International Banking, Money Market

International Banking and Money Market

Objective:

This chapter serves to begin our discussion of world financial markets and institutions.

Outline

International Banking Services The World’s Largest Banks

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International Banking Services Reasons for International Banking

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International Banking Services Reasons for International Banking Types of International Banking Offices

Correspondent Bank Representative Offices Foreign Branches Subsidiary and Affiliate Banks Edge Act Banks Offshore Banking centers International Banking Facilities

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International Banking Services Reasons for International Banking Types of International Banking Offices

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International Banking Services Reasons for International Banking Types of International Banking Offices International Money Market

Eurocurrency Markets Euro credits Forward Rate Agreements Euro notes Euro commercial Paper

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International Banking Services Reasons for International Banking Types of International Banking Offices International Money Market

International Banking Services

International Banks do everything that domestic banks do and: Arrange trade financing. Arrange foreign exchange. Offer hedging services for foreign currency receivables

and payables through forward and option contracts.

The World’s 10 Largest Banks

Bank of America U.S.

Citigroup U.S.

HSBC Holdings U.K.

Credit Agricole Group France

Chase Manhattan U.S.

Industrial & Commercial Bank of China China

UBS Switzerland

Deutsche Bank Germany

Wells Fargo U.S.

Bank One U.S.

Low Marginal Costs Managerial and marketing knowledge

developed at home country can be used abroad with low marginal costs.

Reasons for International Banking

Low Marginal Costs 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.

Reasons for International Banking

Low Marginal Costs Knowledge Advantage

Reasons for International Banking

Low Marginal Costs Knowledge Advantage Prestige

Very large multinational banks have high perceived prestige, which can be attractive to new clients.

Reasons for International Banking

Low Marginal Costs Knowledge Advantage Home Nation Information Services Prestige Regulatory Advantage

Multinational banks are often not subject to the same regulations as domestic banks.

Reasons for International Banking

Low Marginal Costs Knowledge Advantage Home Nation Information Services Prestige Regulatory Advantage Wholesale Defensive Strategy

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

Reasons for International Banking

Reasons for International Banking

Low Marginal Costs Knowledge Advantage Home Nation Information Services Prestige Regulatory Advantage Wholesale Defensive Strategy Retail Defensive Strategy

Multinational banks also compete for retail services such as travelers cheques, tourist and foreign business market.

Knowledge Advantage Home Nation Information Services Prestige Regulatory Advantage Wholesale Defensive Strategy Retail Defensive Strategy Transactions Costs

Multinational banks may be able to avoid government currency controls.

Reasons for International Banking

Home Nation Information Services Prestige Regulatory Advantage Wholesale Defensive Strategy Retail Defensive Strategy Transactions Costs Growth

Foreign markets may offer opportunities to growth not found domestically

Reasons for International Banking

Prestige Regulatory Advantage Wholesale Defensive Strategy Retail Defensive Strategy Transactions Costs Growth Risk Reduction

Greater stability of earnings due to diversification.

Reasons for International Banking

Types of International Banking Offices

Correspondent Bank Representative Offices Foreign Branches Subsidiary and Affiliate Banks Edge Act Banks Offshore Banking Centers International Banking Facilities

Correspondent Bank

A correspondent banking relationship exists when two banks maintain deposits with each other. They do not have their own banking operations.

Correspondent banking allows a bank’s MNC client to conduct business worldwide through his local bank or its correspondents.

A large New York bank will have a correspondent bank account in a London account and the London bank will maintain one with the New York.

Representative Offices

A representative office is 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.

Representative offices also assist with information about local business customs, economic information and credit evaluation of the MNC’s local customers.

The parent bank will open a representative office in a country in which it has many MNC clients or at least one important client.

Foreign Branches

A foreign branch bank operates like a local bank, but is legally part of the parent. Subject to both the banking regulations of home country and foreign

country. US branch banks in foreign countries are regulated through United states

by Federal Reserve Act and its regulations. Branch Banks are the most popular way for U.S. banks to expand

overseas. Branch banks loans limits are based on the capital of the parent bank

and not the branch bank. And hence will likely be able to extend a larger loan to a customer then a locally chartered subsidiary bank of the parent.

The books of the branch bank are part of the parent’s bank books.

Subsidiary and Affiliate Banks

A subsidiary bank is a locally incorporated bank wholly or partly owned by a foreign parent.

An affiliate bank is one that is partly owned but not controlled by the parent.

Both the banks operate under the banking laws of the country in which they are incorporated

Edge Act Banks

Edge Act banks are federally chartered subsidiaries of U.S. banks that are physically located in the U.S. that are allowed to engage in a full range of international banking activities.

The Edge Act was a 1919 amendment to Section 25 of the 1914 Federal Reserve Act.

They accept foreign deposits, extend trade credit, finance foreign projects abroad, trade foreign currencies, and engage in investment banking activities with US citizens involving foreign securities.

Offshore Banking Centers

An offshore banking center is a country whose banking system is organized to permit external accounts beyond the normal scope of local economic activity.

Operate as branches or subsidiaries of the parent bank. The host country usually grants complete freedom from host-country

governmental banking regulations-low reserve requirements, no deposit insurance, low taxes, favorable time zones that favor international banking transactions and to a minor extent strict banking secrecy laws.

The primary activities of offshore banks are to seek deposits and grant loan in currencies other than the currency of the host government

Offshore Banking Centers

The IMF recognizes the Bahamas Bahrain the Cayman Islands Hong Kong the Netherlands Antilles Panama Singapore

as major offshore banking centers

International Banking Facilities An international banking facility is a separate set of accounts that are

segregated on the parents books. An international banking facility is not a unique physical or legal

identity. A US branch or subsidiary of a foreign bank or an US office of an

Edge Act bank may operate an IBF. IBFs operate as foreign banks in US.They are not subject to domestic

reserve requirements on deposits,nor is FDIC insurance required on deposits.

They seek deposits from non-US citizens and can make loans to only foreigners.

Established largely as a result of offshore banking ,but they can never be eliminated as IBFs are restricted from lending to US citizens.

International Money Market

Eurocurrency is a time deposit in an international bank located in a country different than the country that issued the currency. For example, Eurodollars are U.S. dollar-denominated time deposits in

banks located abroad. Euro yen are yen-denominated time deposits in banks located outside of

Japan.. The Eurocurrency market is an external banking system that runs parallel

to the domestic banking system of the country that issued the currency. Both the banking systems seeks deposits and make loans to customers from the deposited funds.

Eurodollar deposits are not subject to arbitrary reserve requirements or deposit insurance, hence the cost of operations is less.

Contd…

The Eurocurrency market operates at the interbank or at the wholesale level .

The Eurobanks with surplus funds and no retail customers to lend to will lend to Eurobanks that have borrowers but need loanable funds.

The rates charged by banks with excess funds is referred to as interbank offered rate;they will accept deposit at interbank bid rate.

Contd…

The LIBOR is the world's most widely used benchmark for short-term interest rates. It's important because it is the rate at which the world's most preferred borrowers are able to borrow money. It is also the rate upon which rates for less preferred borrowers are based. For example, a multinational corporation with a very good credit rating may be able to borrow money for one year at LIBOR plus four or five points. 

An interest rate at which banks can borrow funds, in marketable size, from other banks in the London interbank market. The LIBOR is fixed on a daily basis by the British Bankers' Association. The LIBOR is derived from a filtered average of the world's most creditworthy banks' interbank deposit rates for larger loans with maturities between overnight and one full year.

Countries that rely on the LIBOR for a reference rate include the United States, Canada, Switzerland and the U.K.

Most Eurocurrency transactions are inter-bank transactions in the amount of $1,000,000 and up.

Common reference rates include LIBOR the London Inter-bank Offered Rate PIBOR the Paris Inter-bank Offered Rate SIBOR the Singapore Inter-bank Offered Rate

A new reference rate for the new euro currency

Eurocurrency Market

EURIBOR the rate at which interbank time deposits of are offered by one prime bank to another.

Euro credits

Euro credits are short- to medium-term loans of Eurocurrency extended by Eurobanks to corporations, sovereign govt. and international organisations.

The loans are denominated in currencies other than the home currency of the Euro bank.

Often the loans are too large for one bank to handle; a number of banks form a syndicate to share the risk of the loan.

Euro credits feature an adjustable rate. On Euro credits originating in London the base rate is LIBOR.

Contd…

The credit risk on these loans is greater than on loans to other banks in the interbank market.

Interest rate must on EURO credits must compensate the bank or the banking syndicate for the added credit risk.

On Eurocredits originating in London the base lending rate is LIBOR

The lending rates on these credits is stated as LIBOR + x,where x is the lending margin charged depending upon the credit worthiness of the buyer.

Forward Rate Agreements

What Does Forward Rate Agreement - FRA Mean?An over-the-counter contract between parties that determines the rate of interest, or the currency exchange rate, to be paid or received on an obligation beginning at a future start date. The contract will determine the rates to be used along with the termination date and notional value. On this type of agreement, it is only the differential that is paid on the notional amount of the contract.

Also known as a "future rate agreement".

Contd…

Typically, for agreements dealing with interest rates, the parties to the contract will exchange a fixed rate for a variable one. The party paying the fixed rate is usually referred to as the borrower, while the party receiving the fixed rate is referred to as the lender.

For a basic example, assume Company A enters into an FRA with Company B in which Company A will receive a fixed rate of 5% for one year on a principal of $1 million in three years. In return, Company B will receive the one-year LIBOR rate, determined in three years' time, on the principal amount. The agreement will be settled in cash in three years. 

If, after three years' time, the LIBOR is at 5.5%, the settlement to the agreement will require that Company A pay Company B. This is because the LIBOR is higher than the fixed rate. Mathematically, $1 million at 5% generates $50,000 of interest for Company A while $1 million at 5.5% generates $55,000 in interest for Company B. Ignoring present values, the net difference between the two amounts is $5,000, which is paid to Company B.

Forward Rate Agreements: Uses

Forward Rate Agreements can be used to: Hedge interest rate risk. Speculate on the future course of interest rates.

Euro notes

Euro notes are short-term notes underwritten by a group of international investment banks or international commercial banks.

A client borrower makes an agreement with a bank to issue Euronotes in its own name for a period of time generally 3 to 10 years.

They are sold at a discount from face value and pay back the full face value at maturity.

Maturity is typically three to six months.

Euro-Medium-Term Notes

Typically fixed rate notes issued by a corporation. Maturities range from less than a year to about ten

years. Euro-MTNs is partially sold on a continuous basis

–this allows the borrower to raise funds as they are needed.

Euro commercial Paper

Unsecured short-term promissory notes issued by corporations and banks and placed directly with the investment public through a dealer.

Like Euronotes they are sold at a discount then the face value

Maturities typically range from one month to six months.

Euro commercial paper, is U.S. dollar denominated.