15-1 CHAPTER 15 INTERNATIONAL BANKING

15-2 American International Banking l International banking dates back to the rise of international trade. l Great Britain dominated international finance until after WW II. l American banks entered international finance after 1914.

15-3 The Edge Act (1919) l Federal Reserve Act of 1913 permitted foreign branches. l Agreement corporations were legalized in l Details of the Edge Act –Banks able to create federally chartered subsidiaries located in the United States –Participated in international banking –Could make equity investments –U.S. banks able to compete with European banks –Grew in number and activities after WW II

15-4 The Reasons for Growth in U.S. International Banking l Increased expansion of U.S. trade and foreign markets. l Growth of multinational corporations. l U.S. government business regulation limited U.S. profit opportunities. l Need to finance petroleum induced deficits in foreign countries.

15-5 Recent Activity in U.S. International Banking l Growth slowed in the early 1970s. –U.S. regulations limiting the outflow of funds to foreign countries were eliminated. –Smaller banks could not compete with larger international operations. l International lending increased in –OPEC increased oil prices. –Oil producers and oil importers had surplus/deficit funds flow to invest or finance.

15-6 Regulation of Overseas Banking Activity l Domestic U.S. banking has been regulated to promote the following goals: –bank safety and financial soundness and stability. –bank competition -- performance. –banking business is "special" and kept separate (arms length) from other types of business activities. l Foreign banks are not as regulated the same as U.S. banks, especially in their international banking activity.

15-7 Allowable Banking Activities l Traditionally more types of businesses permitted by U.S. banks operating in foreign countries to enhance competitiveness. –Security underwriting –Equity investments l Restraints are kept on: –U.S. foreign bank subsidiaries owning nonfinancial businesses. –control of foreign companies.

15-8 Delivery of Overseas Banking Services l Representative offices -- assist parent bank customers. l Shell branches -- limited wholesale money market transaction rather than retail public branches. l Correspondent banks -- relationship with foreign banks to provide international banking services. l Foreign branches -- legal branch of domestic parent banking providing full banking services in foreign country.

15-9 Delivery of Overseas Banking Services (concluded) l Edge Act corporations -- federally chartered subsidiaries of U.S. banks engaging in international activities not permitted domestic banks. –International banking activities –International financing activities l Foreign Subsidiaries and Affiliates –Subsidiaries -- separately -- (owned entirely or in part) by a U.S. bank, bank holding company, or Edge Act corporation. –Affiliates -- small ownership interest in foreign bank by U.S. bank.

15-10 Funding International Loans l International loans can be denominated in almost any major currency, but the U.S. dollar is the most common. l The average international loan is larger with large, multinational firms and sovereign countries as borrowers. l Most large international loans are funded in the Eurocurrency market, –International banks issue time deposits and make short or intermediate-term loans –Banks often lend to each other in the interbank market

15-11 Pricing International Loans l The interbank rate in London is called the LIBOR or London Interbank Offered Rate. l Nonbank borrowers pay above the LIBOR. l The interest rate paid to time deposits and the rate charged borrowers will be tied to the interest rate levels of the country and currency used to denominate the deposit and loan. l Lending rates are fixed for the stated credit period (usually a month) but change (float) with the LIBOR at the beginning of each (rollover) period.

15-12 Syndicated Loans l Several banks usually participate in funding the loans, thus spreading the risk to banks and providing the large amounts of funds needed by the borrower. l One or more lead bank(s) package the loan arrangement.

15-13 Collateral l Most international credits are unsecured. l Most business borrowers have high credit ratings. l Borrowing countries pledge their "full faith and credit."

15-14 Risks in International Lending l Credit risk -- the risk of default. l Country risk -- related to the political stability, laws, and regulations of the foreign country. –Expropriation –Nationalization –Change of government l Currency risk -- risk of currency value changes and exchange controls.

15-15 Methods of Reducing Risk in International Lending l Third-party help –Guarantees by governments or central banks –Guarantees by organizations outside the foreign country l Pooling risk -- participation loans among banks to spread risk. l Diversification of foreign loan portfolio l Loan Sales -- selling nonperforming loans in the secondary market at a discount.

15-16 Growth of Foreign Banks in the U.S. -- High Growth after Mid-1970s Until l Japanese banking growth dominated the world in the late 1980's and made significant inroads into west coast U.S. markets. l The waning Japanese equity markets, increased international capital adequacy standards and the recent merger activity among large U. S. banks seem to have slowed the decline in U. S. banks relative to foreign competitors.

15-17 Number of Foreign Banks in the U.S. ( ) Source: American Banker, various issues, , and Federal Reserve System, Structure Data for U.S. Offices of Foreign Banks,

15-18 Foreign and Domestic Bank Assets in the U.S. ( ) Source: American Banker, various issues, , and Federal Reserve System, Structure Data for U.S. Offices of Foreign Banks,

15-19 International Banking Act of 1978 passed to make U.S. banks competitive with foreign banks operating in the United States. l Allow federal chartering of foreign banking facilities. l Limit ability of foreign banks of accepting interstate deposits. l Fed may impose reserve requirements on foreign banks.

15-20 International Banking Act of 1978 passed to make U.S. banks competitive with foreign banks operating in the United States. (concluded) l FDIC insurance required on domestic retail deposits in U.S. based foreign banks. l Foreign banks permitted to form Edge Act corporations. l U.S. based foreign banks were made subject to nonbanking prohibitions of U.S. banking holding companies.