in dollars
• Countries simultaneously defaulted

24
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

25
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

26
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

27
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

28
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

29
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

30
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

31
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

32
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

33
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

34
Exhibit 21.2 Determining Country Risk Ratings
35
Exhibit 21.3 Converting Grade Into Country Rating
36
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