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INTERNATIONAL BANKING
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INTERNATIONAL BANKING
What is International Banking ?
- The industry was transformed in the 1970s. Until then most banks concentrated on their home markets, considering themselves as domestic institutions that handled foreign business.
- With the rapid expansion of international networks, the banking sector occupies a pivotal position in the global economy as it has access to the capital, the technological capabilities, and the international network to facilitate these activities.
What is International Banking?
What is International Banking ?
- International banking is just like any other banking service, but it takes place across different nations or internationally. To put in another way, international banking is an arrangement of financial service by a residential bank of one country to the residents of another country. Mostly multinational companies and individuals use this banking facility for transacting.
What is International Banking ?
- Banking transactions crossing national boundaries
-Undertake International Lending
-All claims of domestic banks offices on foreign residents
-Claims of foreign bank offices on local residents
-Claims of domestic bank offices on domestic residents in foreign currency
EXAMPLE OF INTERNATIONAL BANKING
- Suppose Microsoft, an American company is functioning in Istanbul. It is in need of funds to meet its working capital requirements. In such scenario, Microsoft can avail the banking services in form of loans, overdraft or any other financial service through banks in Istanbul. Here, the residential bank of Istanbul shall be giving its services to an American company. Therefore, the transaction between them can be said to be part of international banking facility.
Services Offered by International Banks
- International banks do everything domestic banks do and:
- Arrange trade financing.
- Arrange foreign exchange.
- Offer hedging services for foreign currency receivables and payables through forward and option contracts
- Offer investment banking services (where allowed).
- Borrow or lend in Eurocurrency market
- Underwrite Eurobonds and foreign bonds.
Services offered by International Banks
Services Offered by International Banks
- International banks provide services to those engaged in international trade and investment: risk-sharing, liquidity, information.
- Like domestic banks, international banks accept deposits and lend.
- International banks lower transaction costs and lower information costs.
- International financial regulation can lead to innovation in banking.
World’s Largest International Banks
- Citigroup (U.S.)
- Mizuho Bank/Mizuho Corp. Bank (Japan)
- HSBC Holdings (U.K.)
- Bank of America (U.S.)
- JP Morgan Chase (U.S.)
- Deutsche Bank (Germany)
- Royal Bank of Scotland Group (U.K.)
- Sumitomo Mitsui Banking Group (Japan)
- HypoVereinsbank (Germany)
- UFJ Bank Ltd. (Japan)
BENEFITS OF INTERNATIONAL BANKING
FLEXIBILITY:
International banking facility provides flexibility to the multinational companies to deal in multiple currencies. The major currencies that multinational companies or individuals can deal with include euro, dollar, pounds, sterling, and rupee. The companies having headquarters in other countries can manage their bank accounts and avail financial services in other countries through international banking without any hassle.
ACCESSIBILITY:
International banking provides accessibility and ease of doing business to the companies from different countries. An individual or MNC can use their money anywhere around the world. This gives them a freedom to transact and use their money to meet any requirement of funds in any part of the world.
BENEFITS OF INTERNATIONAL BANKING
INTERNATIONAL TRANSACTIONS:
International banking allows the business to make international bill payments. The currency conversion facility allows the companies to pay and receive money easily. Also, the benefits like overdraft facility, loans, deposits, etc. are available every time for overseas transactions.
ACCOUNTS MAINTENANCE:
A multinational company can maintain the records of global accounts in a fair manner with the help of international banking. All the transactions of the company are recorded in the books of the banks across the globe. By compiling the data and figures, the accounts of the company can be maintained.
Types of International Banking Offices
Correspondent Bank:
- Bank located in different countries establish accounts in other bank.
- Provides a means for a bank’s MNC (Multinational Corporation) clients to conduct business worldwide through his local bank or its contacts.
- Provides income for large banks
* Smaller foreign banks that want to do business, say in the U.S. , will enter into a correspondent relationship with a large U.S. bank for a free
Types of International Banks
Types of International Banking Offices
Representative Office:
- 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.
* No traditional credit services provided
* Looks for foreign market opportunities and serves as a liaison between parent and clients
* Useful in newly emerging markets
- Representative offices also assist with information about local business customs, and credit evaluation of the MNC’s local customers.
- It is useful when the bank has many MNC clients in a country.
Types of International Banking Offices
Foreign Branch:
- A foreign branch bank operates like a local bank, but is legally part of the parent , not a separate entity.
* Subject to both the banking regulations of home country and foreign country.
*Reasons for establishing a foreign branch
- More extensive range of services (faster check clearing, larger loans)
- Foreign branches are not subject to Canadian reserve requirements or deposit insurance
- Compete with host country banks at the local level
* Most popular means of internationalizing bank operations
Types of International Banking Offices
Subsidiary and Affiliate Bank:
- A subsidiary bank is a locally incorporated bank that is either wholly owned or owned in major part by a foreign parents.
- An affiliate bank is one that is only partially owned, but not controlled by its foreign parents.
- Both subsidiary and affiliate bank operate under the banking laws of the country in which they are incorporated.
- They are allowed to underwrite securities.
Types of International Banking Offices
Offshore Banking Center:
- A country whose banking system is organized to permit external accounts beyond the normal scope of local economic activity.
-The host country usually grants complete freedom from host country governmental banking regulations.
* Banks operate as branches or subsidiaries of the parent bank
* Primary credit services provided in currency other than host country currency
* Reasons for offshore banks
- Low or no taxes, servises provided for nonresident client, few or no FX controls, legal regime that upholds bank secrecy
- The IMF recognizes the Bahamas, Bahrain, the Cayman Islands, Hong Kong, the Netherlands Antilles, Panama, Singapore as major offshore banking centers.
Reasons for International Banking
- There are many various reasons for individuals and companies to bank internationally. Many people around the world use international banks to shelter their money from their home country's income and estate taxes. Hosts of banks are based in countries with low or no income and estate taxes, such as the Cayman Islands, Belize, Panama and the Isle of Man.
- Since international banks lend and borrow on international markets, they’re less affected by domestic interest rate fluctuations.
- International banks also make it easier for a company with an international presence to do business around the world.
- International banks offer many financial services to facilitate international trade. Besides offering payroll services for companies with employees and contractors in other countries, they offer letters of credit to ensure that companies in different countries pay one another for goods and services.
Reasons / Importance of International Banks
Reasons for International Banking
Low marginal cost:
Managerial and marketing knowledge developed at home can be used abroad with 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
Home Nation 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 foreign domestic banks.
Prestige:
Very large multinational banks have high perceived prestige, which can be attractive to new clients.
Reasons for International Banking
Regulatory Advantage:
Multinational banks are often not subject to the same regulations as domestic banks.
Wholesale Defensive Strategy:
Banks follow their multinational customers abroad to avoid losing their business at home and abroad.
Retail Defensive Strategy:
Multinational banks also compete for retail services such as travelers checks, tourist and foreign business market
Transactions Costs:
Multinational banks may be able to circumvent government currency controls.
Growth:
Foreign markets may offer opportunities to growth not found domestically.
Risk Reduction:
Greater stability of earnings due to diversification
Importance of International Banking
- If you want to make a payment abroad, you will have to deal through a bank operating on international level.
- Banks around the world are centers for money transfer business. Dealers in securities or exporters and importers make use of services of international banks.
- With the growth of Multinational companies, the importance and role of such banks have increased.
- International banking is also important for the growth of competition.
- Such banks also help the developing countries in their economic development.
How It Works?
How It Works?
- To initiate global transactions, you need a bank that has the capability to help you enter the global market. International business deals with buying and selling products and services and transacting with other countries. Knowledge has vital informance about financing your imports and exports. Companies that do business internationally need a bank that is able to help them perform a variety of transactions.
- An international bank should be well versed with other methods of international financing. Some companies use banks that issue letters of credit by way of the Internet. This really speeds the transaction along because it gives the exporter the ability to see the letter of credit immediately. Goods and services can then be released to the importer or buyer because payment has been guaranteed by the bank.
What is Eurocurrency Market ?
*The Eurocurrency market is the money market in which currency
held in banks outside of the country where it is legal tender is
borrowed and lent by banks.
*The Eurocurrency market is utilized by banks, multinational corporations, mutual funds and hedge funds that wish to circumvent regulatory requirements, tax laws and interest rate caps often present in domestic banking, particularly in the United States.
*The term Eurocurrency has nothing to do with the euro currency or
Europe, and the market functions in many financial centers around the world.
Euro Currency Market
Features of Euro-Currency Market
Features of Euro-Currency Market
1. International Market:
The Euro-currency market is an international market which accepts deposits and gives credit in currencies from throughout the world.
2. Independent Market:
It is a free and independent market which does not function under the control of any monetary authority.
3. Wholesale Market:
It is a wholesale market in which different currencies are bought and sold usually above $ 1 million.
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4. Competitive Market:
It is a highly competitive market in which the supply and demand for currencies depends on interest rate changes of Euro-banks.
5. Short-Term Market:
It is a short-term money market in which deposits in different currencies are usually accepted for a period ranging from a few days to a year and interest is paid on them.
6. Inter-Bank Market:
It is an inter-bank market in which the Euro-banks borrow and lend dollars and other Euro-currencies from each other.
Origin and Growth of Euro Currency Market
Euro Currency Market
-The eurocurrency market originated in the aftermath of World War II when the Marshall Plan to rebuild Europe sent a flood of dollars overseas. The market developed first in London as banks needed a market for dollar deposits outside the United States. Dollars held outside the United States are referred to as eurodollars, even if they are held in Asian markets such as Singapore or Caribbean markets such as Grand Cayman.
-The eurocurrency market has expanded to include other currencies such as the yen and the British pound whenever they trade outside of their home market. However, the eurodollar market remains the largest.
Growth of Euro Currency Market
Growth of the Euro-Currency Market
1. Flow of US Aid:
The United States emerged as the most powerful nation in the post-war period which spent huge sums of money on the rehabilitation of Europe both in terms of economic and military aid. This led to the transfer of a large number of dollars in Euro-banks.
2. Cold War:
The cold war which started in the 1950s led the Soviet Union and the East European government to transfer their dollar deposits from America to Euro-banks for fear that they might be blocked by the American Government.
3. Decline in the Importance of Sterling:
In the post-war period Britain emerged as a debtor country. Consequently, the British sterling which had dominated the international financial market in the pre-war era gave place to the dollar in the post-war period. The importance of sterling further fell when the British Government placed severe restrictions on the grant of sterling to central banks outside the sterling area under the British Exchange Control Act in the early post-war period.
4. Petro-dollars:
The increase in the oil prices since 1973 has resulted in the tremendous increase in the incomes of the oil producing countries of the world which are known as petro-dollars. These are deposited in Euro-banks. These have further expanded the Euro-currency market.
5. Innovative Banking:
Because of special circumstances that were present in the 1950s, there came into being a banking system distinct from but supplementary to the banking system of Europe. Like any other banking system, its elements consisted of reserves, deposits and loans, in US dollars and other currencies and recorded in Euro-banks.
Consequently, the Euro-currency market has grown rapidly, in which deposits are received and loans made in currencies other than that of the country in which the market is situated. Now the Eurocurrency market dominates international transactions and traditional foreign banking accounts of international banking.
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Euro-Currency Market
Euro-Credit:
- Short- to medium term loans of Euro-currency to corporations, governments, nonprime banks or international organizations.
- Loans are often too large for one banks to underwrite; a syndicate of banks share the risk of the loan.
- Adjustable rate – Rollover 3-6 month.
- On Euro-credits originating in London, the base rate is LIBOR + X% based on the creditworthiness of the borrower.
Euro-Currency Market
Euro-Currency Market
Euro-notes:
- Short-term notes underwritten by a group of international investment banks or international commercial banks (facility). 3-6 months
- They are sold at a discount from face value and pay back the full face value at maturity.
- Interest rate usually less than syndicated Euro-bank loans.
- Bank receives a small fee for underwriting
Euro-Currency Market
Euro-Commercial Papers:
- Unsecured short-term promissory notes issued by corporations and banks. (1-6 month)
- Placed directly with the public through a dealer.
- Euro-commercial paper, while typical U.S. Dollar denominated, is often of lower quality than U.S commercial paper- as a result yields are higher.
- Euro-commercial paper market size -2006 =$635 billion.
Drawbacks of the Eurocurrency Market
To a very large extend the growth of the Eurocurrency market has integrated the world's money and credit markets.
*The impact of this unregulated Eurocurrency markets has been to increase competition in banking througout the world.
*Regulation maintains the liquidity of the banking system. In an unregulated system such as the Eurocurrency market, the probability of bank failure that would cause depositors to lose their money is greater.
*Borrowing funds internationally can expose a company to foreign exchange risk.
Drawbacks of the Euro-currency Market
International Banks – Key Risks
- Every investment and financing decision as well as operational activities undertaking by a bank under uncertain conditions is associated with some form of risk. The major risks of international banks, such as: international lending risk, country risk, credit risk, currency risk and foreign exchange risk.
Major Risks Faced by International Banks
International Lending Risk:
- Lending involves a number of risks. In addition to risks related to the creditworthiness of the borrower, there are others including funding risk, interest rate risk, clearing risk, and foreign exchange risk. International lending also involves country risk.
- It does not deal with the related risk to which banks may be exposed when they lend domestically in the knowledge that the borrower may be exposed to the risk of default by a foreign customer, or to other foreign impediments that might endanger repayment of the banks' loans.
International Banks – Key Risks
Country Risk:
- It covers the various risks that can arise from the economic, social and political environment of a given foreign country, which could have favorable or adverse consequences for foreigners' debt and/or equity investments in that country.
- The presence of country risk in international lending, however, does not mean that international lending necessarily entails more aggregate risk than domestic lending.
International Banks – Key Risks
Credit Risk:
- According to the Bank for International Settlements (BIS), credit risk is defined as the potential that a bank borrower or counterparty will fail to meet its obligations in accordance with agreed terms. Credit risk is most likely caused by loans, acceptances, interbank transactions, trade financing, foreign exchange transactions, financial futures, swaps, bonds, equities, options, and in the extension of commitments and guarantees, and the settlement of transactions.
- Hence, to minimize the credit risk on the bank’s end, the rate of interest will be higher for borrowers if they are associated with high credit risk. Factors like unsteady income, low credit score, employment type, collateral assets and others determine the credit risk associated with a borrower.
International Banks – Key Risks
Currency Risk:
- Commonly referred to as exchange-rate risk, arises from the change in price of one currency in relation to another. Investors or companies that have assets or business operations across national borders are exposed to currency risk that may create unpredictable profits and losses.
- Currency risk is the potential risk of loss from fluctuating foreign exchange rates when an investor has exposure to foreign currency or in foreign-currency-traded investment.
- Currency risk is important to understand because foreign currency exchange rates can drastically change an investor's total return on a foreign investment, despite how well the investment performed. Currency risk can also create an opportunity for investors when the interest rates between two countries reflect the expected changes in their exchange rates.
International Banks – Key Risks
Foreign Exchange Risk:
- Risk describes the risk that an investment’s value may change due to changes in the value of two different currencies.
- Foreign exchange risk sometimes also refers to risk an investor faces when they need to close out a long or short position in a foreign currency and do so at a loss due to fluctuations in exchange rates.
- Some types of exposure associated with foreign exchange risk include economic exposure, translation exposure and contingent exposure.
- Economic exposure, or forecast risk, refers to when a company’s market value is impacted by currency volatility. Translation exposure refers to when foreign exchange rates change, affecting the figures that a multinational company reports to its shareholders. Contingent exposure refers to the risk that firms face when they bid on projects in foreign currencies.
CONCLUSION
- Globalization and growing economies around the world have led to the development of international banking facility. The world is now a marketplace and each business wants to exploit it. Geographical boundaries are no more a concern. With access to technology, banking facilities have grown vastly.
- One prime example of it is international banking. In the years to come, such banks would see higher growth and higher profitability. Big business houses are expanding themselves at a rapid pace. To maintain the growth, these businesses will need the financial services of international banking. Therefore, the demand for international banking facilities will increase.