international banking

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CHAPTER 21 21 Internationa l Banking © 2003 South-W estern/Thom son Learning

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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 - PowerPoint PPT Presentation

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Page 1: International Banking

CHAPTER

2121 International

Banking

© 2003 South-Western/Thomson Learning

Page 2: International Banking

Chapter ObjectivesChapter 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

Page 3: International Banking

International ExpansionInternational 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

Page 4: International Banking

International ExpansionInternational 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

Page 5: International Banking

International ExpansionInternational 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

Page 6: International Banking

Global Bank RegulationsGlobal 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

Page 7: International Banking

Global Bank RegulationsGlobal 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

Page 8: International Banking

Global Bank RegulationsGlobal 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

Page 9: International Banking

Global Bank RegulationsGlobal 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

Page 10: International Banking

Global Bank RegulationsGlobal 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

Page 11: International Banking

Global Bank CompetitionGlobal 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

Page 12: International Banking

Global Bank CompetitionGlobal 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

Page 13: International Banking

Global Bank CompetitionGlobal 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

Page 14: International Banking

Global Bank CompetitionGlobal 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

Page 15: International Banking

Impact of Eastern European Reform on Impact of Eastern European Reform on Global CompetitionGlobal 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

Page 16: International Banking

Risks of Multinational BanksRisks of Multinational Banks

Credit Risk Credit Risk

Exchange Rate RiskExchange Rate Risk

Settlement RiskSettlement Risk

Interest Rate RiskInterest Rate Risk

Combining AllTypes of Risk

Page 17: International Banking

Risks of Multinational BanksRisks 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

Page 18: International Banking

Risks of Multinational BanksRisks 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

Page 19: International Banking

Risks of Multinational BanksRisks 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

Page 20: International Banking

Risks of Multinational BanksRisks 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

Page 21: International Banking

Risks of Multinational BanksRisks 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

Page 22: International Banking

Risks of Multinational BanksRisks 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

Page 23: International Banking

International Debt CrisisInternational 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

Page 24: International Banking

International Debt CrisisInternational 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

Page 25: International Banking

International Debt CrisisInternational 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

Page 26: International Banking

International Debt CrisisInternational 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

Page 27: International Banking

Asian CrisisAsian 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

Page 28: International Banking

Asian CrisisAsian 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

Page 29: International Banking

Asian CrisisAsian 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

Page 30: International Banking

Country Risk AssessmentCountry 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

Page 31: International Banking

Country Risk AssessmentCountry 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

Page 32: International Banking

Country Risk AssessmentCountry 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

Page 33: International Banking

Country Risk AssessmentCountry 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

Page 34: International Banking

Exhibit 21.2 Determining Country Risk Exhibit 21.2 Determining Country Risk RatingsRatings

Short-Term Horizon Medium-Term Horizon

Weighted WeightedWeight Grade Grade Weight Grade Grade

Debt management model .3 80 24 .3 70 21

Economic Indicator model .3 90 27 .2 70 14

Political rating model .2 60 12 .3 50 15

Structural rating model .2 75 15 .2 60 12

78 62

Page 35: International Banking

Exhibit 21.3 Converting Grade Into Exhibit 21.3 Converting Grade Into Country RatingCountry Rating

OverallGrade Rating Rating

91–100 AAA Excellent

81–90 AA

71–80 A

61–70 BBB Satisfactory quality, average risk

51–60 BB

41–50 B

31–40 CCC Low quality, high risk

21–30 CC

11–20 C

0 –10 D Excessive risk

Page 36: International Banking

Country Risk AssessmentCountry 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