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Lecture 32 international banking
 

Lecture 32 international banking

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    Lecture 32 international banking Lecture 32 international banking Document Transcript

    • INTERNATIONAL BUSINESS MANAGEMENT LESSON 32: INTERNATIONAL BANKINGLesson Objectives Rugman and Kamath point out the following reasons for the• TO understand the reasons for the growth of growth of international banking. International banks 1. Low marginal costs - Managerial and marketing knowledge• To understand the various types of International Bank developed at home can be used abroad with low marginal Offices costs.• To understand the concept and features of off shore 2. Knowledge advantage - The foreign bank subsidiary can financial markets draw on the parent bank’s knowledge of personal contacts and credit investigations for use in that foreign market.• To have an understanding on Non Banking Financial Companies 3. Home nation information services - Local firms in a foreign market may be able to obtain more complete• To understand the meaning and scope of Euro currency information on trade and financial markets in the• To understand the important features of Euro Currency multinational bank’s home nation than is otherwise market obtainable from foreign domestic banks.• To understand the origin and growth of Euro Dollar 4. Prestige - Very large multinational banks have high perceived Market prestige, liquidity, and deposit safety that can be used to• To understand the factors that led to growth of Euro attract clients abroad. Dollar Markets 5. Regulation advantage- Multinational banks are often notInteraction subject to the same regulations as domestic banks. ThereLeading international banks include Bank of America, may be reduced need to publish adequate financialCitigroup, HSBC Holdings, Credit Agricole Group, Chase information, lack of required deposit insurance and reserveManhattan, Industrial and Commercial Bank of China (lCBO requirements on foreign currency deposits, and the absenceUBS, Deutsche Bank etc. Most of the world’s 50 largest banks of territorial restrictions (that is, U.S. banks may not beare from Japan, U.S., France, U.K., and Germany. London, New restricted to state of origin).York, and Tokyo, however, is by far the most important 6. Wholesale defensive strategy - Banks follow theirinternational finance centers because of the relatively liberal multinational customers abroad to prevent the erosion ofbanking regulations of their respective countries. These three their clientele to foreign banks seeking to service thefinancial centers are frequently referred to as full service centers multinational’s foreign subsidiaries.because the major banks that operate in them usually provide a 7. Retail defensive strategy- Multinational banks preventfull range of services. erosion by foreign banks of the traveler’s check, tourist, andInternational banks are banks, which accept foreign currency foreign business market.deposits, finance international business and provide associated 8. Transaction costs - By maintaining foreign branches andand ancillary services like hedging and advisory services and foreign currency balances, banks may reduce transaction costsoperate internationally. and foreign exchange risk on currency conversion ifAs Eun and Resnick observe, major distinguishing features government controls can be circumvented.between domestic banks and international banks are the types 9. Growth - Growth prospects in a home nation may be limitedof deposits they accept and the loans and investments they by a market largely saturated with the services offered bymake. Large international banks both borrow and lend in the domestic banks.Eurocurrency market. Additionally, they are frequently members 10. Risk reduction- Greater stability of earnings is possibleof international loan syndicates, participating with other with international diversification.international banks to lend large sums to MNCs needingproject financing and sovereign governments needing funds for Offsetting business and monetary policy cycles across nationseconomic development. Most of them also perform merchant reduces the country specific risk of anyone nation.banking functions. Types of international Banking OfficesAreas in which international banks typically have expertise to There are different types of international banking officesprovide consulting services and advice to their clients are foreign ranging from correspondent bank relationships, through whichexchange hedging strategies, interest rate and currency swap minimal service can be provided to a bank’s customers, tofinancing, and international cash management services. Banks branch offices and subsidiaries providing a fuller array ofthat provide a majority of these services are commonly known services.as universal banks or full service banks. © Copy Right: Rai University11.625.1 203
    • Correspondent Bank: A correspondent bank is bank located International banks regard offshore financial centers as veryINTERNATIONAL BUSINESS MANAGEMENT elsewhere that provides a service on behalf of another bank, good source for raising deposits, taking advantage of lower besides its normal business. The correspondent banking system borrowing costs and tax rates. The offshore financial centers are enables a bank’s foreign client to conduct business worldwide centers for the Eurocurrency market. Offshore banks operate as through his local bank or its contacts. The most important branches or subsidiaries of the parent bank. correspondent banking service often is related to the foreign Offshore financial centers have one or more of the following exchange transactions of the client. However, correspondent characteristics: bank services also include assistance with trade financing, such • Large foreign-currency (Eurocurrency) market for deposits as honoring letters of credit and accepting drafts drawn on the and loans (that in London, for example). correspondent bank. • Market that is a large net supplier of funds to the world The correspondent bank mode is ideal because of its low cost financial markets (that in Switzerland, for example). when the volume of business is small. The possible disadvan- tage is that the clients may not receive- the required level of • Market that is an intermediary or pass-through for service. international loan funds (those in the Bahamas and the Cayman Islands, for example). Representative Offices: A Representative Office is a small service facility staffed by the parent bank personnel that is • Economic and political stability. designed to assist the foreign clients of the parent bank in • Efficient and experienced financial community. dealings with the bank’s correspondents and to provide the • Good communications and supportive services clients with a level of service>greater than that provided • Official regulatory climate favorable to the financial industry, through merely a correspondent relationship. in the sense that it protects investors without unduly Foreign Branches: Foreign branches, which may provide full restricting financial institutions. services, may be established when the volume of business is The International Monetary Fund recognizes the Bahamas, sufficiently large and when the law of the land permits it. Bahrain, the Cayman Islands, Hong Kong, the Netherlands, Foreign branches facilitate better service to the clients and help Antilles, Panama, and Singapore as major offshore banking the growth of business. centers . Subsidiaries and Affiliates: A subsidiary bank is a locally incorporated bank that is either wholly or majority owned by a Non-Banking Financial Companies foreign parent and an affiliate bank is one that is only partially Non-banking financial companies (NBFCs) are financial owned but not controlled by its foreign parent. Subsidiaries and intermediaries engaged primarily in the business of accepting affiliates are normally meant to handle substantial volume of deposits and making loans and advances, investments, leasing, business. Their autonomy, compared to branches, more hire purchase, etc. NBFCs are a heterogeneous lot. They include operational and strategic management leverage. investment companies, finance corporations, mutual benefit funds, hire-purchase finance companies, loan companies and Offshore Financial Centres leasing companies. A major contributor to the growth of international banking is The global liberalization has enabled large NBFls to expand the offshore banking centres. “An offshore banking center is a their business globally. The growth of FII investment in India country whose banking system is organised to permit external is one of the manifestations of their expansion of business in accounts beyond the normal economic activity of the country developing countries. Foreign NBFls are active in India in The principal features that make a country attractive for estab- mutual fund business, hire-purchase financing, insurance etc. lishing an offshore banking operation are virtually total freedom from host-country governmental banking regulations - for Eurocurrency Market example, low reserve requirements and no deposit insurance, The growth of the Eurocurrency market, also known as low taxes, a favourable time zone that facilitates international Eurodollar market, is one of the significant developments in banking transactions, and to a minor extent, strict banking the international economic sphere after the World War II. Its secrecy laws.” phenomenal development,. though poses problems for the national monetary authorities and international monetary The offshore financial centers “are either operational centers, stability, has helped the growth of international trade, with extensive ‘banking activities involving short-term financial transnational corporations and the economies of certain transactions, or booking centers, where little actual banking countries. activity takes place but where transactions are recorded to take advantage of secrecy and low (or no) tax rates. In the latter case, Meaning and Scope individuals may deposit money offshore to hide it from their In a narrow sense, Eurodollars are financial assets and liabilities home-, country tax authorities, either because the money was denominated in US dollars but traded in Europe. True, the US earned illegally- such as in drug trade -or because the individual dollar still predominates the market and most of the transac- or company does not want to pay tax. London is an example of tions are still conducted in the money market of Europe, an operational center; the Cayman Islands is an example of a especially London. But today, the scope of the market stretches booking center.” far beyond Europe and the dollar in the sense that the ‘Euro- dollar’ transactions are held also in money markets other than © Copy Right: Rai University 204 11.625.1
    • European and in currencies other than the US dollar. Inter- market owes a great deal to the fact that it is outside the INTERNATIONAL BUSINESS MANAGEMENTpreted in a currency deposited outside the country of issue. control of any national authority.“Thus, any currency internationally supplied and demanded and 2. It is a short-term money market: The deposits in this marketin which a foreign bank is willing to accept liabilities and loan range in maturity from one day to several months andassets is eligible to become Eurocurrency.”26 Interpreted in a interest are paid on all of them. Although some Eurodollarwider sense, Eurodollar market refers, thus, to transactions in a deposits have a maturity of over one year, Eurodollarcurrency deposited outside the country of its issue. “Thus, any deposits are predominantly a short-term instrument.currency internationally supplied and demanded and in which a “The Eurodollar market is viewed in most discussions moreforeign bank is willing to accept liabilities and loan assets is as a credit market - a market in dollar bank loans - and as aneligible to become Eurocurrency.”27 Interpreted this way, dollar important accessory to the Eurobond market.”3O Thedeposits with banks in Montreal, Toronto, Singapore, Beirut, Eurodollar loans are generally for short periods - threeetc., are also Eurodollars, so are the ‘deposits denominated in months or less, Eurobonds being employed for longer-termEuropean currencies in the money markets of USA and the loans. The Eurobonds developed out of the Eurodollarabove centers. Thus, it is evident that the term ‘Eurodollar’ is a market to provide longer term loans than was usual withmisnomer. ‘Foreign currency Market’ would be the appropriate Eurodollars. A consortium of banks and issuing housesterm to describe this expanding market. The term ‘Eurodollar’ usually issues these bonds.came to be used because the market had its origin and earlierdevelopments with dollar transactions in the European money 3. It is a wholesale market: The Eurodollar market is amarkets. Despite the emergence of other currencies and the wholesale market in the sense that the Eurodollar is aexpansion of the market to other areas, Europe and the dollar currency dealt in only large units. The size of an individualstill hold the key to the market. Today, the tern Eurocurrency transaction is usually above $1 million.market is in popular use. 4. It is a highly competitive and sensible market: Its efficiencyToday, the ‘Eurodollar Market’ consists of Asian dollar market, and competitiveness are reflected in its growth andRio dollar market, Euro-yen market, etc., as well as expansion. The resiliency of the Eurodollar market isEurosterling, Euroswiss francs, Euro-French francs, Euro- reflected in the responsiveness of the supply of and demandDeutsche marks, and so on. for funds to the changes in the interest rates vice-versa.In short, in these markets, the commercial banks accept interest Origin and Growthbearing deposits denominated in a currency other than the The origin of this market can be traced back to the 1920s whencurrency of the country in which they operate and they re-Lend the United States dollars were deposited in Berlin and Viennathese funds either in the same currency or in the currency of the and were converted into local currencies for lending purposescountry in which they operate or in the currency of a third However, the growth of the Eurodollar market began ‘to gaincountry. It its Annual Report in 1966, the Bank for Interna- momentum only in the late 1950s. Since 1967 the growth oftional Settlements (BIS) described the Eurodollar phenomenon the market has been very rapid. The flow of the petrodollarsas “The acquisition of dollars by banks located outside the has given it an added momentum since about the middle ofUnited States, mostly through the taking of deposits, but also the 1970s. The growth of the market since then has beento some extent by swapping other currencies into dollars, and substantial.the re-Lending of these dollars, often after red positing with It is pointed out that32 the phenomenal development of theother banks, to non-bank borrowers anywhere in the world.”28 Eurodollar market since the beginng of 1960s can also beThe currencies involved in the Eurodollar market are not in any viewed from the viewpoint of the width, breadth and resiliencyway different from the currencies deposited with banks in the of the market. The momentum of the market developmentrespective home countries. But the Eurodollar is, outside the accelerated after 1968 when the international gold and currencyorbit of the monetary policy whereas the currency deposited problem developed into recurring crisis every year and thewith banks in the respective home country is enveloped by the United States’ balance of payments deficits supplied additionalnational monetary policy. dollars to the market. More and more participants were drawn into the market due to its growing economic efficiency, competi-Important Features of the Market tiveness and the sure prospect of gain it confidently held out.The important characteristics of the Eurocurrency market are the Besides, central banks and financial intermediaries, multina-following: tional corporations, Middle Eastern Oil firms, developing1. It is an international market and it is under no national countries and the communist countries also entered the market control: The Eurocurrency market has emerged as the most as participants. The centre of the Eurodollar market has spread important channel for mobilizing and deploying funds on from London and West European Financial centres to other an international scale. less known places like Bahamas, Singapore, Lebanon and By its very nature the Eurodollar market is outside the direct Toronto. The depth of the market is reflected in the longer control of any national monetary policy. “It is aptly said that terms of loans and the increased channels of obtaining them. the dollar deposits in London are outside United States Since the market is large, efficient and highly competitive it is control because they are in London, and outside British highly sensitive, too. This is reflected in the fluctuations of control because they are in dollars.”29 The growth of the © Copy Right: Rai University11.625.1 205
    • interest rates depending on supply and demand factors, United States, such as interest equalization and the voluntaryINTERNATIONAL BUSINESS MANAGEMENT internationally. restrictions on lending and investing abroad by United States corporations and banks, have made the market larger than it Factors that Contributed to the Growth otherwise would have been. Without these controls much of The following are the important factors that contributed to the the market’s activity would instead be carried in the New growth of the Eurodollar market at different stages and times: York money market.” 1. The Suez Crisis: The restrictions placed upon sterling credit 6. Innovative Banking: The advent of innovative banking, facilities for financing trade which did not touch the British spearheaded by the American banks in Europe and the shores during the Suez Crisis in 1957 provided a stimulus willingness of the banks in the market to operate on a for the growth of the Eurodollar Market. The British banks, narrow ‘spread’ also encouraged the growth of the Euro in search of an alternative way to meet the demand for credit market. on the part of the traders in this sphere, easily found a good substitute in dollars. There was already available a pool of 7. Supply of Petrodollars: The flow of petrodollars, facilitated US dollars, held by residents outside the US. by the tremendous increase in the OPEC’s oil revenue 2. Relaxation of Exchange Controls and Resumption of following the hikes in the oil prices since 1973, has been a Currency Convertibility: The general relaxation of significant source of growth of the Eurodollar market. exchange control, the stability in the exchange market and the The Participants resumption of currency convertibility in Western Europe in Participants in the Eurocurrency business include governments 1958 provided an added impetus to the growth of the (including of communist countries), international Eurodollar market. In a convertible currency system, some organisations, central banks, commercial banks, corporations, countries are, as a rule, in surplus and others in deficit. The especially multinational corporations, traders, individuals, etc. money market in the surplus country being liquid, short- term funds flow to the Euro market, attracted by the higher Supply and Demand rate of interest. On the other hand, credit flows from the The supply of and demand for funds in the Eurocurrency Euro market to the deficit countries where the money market market come from the above participants. Central banks of is tight. The relaxation of exchange controls not only enable various countries are very important suppliers. The bulk of the the holder of dollar “...claims to retain them rather than central bank funds are channeled through the BIS in Basle, surrendering the mighty God” called dollar to the exchange Switzerland. The enormous oil revenue of the OPEC has control authorities, but also increased the demand for US become an important source of flow of funds to the Eurodol- dollars as they could be freely converted into domestic lar market. Multinational corporations and traders place their currency to finance domestic economic activity. surplus funds in the market to obtain short-term gains. 3. The Political Factor: The cold war between the United Governments have emerged as significant borrowers in the States and the communist countries also contributed to the Eurocurrency market. The frequent hike in the oil prices and the growth of the Euro market. Due to the fear of blocking or consequent increase in the current account deficits of many seizure of deposits by the US in the event of hostilities, the countries compel them to increase their borrowings. Russian and East European banks sought to place their The commercial banks in need of additional funds for lending dollar balances with European banks, especially British and purposes may borrow from the Euro market and re-Lend it. At French, rather than with banks in the United States. the end of the financial year, sometimes they resort to borrow- 4. Balance of Payments Deficits of the us: The large and ing for ‘window dressing’ also. Business corporations, especially persistent deficit in the balance of payments of the US multinationals, and traders borrow from the market for their meant an increasing flow of the US dollar to those countries short-term requirements. which had surplus with the US. The US has had a deficit in An Evaluation of the Eurodollar Market international payments every year since 1950, except in 1957. The advantages and dangers associated with the Eurocurrency Since 1958, the deficits assumed alarming proportions. This market have given rise to the doubt whether it is a welcome is one of the most important factors responsible for the tonic or a slow poison to the international system. rapid growth of the Eurodollar market. The growth of the Euro market has helped to alleviate the 5. The Regulation IQI: Some of the regulations of the Federal international liquidity problems considerably, provided credit to Reserve System, especially the Regulation ‘Q; which fixed the finance the balance of payments deficits, enabled the exporters maximum rate of interest payable by the banks in the US and importers to obtain credit, helped to meet the short-term and the prohibition of payment of interest on deposits for credit requirements of the business corporations, and provided less than 30 days very significantly contributed to the fast better opportunities for the investment of short-terms funds. growth of the Eurodollar market. Although Eurodollar It has provided a market for profitable investment of funds by rates had their ups and downs, they were all the time - except the central banks. The supply of funds by the Euro market has for brief periods in 1958 for three months’ deposits - enabled commercial banks in some countries to expand appreciably higher than the deposit rates in the US. Unlike in domestic credit creation and helped ‘window dressing.’ The the US, the Eurodollar market paid interest on deposits for Eurocurrency has helped to accelerate the economic develop- less than 30 days also. Further, “Selective Controls in the © Copy Right: Rai University 206 11.625.1
    • ment of certain countries including South Korea, Brazil, Taiwan INTERNATIONAL BUSINESS MANAGEMENTand Mexico.However, the growth of this market has given rise to someserious problems, especially in the sphere of monetary stability.“Central Banks and governments have been uneasy about theEurodollar market ever since it became visible in 1958. Itsexplosive growth baffles them, they know that something isgoing on but they are seldom sure what it its. They do knowthat one of its attractions for the participants is that theEurodollar market provides opportunities for avoiding manyof the regulations that they try to enforce on national moneymarkets.”“Despite the many advantages of the Eurodollar as a ‘vehiclecurrency’ for carrying on world trade and as a source of interna-tional liquidity, there remains the unsettling prospect of amachine, controlled by no one, that can add to the world’smoney supply by creating dollars.”35 As Milton Friedman hassaid “... the Eurodollar market has almost surely raised theworld’s nominal money supply (expressed in dollar equivalents)and has thus made the world price level (expressed in dollarequivalents) higher than it would otherwise be.”The Eurodollar and Eurobond markets have become impor-tant sources of finance for governments and private firms. Thegrowing integration of the world economy and globalisation ofbusiness increase the importance of these markets.Government of India has made use of the Euro market onseveral occasions. There is an increasing realization of theimportance of this market by the Indian companies. Thechange in the business environment in India increases theimportance of this market for Indian business.Notes: © Copy Right: Rai University11.625.1 207