Chapter 11: International Banking and Money Market

Correspondent Bank

-Established when two banks maintain a correspondent account with one another -Enables a bank's MNC client to conduct business worldwide through their local bank or its contacts -Services center around foreign exchange conversions

Regulatory Advantage

-Multinational banks are often not subject to the same regulations as domestic banks -Reduced need to publish adequate financial information , lack of required deposit insurance, and reserve requirements on foreign currency deposits, and absence of territorial restrictions

International Debt Crisis

-Some of the largest banks in the world were endangered when loans were made to sovereign governments of some less-developed countries -At the height of the crisis in the mid 1980s, third world countries owed $1.2 trillion

Offshore Banking Centers

-a country whose banking system is organized to permit external accounts beyond the normal scope of local economic activity -primary function is to seek deposits and grant loans in currencies other than the host country currency -major centers: Bahamas, Bahrain, the Cayman Islands, Hong Kong, Panama, and Singapore -operates as branches or subsidiaries of the parent bank

Representative Offices

-a small service facility staffed by parent bank personnel that is designed to assist MNC clients of the parent bank in dealings with the bank's correspondents -ability to provide MNC client with a level of service greater than that provided through a correspondent relationship -parent bank may open representative office in a country in which it has many MNC clients or at least an important client

Eurocurrency

-a time deposit of money in an international bank located in a country other than the country that issues the currency -also known as international currencies -ex: Eurodollars

International banking facilities (IBFs) are located in the US, and they:

-accept deposits and make loans to foreigners. -are not subject to the Fed's reserve requirements for deposits. -do not have to meet FDIC insurance requirements on deposits. -cannot make loans to US citizens

Forward Rate Agreements (FRA)

-an interbank contract that is used to hedge the interest rate risk in mismatched deposits and credits -allow Eurobanks to hedge against the interest rate risk of mismatched Eurodeposits and Eurocredits

Euro Commercial Paper

-an unsecured short term promissory note issued by corporations and banks -placed directly with the public through a dealer -maturities range from 1 to 6 months (longer than US CP) -typically US dollar denominated -often is of lower quality than US commercial paper which results in higher yields

International Banking Facilities (IBFs)

-banking operation within domestic US banks that act as foreign banks in the United States and, as such, are not bound by domestic reserve requirements or FDIC insurance requirements -seek deposits from non US citizens and can make loans only to foreigners

Adjustable Rate of Eurocredits

-base rate (which adjusts) is a reference rate -the lending rate, X, is an additional, fixed amount that reflects the credit worthiness of the borrower -ex: SOFR + X%

Edge Act Banks

-federally chartered subsidiaries of US banks that are physically located in the US and are allowed to engage in a full range of international banking activities -do NOT compete directly with the services provided by US commercial banks -typically located in a state different from that of its parent in order to get around the prohibition on interstate branch banking

FRA Uses

-hedge assets that a bank currently owns against interest rate risk -speculate on the future course of interest rates

Foreign Branches

-operates like a local bank, but is legally part of the parent. -Subject to both the banking regulations of home country and foreign country. -Can provide a much fuller range of services than a representative office. -Most popular way for US banks to expand operations overseas

Eurocurrency Banking System

-runs parallel to domestic banking systems of the countries that issued the currencies -less regulated than domestic banking systems (lower costs for Eurobanks and more risk for customers)

Eurocredits

-short to medium term loans of Eurocurrency extended by Eurobanks to corporations, sovereign governments, non-prime banks, or international organizations -loans are denominated in currencies other than the home currency of the Eurobank -adjustable rate

Euronotes

-short-term securities issued in bearer form with common maturities of one, three, and six months -underwritten by a "facility" (i.e., a group of international investment of commercial banks) -borrower is typically a MNC or government -sold at a discount from face value and pay back the full face value at maturity -interest rate tends to be lower than a standard Eurobank loan

Debt-for-Equity Swaps

-the sale of sovereign debt for US dollars to investors desiring to make equity investment in the indebted nation -MNC would use the local currency to make a pre approved new investment in the LDC was economically or socially beneficial to the LDC

Basel II Accord (2004-2005)

-was endorsed by central bank governors and bank supervisors in the G10 countries -sets out the details for establishing more risk sensitive minimum capital requirements -the key variables the bank must estimate are the probability of default and the loss given default for each asset on their books

If loan rolls over first...

-worried about interest rates decreasing -would sell

If deposit rolls over first...

-worried about interest rates increasing -would buy

Basel Accord

Established in 1988 by the Bank for International Settlements, this act established a framework to measure bank capital adequacy for banks in the Group of Ten and Luxembourg.

According to your textbook, US banks typically expand their operations overseas by establishing:

Foreign Branches

Shell Branches

Offshore locations established in order to escape the burden of regulation

For eurocredits of US dollars originating in London the interest rate is (SOFR + X%), where:

SOFR adjusts at regular intervals and X is fixed

Syndicate

a group of Eurobanks banding together to share the risk of lending Eurocredits

Settlement Rate (SR)

actual rate when rate rollsover

Why are international banks often structured as bank holding companies?

allows them to perform both traditional commercial banking functions and also engage in investment banking activities

Basel III (2010)

attempted to substantially strengthen the regulatory capital framework and increase the quality of bank capital

While traditional bank capital standards protect depositors from traditional credit risk, they may not be sufficient protection from __________ _______.

derivative risk

International Banking Services

do everything domestic banks do and also: -arrange trade financing for clients -arrange foreign exchange for clients -assist clients in hedging FX risk through forward and option contracts -serve as underwriters for international bonds -borrow and lend in the Eurocurrency market -trade FX products for their own account

Growth

foreign markets may offer opportunities for growth not found domestically

Basel 2.5 (2009)

intended to tighten regulation and oversight with regard to all three pillars

Eurocurrency Transactions

interbank transactions in the amount of $1,000,000 or more

Risk Reduction

international diversification leads to more stable bank earnings

The project proposed by Detroit Motors is a likely candidate for approval by a foreign central bank because it:

is export-oriented

Home Country Information Services

local firms in a foreign market may be able to obtain more complete information on trade and financial markets in the multinational bank's home nation than is obtainable from their own domestic banks

Subsidiary Bank

locally incorporated bank wholly or partly owned by a foreign parent

Low Marginal Costs

managerial and marketing knowledge developed at home can be used abroad with low marginal costs

Retail Defensive Strategy

multinational banks are better able to compete with foreign banks for retail services such as travelers checks and in the tourist and foreign business market

Transaction Costs

multinational banks may be able to reduce transaction costs and foreign exchange risk on currency conversion

FRA Forward: Seller

paid if the interest rate decreases (SR < AR)

FRA Forward: Buyer

paid if the interest rate increases (SR > AR)

Affiliate Bank

partly owned but not controlled by the parent

Agreement Rate (AR)

rate we would like to receive

What are IBORs being replaced by?

reference rates that are based on more active and liquid overnight lending markets

Bank Capital Adequacy

the amount of equity capital and other securities a bank holds as reserves against risky assets to reduce the probability of a bank failure

Prestige

very large multinational banks have high perceived prestige and increased liquidity, which can be attractive to new clients

3 Pillars of Capital Adequacy

1. minimum capital requirements 2. supervisory review process 3. effective use of market discipline

The World's Largest Banks (by total assets)

7 from China, 6 from US, 4 each from Australia and Canada, 3 from Japan, 2 each from France and UK, and 1 each from Spain and Netherlands

Eurobanks

Banks accepting Eurocurrency deposits

Wholesale Defensive Strategy

Banks follow their multinational customers abroad to avoid losing their business at home and abroad.

Eurodollars

Deposits of US dollars in banks located outside of the US

Knowledge Advantage

The foreign bank subsidiary can draw on the parent bank's knowledge of personal contacts and credit investigations for use in that foreign market.