Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-07 International Banking and Money Market(Chapter 11)Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-1Essential ReadingThe Whole ChapterIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-2Main ContentslInternational BankinglInternational Money MarketlInternational Debt CrisisIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-3The Worlds 10 Largest Banks1.BNP Paribas France 2.Royal Bank of Scotland Group United Kingdom3.HSBC United Kingdom 4.Crdit Agricole France 5.Bank of America United States6.BarclaysUnited Kingdom7.Deutsche Bank Germany8.JP Morgan ChaseUnited States 9.Mitsubishi UFI Financial Group Japan10.Citigroup United StatesIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-4lLow Marginal CostsnManagerial and marketing knowledge developed at home can be used abroad with low marginal costs.Reasons for International BankingIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-5lLow Marginal CostslKnowledge AdvantagenThe foreign bank subsidiary can draw on the parent banks knowledge of personal contacts and credit investigations for use in that foreign market.Reasons for International BankingIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-6lLow Marginal CostslKnowledge AdvantagelHome Nation Information ServicesnLocal firms in a foreign market may be able to obtain more complete information on trade and financial markets in the multinational banks home nation than is obtainable from foreign domestic banks.Reasons for International BankingIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-7lLow Marginal CostslKnowledge AdvantagelHome Nation Information ServiceslPrestigenVery large multinational banks have high perceived prestige,which can be attractive to new clients.Reasons for International BankingIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-8lLow Marginal CostslKnowledge AdvantagelHome Nation Information ServiceslPrestigelRegulatory AdvantagenMultinational banks are often not subject to the same regulations as domestic banks.Reasons for International BankingIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-9lLow Marginal CostslKnowledge AdvantagelHome Nation Information ServiceslPrestigelRegulatory AdvantagelWholesale Defensive StrategynBanks follow their multinational customers abroad to avoid losing their business at home and abroad.Reasons for International BankingIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-10Reasons for International BankinglLow Marginal CostslKnowledge AdvantagelHome Nation Information ServiceslPrestigelRegulatory AdvantagelWholesale Defensive StrategylRetail Defensive StrategynMultinational banks also compete for retail services such as travelers checks,tourist and foreign business market.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-11lKnowledge AdvantagelHome Nation Information ServiceslPrestigelRegulatory AdvantagelWholesale Defensive StrategylRetail Defensive StrategylTransactions CostsnMultinational banks may be able to circumvent government currency controls.Reasons for International BankingIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-12lHome Nation Information ServiceslPrestigelRegulatory AdvantagelWholesale Defensive StrategylRetail Defensive StrategylTransactions CostslGrowthnForeign markets may offer opportunities to growth not found domesticallyReasons for International BankingIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-13lPrestigelRegulatory AdvantagelWholesale Defensive StrategylRetail Defensive StrategylTransactions CostslGrowthlRisk ReductionnGreater stability of earnings due to diversification.Reasons for International BankingIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-14Types of International Banking OfficeslCorrespondent BanklRepresentative OfficeslForeign BrancheslSubsidiary and Affiliate BankslEdge Act BankslOffshore Banking CenterslInternational Banking FacilitiesIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-15Correspondent BanklA correspondent banking relationship exists when two banks maintain deposits with each other.lCorrespondent banking allows a banks MNC client to conduct business worldwide through his local bank or its correspondents.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-16Representative OfficeslA 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 banks correspondents.lRepresentative offices also assist with information about local business customs,and credit evaluation of the MNCs local customers.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-17Foreign BrancheslA foreign branch bank operates like a local bank,but is legally part of the the parent.nSubject to both the banking regulations of home country and foreign country.nCan provide a much fuller range of services than a representative office.lBranch Banks are the most popular way for U.S.banks to expand overseas.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-18Subsidiary and Affiliate BankslA subsidiary bank is a locally incorporated bank wholly or partly owned by a foreign parent.lAn affiliate bank is one that is partly owned but not controlled by the parent.lU.S.parent banks like foreign subsidiaries because they allow U.S.banks to underwrite securities.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-19Edge Act BankslEdge 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.lThe Edge Act was a 1919 amendment to Section 25 of the 1914 Federal Reserve Act.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-20Edge Act BankslFederal Reserve Regulation K allows Edge Act banks to do the following:nAccept foreign depositsnExtend trade creditnFinance foreign projects abroadnTrade foreign currenciesnEngage in investment banking activities with U.S citizens involving foreign currencieslIt is throughj the Edege Act that U.S parent banks own foreign banking subsidiaries and have ownership positions in foreign banking facilities.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-21Offshore Banking CenterslAn offshore banking center is a country whose banking system is organized to permit external accounts beyond the normal scope of local economic activity.lThe host country usually grants complete freedom from host-country governmental banking regulations.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-22Offshore Banking CenterslThe principal features that makes a country attractive for establishing an offshore banking operation are total freedom from host-country government banking regulations-nLow reserve requirements and no deposit insurancenLow taxesnA favorable time zone for international banking transaction.nStrict banking secrecy lawsnAttractive Interest rateIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-23Offshore Banking CenterslThe IMF recognizesnthe BahamasnBahrainnthe Cayman IslandsnHong Kongnthe Netherlands AntillesnPanamanSingaporelas major offshore banking centersIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-24International Banking FacilitieslAn international banking facility is a separate set of accounts that are segregated on the parents books.lAn international banking facility is not a unique physical or legal identity.lAny U.S.bank can have one.lInternational banking facilities have captured a lot of the Eurodollar business that was previously handled offshore.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-25Capital Adequacy StandardslBank capital adequacy refers to the amount of equity capital and other securities a bank holds as reserves against risky assets to reduce the probability of a bank failure.lIn a 1988 agreement known as the Basle Accord,the Bank for International Settlement(BIS)established a framework for measuring bank capital adequacy.8%is stipulated as the minimum rate.lThere are various standards and international agreements regarding how much bank capital is“enough”to ensure the safety and soundness of the banking system.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-26Capital Adequacy StandardslWhile traditional bank capital standards may be enough to protect depositors from traditional credit risk,they may not be sufficient protection from derivative risk.lFor example,Barings Bank,which collapsed in 1995 from derivative losses,looked good on paper relative to capital adequacy standards.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-27Capital Adequacy Standards Shareholder equity lTier 1:Core Capital 50%l Retailed Earningsl l Preferred stocks lTier 2:Supplementary Capital:50%l Subordinated bonds l government obligation 0%l short-term interbank assests 20%lAssets l residential mortage 50%l other assets 100%l Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-28Capital Adequacy StandardslIn June 2004,the new capital adequacy framework commonly referred to as Basel II was endorsed by central bank governors and bank supervisors in the G-10 countries.lIts implemented in the end of 2006.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-29Capital Adequacy StandardslBasel II is based on three mutually reinforcing pillars:minimum capital requirements,a supervisory review process,and the effective use of market discipline.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-30Capital Adequacy StandardslWith respect to the first pillar(the minimum capital requirements),bank capital is defined as per 1988 accord,but the minimum 8%ratio is calculated on the sum of the banks credit,market,and operational risk.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-31Capital Adequacy StandardslThe second pillar is designed to ensure that each bank has a sound internal process in place to properly assess the adequacy of its capital based on a thorough evaluation.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-32Capital Adequacy StandardslThe third pillar is designed to complement the other two.It is believed that public disclosure of key information will bring market discipline to bear on banks and supervisors to better manage risk and improve bank stability.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-33International Money MarketlThe international money market:Where borrowing or lending have a year or less to maturityIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-34The International Money MarketlFunctionsnBanks with a temporary shortage of money can borrow from those with a surplusnCompanies,financial institutions and local governments with a temporary shortage of money can borrow form those with a surplusIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-35The International Money MarketlCharacteristicsnThere is no single marketplacenWebs of borrows and lenders-linked by telephones and computersnA wholesale marketnAll short term lending and borrowingnNo mortgagenNo single set of posted pricesnMoney market instruments pay fixed interest-and most are sold at a discount to the face valueIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-36The International Money MarketlActually,the international money market mainly includes eurocurrency business.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-37International Money MarketlEurocurrency is a time deposit in an international bank located in a country different from the country that issued the currency.nFor example,Eurodollars are U.S.dollar-denominated time deposits in banks located abroad.nEuroyen are yen-denominated time deposits in banks located outside of Japan.nThe foreign bank doesnt have to be located in Europe.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-38lMost Eurocurrency transactions are interbank transactions in the amount of$1,000,000 and up.lCommon reference rates includenLIBOR the London Interbank Offered RatenPIBOR the Paris Interbank Offered RatenSIBOR the Singapore Interbank Offered RatelA new reference rate for the new euro currencyEurocurrency Marketn EURIBOR the rate at which interbank time deposits of are offered by one prime bank to another.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-39EurocreditslEurocredits are short-to medium-term loans of Eurocurrency.lThe loans are denominated in currencies other than the home currency of the Eurobank.lEurocredits feature an adjustable rate.On Eurocredits originating in London the base rate is LIBOR.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-40EurocreditslBecause eurocurrency loans are frequently too large for a single bank to handle,Eurobanks will band together to form a bank lending syndicate to share the risk.lThe lending rate on these credits is stated as LIBOR+X%lRollover pricing is created on Eurocredits so that eurobanks do not end up paying more on time deposits than they earn from the loans.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-41Eurocredits ExamplelTeltrex international can borrow$3,000,000 at LIBOR plus a lending margin of 0.75 percent per annum on a three-month rollover basis from Barclays in London.Suppose that three-month LIBOR is currently 5 17/32 percent.Further suppose that over the second three-month interval LIBOR falls to 5 1/8 percent.How much will Teltrex pay in interest to Barclays over the six-month period for the Eurodollar loan?Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-42ExerciseslGrecian Tile Manufacturing of Athens,Georgia,borrows$1,500,000 at LIBOR plus a lending margin of 1.25 percent per annum on a six-month rollover basis from a London bank.If six-month LIBOR is 4 percent over the first six-month interval and 5 3/8 percent over the second six-month interval,how much will Grecian Tile pay interest over the first year of its Eurodollar loan?Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-43Forward Rate Agreements(FRAs)lFRAs are useful devices for hedging future interest rate risks.lThey are agreements about the future level of interests.lThe rate of interest at some point in the future is compared with the level agreed when the FRA was established.lThe compensation is paid by one party to the other based on the difference.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-44Forward Rate AgreementslAn interbank contract that involves two parties,a buyer and a seller.lThe buyer agrees to pay the seller the increased interest cost on a notational amount if interest rates fall below an agreed rate.lThe seller agrees to pay the buyer the increased interest cost if interest rates increase above the agreed rate.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-45Forward Rate Agreements:UseslForward Rate Agreements can be used to:nHedge assets that a bank currently owns against interest rate risk.nSpeculate on the future course of interest rates.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-46Forward Rate AgreementlA company needs to borrow$6million in 3 month for a period of one year.Current interest rate is 7%.How will the company use the FRA?nThe company is concerned that the interest rate will rise in 3 month.So it will buy the FRA.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-47Forward Rate AgreementlA$10million is expected to be available for putting into a one-year bank deposit in three month.How will the company use the FRA?nThe company could lock into a rate now by selling an FRA to a bank.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-48Financial InstrumentsTreasury Bill(T-Bills)EuronotesEuro-commercial paperIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-49Treasury BilllWhat is a Treasury bill?nTreasury bill are securities with a maturity of one year or less,issued by national governmentsnIf issued by reputable government they are the safest investments.nUS:3 or 6 months,1 year maturitynUK:3 or 6 months maturityIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-50Treasury BilllCharacteristicsnSecuritynHigh liquidity-holders can convert to cash easilynTax waivedIrwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-51Treasury BilllIf a 3 month T-bill is issued on 15th,January,it will mature on 15th,April.lUK money markets assume a 365-day year.lUS&Euro market assume a 360-day year.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-52Treasury BilllHow to calculate the interest rates?nT-bill are often sold at a discount,ue.g.1 year US T-bill,uFace(par)value=$100uDealer bids and pays for$95uDiscounted by 5%uInterest rate earned,5/95=5.26%Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-53Treasury BilllA UK 91 day 100 Treasury bill issued with a quoted annual interest rate of 10.256%.How much would the issuing price be?P=100 =97.5068 1+0.10256(91/365)Or,more generally,P =F 1+r(N/365)Where:F=face value P=issue price or market price r=interest rate(annual rate)N=number of days to maturity Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-54Treasury BilllAlternatively,we may know the price and have to solve for the yield:97.5068=100 1+r(91/365)r=10.256%This is the same as an annual discount rate of 10%:2.4932(365/91)=10%100Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-55EuronoteslEuronotes are short-term notes underwritten by a group of international investment banks or international commercial banks.lThey are sold at a discount from face value and pay back the full face value at maturity.lMaturity is typically three to six months.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-56Eurocommercial PaperlUnsecured short-term promissory notes issued by corporations and banks.lPlaced directly with the public through a dealer.lMaturities typically range from one month to six months.lSold at a discount from face value.Irwin/McGraw-Hill Copyright 2001 by The McGraw-Hill Companies,Inc.All rights reserved.6-57Exercise(Problem 4)lA“three against nine”FRA has a agreement rate of 4.75%.You believe six-month LIBOR in three months will be 5.125%.You decide to take a speculative position in a FRA with a$1,000,000 notational value.There are 183 days in FRA pe。