International Banking

Introduction

International banking has been one of the major growth industries of the 1970s, 1980s

and 1990s. It seems at times as if the entire industry is rushing on fast-forward into the

future. The changes in the world of international banking over the last few years have

been nothing if not swift and sweeping. New financial centres have sprung up during the

period and any bank which has any pretensions or ambitions for growth can no longer

afford to operate just within its home country.

Objective of Study

1) To understand the meaning and concept of International Banking.

2) To understand the advantage & disadvantages of International Banking.

3) To understand the features of International Banking.

4) For understand the different reasons for the growth of International Banking.

5) For checking the size of the International Banking Market.

6) For distinguish the various organizational forms of International Banking.

7) To understand the International Money Transfer Mechanism.

8) To understand the regulation of International Banking.

Time Period of Study

We have started this project from 15 October and we have done it on 08 November. And

We have completed this project in 25 days.

Methodology used in Research:-

“All progress is born of inquiry. Doubt is often better than over confidence, for it

leads to inquiry and inquiry leads to inventions.”

The methodology of the research combines systematic and comparative analysis of

scientific literary sources, periodicals and virtual databases. The secondary data was

collected from the books, magazine, journal and from the internet.

Operational Definition of International Banking

Aliber defines "international banking" as a sub-set of commercial banking transactions

and activity having a cross-border and or cross currency element, other words,'

international banking comprises a range of transactions that can be distinguished from

purely domestic operations by (a) the currency of denomination of the transaction, (b) the

residence of the bank customer and (c) the location of the booking office. A deposit or

loan transacted in local currency between a bank in its home country and a resident of

that same country may be termed pure domestic banking. Anything else, in one form or

another, is international banking. The range of possible variations of international (or

cross-border) banking is obviously considerable.

International banking is the process in which financial institutions allow foreign clients

both companies and individuals to use their services. Perhaps the most talked-about

international banks are located in Switzerland. However, many other countries have fully

developed international banking infrastructures. Many individuals and companies

participate in international banking to minimize (or evade) their tax liability. This

strategy, however, has certain disadvantages. In addition, several international

organizations have made recent efforts to curb the use of international banks as tax

havens.

International Banking Hubs:-

These countries generally have similar characteristics. They are usually smaller wealthy

countries. Often times, they are small island countries, which is where the term

"offshore" banking comes from. These countries generally offer low---and in some cases

zero---taxes to international clients. They usually keep their clients' information secret

from tax authorities from other countries. They often have little transparency and have no

residency requirements for their clients.

Specific Countries:-

According to the U.S. National Bureau of Economic Research, about 15 percent of the

world's countries operate as tax havens. These countries include, among others, Aruba,

Belize, Bermuda, Cayman Islands, Cyprus, Hong Kong (China), Isle of Man, Macau

(China), Panama, Samoa, San Marino, Switzerland and the U.S. Virgin Islands. For a

more exhaustive list of countries generally designated as "offshore centers," please

consult Resources.

The Advantages of International Banking

In general, mostly wealthy individuals and companies use international banks. While

there are many benefits to international banking particularly taxation the process can be

quite expensive. Some advantages of international banking include tax evasion, foreign

direct investment, protection from lawsuits, the fostering of international trade and

protection against fluctuating domestic interest rates. International banking also makes

sense for companies that operate internationally.

The Disadvantages of International Banking

Despite the benefits of international banking, several disadvantages exist. First, if the

country in which one banks becomes economically or politically unstable, he could

absorb dire financial risks like nationalization of his assets. Second, while offshore

banking certainly falls into a gray area of U.S. law, if one is determined to be illegally

sheltering money, the Internal Revenue Service imposes stiff penalties for such abuse.

Currency exchange rates can fluctuate, thus potentially devaluing one's assets.

Efforts to Curb Tax Evasion

G20 world leaders, at their April 2, 2009, summit, created a tax haven blacklist of

countries. They created a four-tier system to rate countries and to what extent they

comply with international tax standards. The Organization for Economic Cooperation and

Development (OECD) club of rich nations issued a report in 2000 listing a number of

countries as tax havens. The European Union recently pushed several international

banking centers to sign the European Union Withholding Tax and Exchange Information

Directive, which forces those banks to deduct 15 percent tax or fully disclose information

on its clients to their home countries.

International banking facility:-

International banking facility (IBF) A banking facility in the USA that is authorized by

the Federal Reserve System to participate in eurocurrency lending. Such facilities are

exempt from reserve requirement and may have many other advantages usually

associated with offshore banking.

Features of International Banking

Key aspects: currency risk and complexity of credit risk besides typical banking

risks.

Competition for market share among banks (typically spreads very narrow)

Cyclical nature, with periodic crises.

Competition for bank loans from the international bond market (close substitutes

for loans)

Importance of international interbank market (IIBM) as source of liquidity and

funding for banks, and risks arising.

Role of risk management activities (swaps, options, futures).

Reasons for International Banking

Migration of domestic customers, notably MNEs growing foreign activities effects of

regulatory differences (structural and prudential) Input cost differences (e.g. in cost of

domestic funding) - Japanese in the past Comparative advantages in retail banking

(Citibank)

Development of major financial centres offering benefits to banks:

Location of customers

Business Contracts

Pool of skilled labour

Trades and professions

Liquidity and efficiency of markets (thick market externalities)

Interrelation of markets (e.g. derivatives and underlying)

Potential for increasing returns to scale and self sustaining growth of centres.

Main financing activities:

Key feature is nationality of issuer and investor differs:-

(1) Syndicated lending :-

Credit facility offered simultaneously by a number of banks from more than one country

who sign same loan agreement and stand equally in right of repayment. Lead manager

does credit assessment and (delegated) monitoring. Unsecured but extensive covenants

Use in finance of projects and mergers.

(2) Eurobond issuance and trading :-

Bearer bonds issued in markets other than the country of issue. Unsecured and few

covenants except negative pledge (no future borrowing at higher seniority), and

usually call provisions. And next is

(3) Euronotes, international equity, international interbank market.

Reasons for the growth of International Banking

It can be classified under three headings:-

(1) Financial activity following real-sector transactions:-

(A) Cross-border financial transactions, many of them conducted from home-country

offices of finailcia1 institutions, that were closely associated with and driven by

cross- border trade in goods and services.

(B) Establishment by financial institutions of affiliated offices abroad to improve service

for existing non-financial customers who themselves had established operations

abroad.

(2) Financial activity leading real-sector transactions:-

(A) Cross-border financial transactions, conducted from home offices of financial

institutions that proceeded in advance and independently of cross-border trade in

goods and services.

(B) Establishment by financial institutions of affiliated offices abroad in advance and

independent of the current requirements of existing non-financial customers in the

home country.

(3) Regulatory, tax and supervisory explanations:

(A) Lowering of national separation fences.

(B) Establishment by financial institutions of affiliated offices abroad to escape from

more stringent regulation, taxation and supervision in the home environment.

NEW CHARACTERISTICS AND DIMENSIONS

As stated above international banking is certainly a very old business, but since 1973 it

has acquired new characteristics and dimensions. First, the number of participants, which

at the beginning of the period were mainly American banks, has considerably widened to

include German, UK, Japanese, French and Italian banks operating directly or through

foreign branches and subsidiaries. Second, the foreign component of total assets of the

big international banks has grown at a rate considerably above the average so that many

major banks have now more international loans outstanding than domestic ones. Third,

nearly three quarters of the deficit of LDCs have probably been financed by commercial

banks. Fourth, the amount of individual loans has risen considerably thus increasing the

risk from individual borrowers. Fifth, there has been a lengthening of maturities.

Average maturities are now about 10 years. Finally, along with the assets international

banks have diversified their sources of funds.

Two novel kinds of overseas bank operations characterized international bank expansion

in the late 1960s and 1970s. The first was the multinational consortium bank, a new bank

'created by several established parent banks. The second was the shell branch which is

not really a bank at all but a device to get around domestic government regulation.

The global network in place the volume of international banking business exploded 17

loans and other international business began to grow much more rapidly than domestic

business. The rate of increase of international business was so explosive that it soon

became the growth industry of the financial world, For the big American banks the boom

in international business came along just in time, like a deus ex machina to rescue them

from facing oceans of red ink and possible failure, liquidation or forced mergers

resulting from the lugubrious performance of the domestic banking.

SIZE OF THE INTERNATIONAL BANKING MARKET

According to Bank for international Settlements, the total assets and liabilities of the

international banking market were US$ 10491.5 billion and US$ 10306.5 billion

respectively at the end June 1998 up from 843.36 billion and 734.9 billion respectively at

the end of December 1977, The net international banking credit increased from $ 415

Billion to $ 5390 billion during this period, The market has been charting an upward

trajectory on the back of the forces of deregulation, liberalization, institutionalization,

globalisation and securitisation.

Offices of foreign-owned banks are becoming common-place in financial districts of

large cities and towns. Banks are competing in each others' markets for deposits and

loans, taking bigger and bigger shares of activity according to just every measure.

ORGANISATIONAL FORMS OF INTERNATIOAL BANKING

International banks are linked together in various formal and informal ways from simple

holding account with each other-correspondent accounts-to common ownership. These

and other forms of banking organisation are described below:-

1. Correspondent Banking: -

An informal linkage between banks in different countries is set up when banks maintain

correspondent accounts with each other. Large banks have correspondent relationships

with banks in almost every country in which they do not have an office of their own. The

purpose of maintaining foreign correspondent. is to facilitate international payments and

collections for customers. The term "correspondent" comes from the main or cable

communications that the banks use$ for settling customer accounts. Today, these

Communications have largely been replaced by SWIFT messages, and the settling

between banks occurs via CHIPS. For example, if Aviva wants to pay a Canadian

supplier, it will ask its U.S. Bank which will communicate with its Canadian

correspondent bank via SWIFT, The Canadian bank credits the account of the Canadian

firm, while Aviva's hank debits Aviva's account. The U.S. and Canadian banks then settle

through Chips.

Correspondent banking allows banks to help their customers who are doing business

abroad, without having to maintain any personnel or offices overseas. ?'his relationship is

primarily for settling customer payments, but it can extend to providing limited credit for

each other's customers and to setting up contacts local business people and the clients of

the correspondent banks,

2. Resident Representatives: -

In order to provide their customers with help from their own personnel on the spot in

foreign countries, banks open overseas business Offices. These are not banking offices in

the Sense of accepting local deposits or providing loans. The primary purpose of these

offices is to provide information about local business practices and conditions, including

the creditworthiness of potential customers and the bank's clients. The resident

representatives will keep in contact with local correspondent banks and provide help

when needed. Representative offices are generally small, and they have the appearance of

an ordinary commercial office rather than a bank.

3. Bank Agencies:-

An agency is like a full-fledged bank in every respect except that it does no: handle

ordinary retail deposits. The agencies deal in the local money markets and in the

foreign exchange markets, arrange loans, clear bank drafts and checks, and channel

foreign funds into financial markets. Agencies are common in New York, for example,

Canadian and European banks keep busy offices there, with perhaps dozens of personnel

dealing in the short-tern1 credit markets and in foreign exchange, Agencies also often

arrange long-term loans for customers and act on behalf of the home office to keep it

directly involved in the important foreign financial markets.

4. Foreign Branches:-

Foreign branches are operating banks like local banks, except that the directors and

owners tend to reside elsewhere. Generally, foreign branches are subject to both local

banking rules and the rules at home, but because they can benefit from loopholes, the

extra tier of regulations is not necessarily onerous. The books of a foreign branch are

incorporated with those of the parent bank, although the foreign branch will also maintain

separate books for revealing separate performance, for tax purposes, and so on, The

existence of foreign' branches can mean very rapid check clearing for customers in

different countries, because the debit and credit operations are internal and can be

initiated by fax or electronic mail. This can offer a great advantage over the lengthy

clearing that can occur via correspondents. The foreign branch also offers bank customers

in small countries all the service and safety advantages of a large bank, which the local

market might not be able to support.

5. Foreign Subsidiaries and Affiliates:-

A foreign branch is part of a parent organization that is incorporated A. foreign

subsidiary is a locally incorporated bank that happens to be owned either completely or

partially by a foreign parent. Foreign subsidiaries do all types of banking, and it may be

very difficult to distinguish them from, an ordinary locally owned bank.

Foreign subsidiaries are controlled by foreign owners, even if the foreign ownership is

partial. Foreign affiliates are similar to subsidiaries. In being locally incorporated and so

on, but they are joint ventures, and no individual foreign owner has control (even though

a group of foreign owners might have control).

6. Consortium Banks:-

Consortium banks are joint ventures of the larger commercial banks. They can involve

half a dozen or more partners from numerous countries. They are primarily concerned

with investment, and they arrange large loans and underwrite stocks and bonds,

Consortium banks are not concerned with taking deposits, and they deal only with large

corporations or perhaps governments. They will take equity positions part ownership of

an investment-as well as rnake loans, and they are frequently busy arranging takeovers

and mergers.

The LDC debt crisis 1982

High and volatile inflation and interest rates in 1970s, and shifts in wealth holding due to

rise in commodity prices. Increase in payment imbalances, financed by syndicated

credits, which lowered sunk costs of entry to international bank lending, Rise in public

debt and leverage, often in foreign currency, Wide range of banks participated, with fine

spreads, Short maturity of loans may have encouraged banks to believe they could easily

exit the market.

Some encouragement by authorities Banks’ focus on balance sheet growth, possible

moral hazard, misunderstanding of sovereign risks, Oil shock raised needs for financing

and cut ability to service.

Shock of Mexican default in 1982 led to cut-off in lending (although interbank market

continued to function with government support). After crisis, banks would only lend to

countries which rescheduled and/or seen as best risks.

Resolution took many years – banks technically insolvent and ldcs suffered fiscal

austerity and slower growth to correct imbalances and recover credit standing, Banks lost

out to securities markets as had to rebuild capital, Variety of international efforts (such as

“Brady Plan”) contributed to resolution.

The Asian crisis 1997

Strong economic growth, profit opportunities, overinvestment, diminishing marginal

returns, property booms. Rise in private debt and leverage, often in foreign currency,

notably by local Banks. Belief domestic governments would protect their own banks

allowed them to operate in IIBM, while Mexican rescue of 1994 encouraged belief in

international safety net for Asian countries.

Fixed exchange rate regime – and sound fiscal positions - gave confidence that such

borrowing was sustainable. Regime shift to an open economy may have led to errors in

credit assessment by domestic banks.

Foreign banks (e.g. Japanese and Continental) may have sought market entry at loss

leading prices, while IIBM saw declining spreads, plentiful liquidity.

Growing current account deficits and inflation made pegs less sustainable, Concentration

of risk in few large borrowers and “crony capitalism”. Potential correlations within and

between countries ignored, Cyclical weakening and speculation led to collapse of

currency pegs, and monetary tightening to compensate.

Domino effect on a range of countries – like contagious bank run, Reversal of

international lending flows, bank runs, severe macroeconomic effects.

Key role of IIBM - $184 bn cut in net private flows, of which $149 bn from commercial

banks – fall in external finance to 5 most affected countries equal to 5% of GDP.

IMF rescue operations – and possible further moral hazard.

Institutions in International Banking

International financial organizations have been established by governments. The purpose

of these institutions is to maintain orderly international financial conditions and to

provide capital and advice for economic development, particularly in those countries that

lack resources to do it themselves. The majority of these organisations have been

established towards the end of the World War II as part of an over all spirit of co-

operation. The funds for the these institutions come from the Contribution of Capital that

each Nation makes when it becomes a member and through the Borrowings. The

international financial organisations can be broadly classified in seven categories.

They are:-

1. The World Bank Group-International Bank For Reconstruction and Development and

its three subsidiary organizations

a. International Development Association (IDA)

b. International Finance Corporation (IFC)

c. Multilateral Investment Guarantee Agency (MIGA)

2. The International Monetary Fund (IMF)

3. European Bank for Reconstruction and Development (EBRD)

4. Asian Development Bank (ADB)

5. Inter-American Development Bank I

6. African Development Bank

7.Bank for International Settlement (BIS)

INTERNATIONAL MONEY TRANSFER MECHANISM

If we want to make a payment abroad, we will have to deal through a bank operating on

international level. Banks around the world are centres for money transfer business.

Dealers in securities or exporters and importers make use of services of international

banks. With the growth of MNC's, the importance and role of such banks have increased.

Such banks also help the developing countries in their economic development. In this part

you will learn about international, money transfer mechanism and syndicated lending

arrangements.

A bank entering in international banking business may enter through one or more

of the following organizational forms:

A) Correspondent Bank :-

A correspondent bank is a bank located elsewhere that provide a service for another bank.

A bank which does not have an office in a foreign country maintains a correspondent

account with a bank in that country.

B) Foreign Branch :-

It is a full fledged office of the home bank which operates subject to banking rules of the

home and foreign countries.

C) Foreign Agencies :-

They are like branches, except that they are not authorized to accept ordinary deposits

(although they may accept credit balances of customers doing business with them).

D) Foreign Subsidiary Bank :-

Foreign subsidiary bank is a bank incorporated in a host country and operate under same

rules as local domestic banks. In U.S.A., subsidiaries of US banks are called Edge Act or

Agreement Corporations.

E) Representative Offices :-

They are small offices opened up to provide advisory services to banks and customers

and to expedite the services of correspondent bank.

Sometimes, a bank may acquire an existing bank in a foreign country.

The overwhelming majority of all payments are effected through a transfer of ownership

of demand deposits from payer to payee, by sending instructions to the banks involved

via cheques, written transfer orders, phone, telegraphic instructions(wire transfers), or,

increasingly linked computer networks. Hence, any person(or a corporate treasurer),

making or intending to make payment to someone in another country needs first to obtain

ownership (directly or indirectly), of a demand deposit in a bank in a foreign country,

which can subsequently be transferred to the foreign recipient (payee) of the funds. Even

very large corporations rarely maintain current accounts in foreign countries, because

there is no need for it. Major banks maintain demand-deposit accounts with their foreign

correspondent banks (overseas). These correspondent banks are chosen to facilitate the

business dealings of another bank in another country (or, different location). The

correspondent banks are preferably those that are members of the respective national

clearing system in the place where they are located. Funds are made available in the

current account of the overseas bank with the correspondent bank. The correspondent

bank will then make payment to the respective payee after receiving instructions from the

overseas bank. For example, assume a Hong Kong based firm Wing On Company,

wishes to pay its Singapore supplier S$ I million. The treasurer from Wing On will

contact the foreign exchange trader in his bank, The Hang Seng Bank, Hongkong to sell

him (Wing On) S$ 1 Million at a rate of (say), HK$ 21 per Singapore dollar.

It will then initiate two. Simultaneous transfer:-

1) Hang Seng Bank, Hongkong will debit Wing On's current account in Hongkong

dollars for HK$ 21 million and credit that amount to its correspondents bank account.

2) Hang Seng Bank will then instruct its correspondent bank in Singapore (one in which

it keeps a current account balance), to debit Hang Seng's account and credit the amount

to the account of the Singapore company within the banking system of Singapore.

This illustrates the fact that international transactions really involve two simultaneous

payments involving each national payment. In our example above,(l) there was a transfer

of funds in the Hongkong system from the payer to its bank and (2) a parallel payment

within Singapore from the Hongkong bank's account with the Singapore bank to that of

the payee. Of course, a receipt of funds would involve two transfers in the opposite

direction.

Foreign and Domestic Electronic Banking

Electronic funds transfer has spawned many few ways of doing banking all over the

world. For instance, banks in Europe are considering using point of sale terminals to debit

and credit individual accounts or purchases The French, on the other hand, are working

on a system that would link on the line terminal, such as stores, with lines in a central

computer. France is also considering using an off-line system in which a card will be

used and the transaction placed in memory and taken on a later date to the bank for

processing. In the United States we are using such systems as pay by phone by which we

are able to pay such bills as utilities and bank loans by telephoning a special teller who

enters your payment order into a computer to be processed electronically.

Another system that is being used is the savings accounts card. This card allows

depositors to get discounts from certain local merchants. Each time a purchase is made

using the card, the discount is automatically deposited into the shopper's saving account.

Another service that is offered by many banks is bill checks. This service lets the

customer decide on when payment of monthly bills should be paid by allowing him to

authorize them individually each month. Special stubs are signed on certain bills and then

sent back to the different companies that sent you the bills. These stubs act as checks

which gives the bank permission to put the funds needed to cover the bill into the

company's account.

Banks also offer what is called a NOW account. The NOW account is checking account

that earns interest. This is definitely something new and innovative. An individual need

not switch money from savings to checking every time they pay a bill, the age of the

computer has brought with it many new and exciting ways of doing banking, each

making the industry more efficient and it is hoped more profitable.

In general the United States needs a nationwide electronic banking system, and it will

eventually get one. But the pace of advancement will be slower than previously thought,

and the ultimate configuration of the system at present is almost impossible to predict.

Another development that is still in its infancy, and undergoing an extended period of

immaturity, is that which permits telephone transfer of funds between accounts and for

directing payments of bills to stores, credit card, groups, and utilities. Until all telephones

are equipped for pushbutton delivery, however, the oral instructions provide little cost

savings because someone must take the orders.

Regulation of International Banking

Issues arising include:

– cross border supervision of banks

– regulation of foreign banks (by home or host supervisor)

– need for international agreements to ensure stability (safety net) without generating

moral hazard (also prudential regulation)

– need to keep a “level playing field” e.g. via capital adequacy agreements

– regulation of offshore financial centres

– regulation of hedge funds and other offshore vehicles.

Summary

International banking has been dominated over the past four decades by a number of

trends, the blurring of distinctions between banks, securities houses and other financial

institutions, the displacement of banks as the main conduit for depositing and borrowing

money (the process disintermediation), the erosion of the distinction between debt and

equity through the development of tradeable paper (securitisation), the globalisation of

markets. All these trends are becoming as real in the domestic market place as they are in

International sphere. For centuries banking and finance have been pursued at a local level

with scant regard to changes or movements in the world scene, no longer.

The most immediate impact of this revolution is clearly on the industry itself, the players

in the market. For them this has so far been a story largely of competitive forces and

opportunities for growth. Global integration of financial markets is being driven by the

worldwide search on the part of investors and issuers for more favourable returns and

lower cost of funds respectively in securities packaged to meet their specific and varied

needs. Meeting these objectives has been facilitated by improved communications, the

erosion of barriers to capital flows, the modernization of key national financial systems

and the gradual liberalisation of international trade in services. The effect of globalisation

is to give participants in financial markets a wide range of viable alternatives.

Foremost, among the global trends in the world's financial industry are consolidation and

convergence. These deals encompass financially driven mergers within domestic markets

designed to cut costs, more strategic cross-border deals as banks with large shares in their

own domestic markets seek to expand across in other countries and a growing number of

deals between banks and insurance companies.

Financial institutions are under increasing and accelerated pressure to strategically

reposition themselves in a marketplace where the competitive landscape has been

redefined almost overnight. Banks will be forced to identify new ways to increase

efficiency, enter into developing markets, provide new products, shed unprofitable

operations and capitalize on new opportunities.

Conclusion

International Banking is a very old business but since 1973 it has acquired new

characteristics and dimensions. The number of participants, which at the beginning of the

period were mainly American banks, has considerably widened to include German, UK,

Japanese, French and Italian Banks operating directly or through foreign branches and

subsidiaries. The foreign component of total assets of the big international banks has

grown at a rate considerably above the average so that many major banks have now more

international loans outstanding than domestic ones. Nearly three quarters of the deficit of

LDCs have probably been financed by commercial banks. The amount of individual

loans has risen considerably thus increasing the risk. There has also been a lengthening of

maturities.

Aliber defines "International banking" as a subset of commercial banking transactions

and activity having a cross-border and/or cross currency element Multinational balking

refers to the location and ownership of banking facilities in a large number of countries

and geographic regions.

Reasons for growth of international banking can be summarized as: i) Financial activity

following real-sector transactions, ii) Financial activity leading real-sector transactions,

and iii) Regulatory, lax and supervisory explanation.

International banks are linked together in various formal and informal ways from simply

holding account with each other correspondent accounts - to common ownership.

Profitability of International Banking has gone through four distinct phases.

“Not even love has made so many fools of men as the pondering over the nature of money."