international banking.ppt

7/27/2019 International Banking.ppt

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International Banking

August-December 2013

Facilitator: Wajahat A Qureshi


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Introduction & Overview

Banking transactions crossing national boundaries

Cross border lending All claims of domestic banks offices on foreign residents

Claims of foreign banks offices on local residents

Claims of domestic banks offices on domestic residents in foreign

currency

Similar classification of deposits

Eurodollar Bonds


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Products & Services

Commercial banking--branch banking, and other services conventionally offered by domestic banks,like accepting deposits and lending

Trade Finance--financing imports and exports

Corporate Finance and other investment bankingproducts & services

Foreign Exchange & Foreign Currency Hedging--using derivatives and structuring customisedsolutions


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Types of International Banks

Subsidiary & Affiliate Bank

Subsidiary is normally a wholly or majority owned entityincorporated locally

Affiliate bank is a partially owned entity, without havingcontrol

Foreign Branch

Operates like a local bank, legally part of the parent, andnot a separate entity

Subject to regulations of both home country and foreigncountry


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Representative Office

Established to assist with information of localcustoms and develop and/or further strengthenrelationship with multinational customers, whomay have operations in home country

May also be used to explore prospects for settingup a full service facility--by acquiring a local entityor establishing one


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Correspondent Bank

Offering services to banks, located cross border,in settling their claims/receipts in that particular currency

Banks located in different countries establishaccounts in other banks

Accounts used to settle trade payments andtransfers


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Financing International Trade

One of the core functions performed byinternational banks

Different payment methods used in facilitatinginternational trade:

Clean Payments/Advance Payments

Letters of Credit

Documentary Collections

May also be facilitated using non-fundedinstruments like Guarantees


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Financing International TradeClean/Advance Payment (Contd....)

Two types:

Advance Payment

Exporter receives the value of goods to be shipped, in advance,and then effects the shipment, thus zero risk but may accept lower price--Time value of money and risk mitigation

Open Account

Importer receives the shipment/goods and documents directly fromthe exporter and then makes the payment, as per the agreed terms

No risk to importer; High risk to exporter--non payment, rejection,etc.; May get a higher price due to these risks and delayed payment


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Financing International TradeLetter of Credit (Contd...)

Underlying principle--Banks deal in documents and not goods

If the documents, on the face, are in accordance with the termsand conditions of the L/C, bank is liable to effect the payment,regardless of the fact that the actual shipment received is notas per agreed between the buyer and the seller

International Chamber of Commerce (ICC) issues

standardised/agreed upon rules, definitions and practicesgoverning L/Cs--called UCP for Documentary Credits (Version600 effective July 2007 currently available and in practice)

ICC has also issued and regularly updates the standard termsused in international trade--International Commercial Terms

(INCOTERMS)


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Types of Letter of Credit

Letter of Credit Types/Terms

Revocable & Irrevocable

Unconfirmed & Confirmed

Sight & Usance

Transferrable & Assignment of Proceeds

Revolving & Standby


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Revocable Letter of Credit

Could be revoked by the applicant (importer) anytimewithout getting consent from the exporter

Cancelled and amended anytime before the receipt of documents

Not much in use/practice

Irrevocable Letter of CreditNon-cancellable or amendable without prior consent of theexporter

Almost all of the L/Cs currently used are Irrevocable


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Unconfirmed L/C

Where the credit-worthiness of the L/C issuing bank andcountry risk is acceptable to exporter

All L/Cs are unconfirmed, unless otherwise mentioned

Confirmed L/C

In cases where the exporter has doubts about the creditquality of the L/C issuing bank or is not comfortable withthe country risk

Requires confirmation from a third bank, usually a soundcredit quality international bank or a bank located in thecountry of exporter


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Revolving L/C

Replaces the need for opening more than one L/Cs

Single L/C covering more than one shipments

Allows for relatively longer period, until maturity, as againsta normal L/C

Cumulative--Allowing for roll-over of un-utilised amount

Non-Cumulative--Which doesn t allow for roll-overs


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Standby L/C

Acts as a guarantee to third party, issued on behalf of customer, to ensure payment in case of non-payment bythe original obligor

Issued with a validity of one year

Used in place/leu of bank guarantee, where it is otherwise

legally barredCertain conditions imposed in Pakistan, on its issuance


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L/C Process Flow

L/C Process FlowExporter (Seller) sends in Pro-forma invoice to Importer (Buyer)

Importer submits Accepted Pro-forma Invoice, Purchase Order or Contractto Exporter

Importer places application for Letter of Credit with Importer s bank

Importer s bank sends confirmation of opening of Letter of Credit toExporter s/confirming bank

Confirming bank sends copy of Letter of Credit to Exporter

Exporter sends order confirmation to Importer

Exporter ships the goods through Air/Sea/Land route


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L/C Process FlowL/C Process Flow (Contd...)

Exporter presents Letter of Credit and export documentation toconfirming/own bank for settlement/negotiation/discounting

Confirming bank confirms authenticity of L/C and export documents, pays

Exporter per terms of the L/C

Confirming bank forwards export documents to Importer s Bank

Importer s bank presents copies of export documents to Importer

Importer pays bank under terms of the L/C

Importer s bank releases original export documents to the Importer

Importer presents original export documents to local customs authorities

Customs authorities after verifying the authenticity of documents release

goods to the Importer


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Documentary CollectionsMethod of payment whereby Exporter assigns theresponsibility of handling export documents to banks, andinstructs the banks concerning the release of thesedocuments to the Importer.

Banks do not guarantee the payment

Collections are subject to the the Uniform Rules for Collections (URC)

Comes mainly in two types

Documents Against Payment (DP)

Documents Against Acceptance (DA)


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Documents Against Payment (DP)

Documents released to the Importer only after the paymentis effected

Also known as a Sight Collection or Cash Against Documents(CAD)

Less costly than L/C, but carries risk of refusal, commercial

and country risks for exporter No credit line/limit required for importer

Forward cover/Currency hedging not allowed in Pakistan


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Documents Against Acceptance (DA)

Documents released to the Importer only againstacceptance of a draft

Carries risk of non-acceptance of documents, for exporter

Even after the acceptance by the importer, there is no

guarantee for the paymentBeneficial for importer, because of no payment obligationupon receipt of documents


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Foreign Exchange Markets

Currency Markets where money denominated in onecurrency is bought and sold with money denominated inanother currency

A foreign exchange transaction is an agreement between abuyer and a seller that a fixed amount of one currency will bedelivered for some other currency at a specified date

International International Trade and

Capital Transactions facilitated with the ability totransfer purchasing power between countriesMostly OTC transactions (with no exchange or clearing

house, customized trades, etc.) done over phone, throughbroker, system Reuters, Bloomberg


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Works almost 24 hour-a-day with no specific location housed in any particular building like an exchange

Highly flexible and liquid

Exists in Spot Value date 2 business days from the dateof transaction, and Forward Value date beyond Spot

Value date means the date of settlement of the transaction

Central banks also participate to maintain some sort of control on their currency, especially in terms of its value


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Fixed exchange rate is the official rate set by the monetaryauthorities/central banks

Under floating exchange rate, the value of the currency isdecided by supply and demand factors

Outright Forward Single leg sale or purchase transactionmaturing at any future date

Swap Dual leg transaction, with near leg maturing inspot/forward and the far leg in forward (Ready-Forward,Spot-Forward or Forward-Forward Swap)


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Foreign exchange Markets

Foreign Exchange Mechanism

Managed Exchange Rate

Dual Exchange Rate

Floating Exchange Rate


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Forward FX Agreement between two parties for purchase/sale of a specific amountof one currency against another at a predetermined rate and a date infuture

Price is worked out using the interest rate differential

May be Fixed for delivery or may carry an option period

Option period provides the buyer/seller with the privilege of take-up/delivery during the specified period

Non cancellable, unless otherwise required under specificcircumstances

Closed out upon expiry, if remained un-utilized

Difference to be settled with payment or receipt to/from the customer


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Forward Rate Calculation

3-Month USD Interest Rate = 0.50% P.A & 3-Month PKR Interest Rate= 9.50% P.A

USD/PKR Spot Rate = 104

Day-count For USD = Actual / 360 & Day-count for PKR = Actual / 365

Three Month Forward Rate = Spot Rate * (1+PKR Interest Rate *91/365) / (1+USD Interest Rate * 91/360)

104 * (1 + 0.095 * 91/365) / (1+0.005 * 91/360) = 104 * (0.273 / 0.254)

Based on these calculations 3-Month USD/PKR would be 111.78

Also be presented in percentages--(Forward Premium or Discount /spot rate) * (360/Number of contract days)


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International Banking Crisis

Real Estate Bubbles and Financial Crisis

Housing Bubble Burst, after it peaked in 2006

Causing real-estate backed assets prices toplummet

Damaging Financial Institutions Balance Sheets

and P & L holding such assets Liquidity Evaporated, Credit tightened due to

deteriorating financial conditions


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International Banking Crisis

Affected Exposure Limits (Among Counter-parties) and Impacted Banks Liquidity &Balance Sheet Management

Resulting in Global Economic slowdown

High Risk, Complex Financial Products,Failure of Regulators & Credit Rating

Agencies, Conflicts of Interest, Market Self Discipline and Investors Greed could beconsidered the possible reasons for thecrisis


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Risks in International Banking--Liquidity & Liquidity Risk Management

Liquidity Risk Defined

Probability of loss arising from a situation where:

There will not be enough cash (or cash equivalents) to meet the need

of borrowers or depositors Sale of illiquid assets yield a value lesser than their fair value

Illiquid assets will not be sold at the time it is needed, due to lack of demand/buyers

Availability of funds to meet all known and unknown commitments

- In the right currency

- In the right place

- At the right time


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Liquidity & Liquidity Risk Management

Funding Liquidity

Ability of an institution to arrange funding for its assets when it is needed

Refers to funding of long term assets with short term liabilities

Market Liquidity

An assets ability to get liquidated without causing a significant movement in the price and with minimumloss of value

TFCs, Pak Eurobonds, Dubai Government Sukuk, Other emerging market Sukuk and bonds

Funding and Market Liquidity

Both are closely related to each other

Inability to generate funding could affect the market liquidity

The dealer would find it hard to fund high margin instruments, affecting the market liquidity of suchinstruments


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Liquidity & Liquidity Risk Management

Liquidity Vs. Solvency Liquidity refers to cash and instruments that can be

converted into cash to meet the business requirements

Solvency refers to a firms ability to meet its obligationsas these become due

Liquidity relates more to short term business strategywhile Solvency is something related to the firms overallhealth


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The Treasury Function

Functions like a heart in the human body Funds flow in, from units with surplus, and flow out to units with deficit

Local currency (LCY) and FX

Customer facilitation--with profitability objective

Interest Rate Risk management

Liquidity & Funds management Fund Transfer Pricing

Medium to long term Investment


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The Treasury Function--Organizational Design

Generic Design has Treasury as a separate group headed by a direct report

May contain different departments depending on the size and complexity of the function

FX desk--Dealing with the foreign exchange exposure

Buying from exporters and selling to importers; market maker--dealing with the

interbank

Money Market--To deal with the short term liquidity issues

Placing surplus liquidity and managing shortfalls

Equity Desk--Dealing with investments in the equity market, Margin Financing, CFS, etc.

Derivatives Desk--To deal with structuring and trading of derivatives like FRA, IRS,Currency Options, etc.

Corporate Desk-- Treasurys Face With The Customer

deals with customer requirements for various solutions


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The Treasury Function Key Functions/Activities

Liquidity & Funding

LCY

Call/Clean Borrowing/Placement

Investment in T Bill & PIB

Repo/Reverse Repo

FX

Balance Sheet Management/ALM

Interest Rate Risk Management

Market & Liquidity Risk Management


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The Treasury Function Supporting Roles

Middle Office

Reporting line with Risk or Operations

May act as Risk Watchdog or support to Operations

Monitoring and reporting of treasury positions and risk limitsProfit reconciliation

Back Office/TROPS

Processing and settling Inter-bank deals initiated at Front Office

Dealing with branches for placement (record keeping) of their LCY and FXdeposits

Generating position related MIS

Maintaining Nostros