Chapter 20 International Banking Debt and Risk Topics (2024)

Chapter 20 International Banking, Debt, and Risk

Topics to be Covered • Eurocurrency Market • Origins of Offshore Banking • International Banking Facilities • Offshore Banking Practices • International Debt • IMF and IMF Conditionality • Role of Corruption • Country Risk Analysis Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 2

Eurocurrency Market • Eurocurrency Market—is the deposit and loan market foreign currencies. • Banks that accept deposits and make loans in the Eurocurrency market are called Eurobanks. • The term Eurocurrency or Eurobank is a misnomer since it refers to offshore banking and is not limited to Europe. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 3

Origins of Offshore Banking • The Eurodollar market started in the late 1950 s when European banks began accepting deposits in U. S. dollars. • Why and how did this market get started? The reserve-currency status of the dollar was an important factor. Some communist countries were the earliest source of dollar deposits held in Europe. Eurobanks developed as a result of profit considerations. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 4

Offshore Banking (cont. ) • Offshore banking has grown rapidly over the past decades because Eurobanks are essentially unregulated. • Eurobanks can offer narrower spreads than U. S. banks (the “spread” is the difference between the deposit and loan interest rates). Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 5

Eurobank vs. U. S. Bank Spreads • Refer to Figure 20. 1 • Eurobanks are able to offer a lower rate on dollar loans and a higher rate on dollar deposits than U. S. banks. • Eurodollar transactions are considered riskier to U. S. residents compared to domestic dollar transactions in the U. S. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 6

LIBOR • London Interbank Offered Rate (LIBOR)—the interest rate at which large London banks make deposits or lend to each other. • In the Eurodollar market, loan interest rates are quoted as percentage points above LIBOR. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 8

International Banking by Countries • Refer to Figure 20. 2 Foreign assets held by banks, by country • The U. K. and U. S. banks account for the largest shares of foreign assets, primarily cross-border interbank claims. • Interbank claims are deposits held in banks in other countries. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 9

International Banking Facilities • In December 1981, the Federal Reserve permitted U. S. banks to engage in Eurobank activity on U. S. soil. • International banking facilities (IBFs) are international banking divisions of onshore U. S. banks. • The loans and deposits of IBFs are kept separate from the rest of the U. S. bank’s business because IBFs are not subject to reserve requirements, interest rate regulations, or FDIC deposit insurance premiums. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 11

Offshore Banking Practices • Because of the importance of interbank transactions, gross deposits at Eurobanks overstate the actual amount of activity of these banks in intermediating funds between nonbank savers and nonbank borrowers. • To measure the amount of credit actually extended by Eurobanks, the net size of the market is determined by subtracting interbank activity from total deposits. • Refer to Tables 20. 1, 20. 2, and 20. 3 for an example. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 12

Effects of Eurodollar Market • Eurodollars are not spendable money, but are money substitutes such as time deposits in a bank. • In countries without efficient money markets, access to a competitive Eurodollar market may reduce the demand for domestic money as residents shift funds to the offshore market and earn profit. • If the Eurodollar market encourages more international capital flows, then central banks need to engage in more sterilization operations to achieve their domestic monetary policy. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 16

Characteristics of Eurobanks • Eurobanks are just like domestic banks in terms of maximizing spreads and managing risk. • Deposits are for fixed terms ranging from days to years, mostly for less than six months. Eurocurrency deposits are similar to domestic banks’ certificates of deposits. • Eurocurrency loans can range up to 10 years or more. Large loans are generally made by syndicates of Eurobanks. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 17

International Debt • Petrodollars—are Eurodollar deposits arising from the trade surpluses of OPEC nations. • In turn, the Eurobanks lent these petrodollars to developing countries. • Refer to Table 20. 4 External debt of developing countries during the debt crisis period. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 18

International Debt (cont. ) • Debtor countries such as Argentina and Brazil borrowed more to service their outstanding debt and/or rescheduled or renegotiated the terms of the loans. • Paris Club—meetings of creditor governments (typically Western industrialized countries) with debtor nations. The debtor must first apply for a standby credit arrangement with the IMF before the meeting is held. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 20

Debt/Equity Swap • Debt/Equity Swap—involves an exchange of a developing country’s debt for an ownership or equity position in a business in the debtor country. • The use of debt/equity swaps has stimulated the growth of a secondary market where creditor commercial banks may sell their developing country debt. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 21

IMF Conditionality • The International Monetary Fund (IMF) has been an important source of funding for debtor countries with repayment problems. • IMF Conditionality refers to the IMF pre-conditions which require borrowers to adjust their economic policies to reduce balance of payments deficits and improve the chance of debt repayment. These conditions involve macroeconomic targets such as money supply growth and the budget deficit. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 22

IMF • The IMF is a multinational organization of over 180 countries. • Its objective is to provide short-term loans to countries with temporary balance of payments disequilibria (if the countries agree to certain IMF conditions). • IMF policy is determined by member countries’ votes. Voting power is based on a country’s quota or financial contribution to the IMF. • The U. S. has the most votes since its quota accounts for almost 18% of the total fund. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 23

The Role of Corruption • Research shows that there is a negative relationship between the level of corruption in a country and the country’s growth and investment. • Corruption thrives in countries where government policies create economic distortions or imperfect markets. • The more competitive a country’s markets, the fewer the opportunities for corruption. • In the late 1990 s, both the IMF and World Bank began including anticorruption policies as part of their lending process. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 24

Country Risk Analysis • Country Risk—refers to the overall political and financial situation in a country and how these conditions may affect the ability of the country to repay its debts. • Country risk analysis involves the evaluation of both qualitative and quantitative factors. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 25

Qualitative or Political Risk Factors • Splits between different language, ethnic, and religious groups that undermine stability. • Extreme nationalism and aversion to foreigners that may lead to preferential treatment of local interests and nationalization of foreign holdings. • Unfavorable social conditions, including extremes of wealth. • Conflicts in society evidenced by demonstrations, violence, and guerilla war. • The strength and organization of radical groups. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 26

Quantitative or Economic Factors • External debt as a % of GDP or exports • International reserve holdings relative to imports • Export level and diversity • Economic growth Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 27

Chapter 20 International Banking Debt and Risk Topics (2024)

FAQs

What is the problem with the IMF? ›

Since the collapse of fixed exchange rates in 1973, the fund has taken a more active role, especially in developing countries. Some critics say the conditions the IMF attaches to its loans are too harsh and have harmed developing countries.

What are the issues with international banking? ›

Some of the issues are illiquidity, insolvency, country risk and international lending risk. Currency risk and large bureaucratic structures leading to operational risks are all threats to the international banking system.

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Which of the following risk is the most important risk of the banks that is connected to the assets held by the banks? ›

Credit risk is the biggest risk for banks. It occurs when borrowers or counterparties fail to meet contractual obligations. An example is when borrowers default on a principal or interest payment of a loan.

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What were the three major forces behind the credit crisis of 2007 and 2008? ›

The Great Recession, one of the worst economic declines in US history, officially lasted from December 2007 to June 2009. The collapse of the housing market — fueled by low interest rates, easy credit, insufficient regulation, and toxic subprime mortgages — led to the economic crisis.

Why did the IMF fail? ›

The IMF lost its primary mission when the international financial system moved away from the gold standard to a floating exchange rate system. It also is clear that the IMF's approach to economic development has been a colossal failure.

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What causes the IMF crisis? ›

The crisis was rooted in economic growth policies that encouraged investment but also created high levels of debt (and risk) to finance it. The International Monetary Fund (IMF) bailed out many countries but imposed strict spending restrictions in exchange for the help.

Why do we need international banking? ›

International banking allows businesses to access capital from global markets and make investments overseas. It also enables customers to make transfers between foreign countries without having to use local currency exchange services.

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What is international banking in simple words? ›

What is international banking? International banking summarises all services offered by banks to facilitate international trade, including investments, lending operations and cross-border transactions.

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Why do international transactions fail? ›

Geographic restrictions, currency limitations, and other factors can also contribute to payment failures. Issues like OTP problems, network or authentication issues, and suspicious transactions can further complicate the payment process. There are times when we want to shop from international websites.

What are the 6 core risks in banking? ›

While the types and degree of risks an organization may be exposed to depend upon a number of factors such as its size, complexity business activities, volume etc, it is believed that generally the risks banks face are Credit, Market, Liquidity, Operational, Compliance / Legal /Regulatory and Reputation risks.

What are the top 3 bank risks? ›

Types of financial risks:

Credit Risk. Credit risk, one of the biggest financial risks in banking, occurs when borrowers or counterparties fail to meet their obligations. ...
Liquidity Risk. ...
Model Risk. ...
Environmental, Social and Governance (ESG) Risk. ...
Operational Risk. ...
Financial Crime. ...
Supplier Risk. ...
Conduct Risk.

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What caused the 2008 debt crisis? ›

Predatory lending in the form of subprime mortgages targeting low-income homebuyers, excessive risk-taking by global financial institutions, a continuous buildup of toxic assets within banks, and the bursting of the United States housing bubble culminated in a "perfect storm", which led to the Great Recession.

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What was the worst financial crisis in history? ›

The Great Depression of 1929–39

Encyclopædia Britannica, Inc. This was the worst financial and economic disaster of the 20th century. Many believe that the Great Depression was triggered by the Wall Street crash of 1929 and later exacerbated by the poor policy decisions of the U.S. government.

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Who is most responsible for the financial crisis of 2008? ›

Though the 2008 crisis impacted the entire global financial system, it was caused by the subprime mortgage crisis in the United States. As a result, many of its major players were U.S. government officials and corporate leaders of U.S. financial institutions.

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What is one criticism of the IMF or the World Bank? ›

Critics argue that in fostering wider participation, the IMF and the World Bank become gatekeepers of social organizations and power. Because the institutions must choose which NGOs to recognize and consult, they end up making decisions with deep social and political consequences.

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Is the IMF actually helpful? ›

The IMF helps member countries facing an economic crisis by offering loans, technical assistance, and surveillance of economic policies. Money to fund the IMF's activities comes from member countries that pay a quota based on the size of each country's economy and its importance in world trade and finance.

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Has the IMF ever helped anyone? ›

In following decade, IMF provides financing of about $500 billion to 90 countries and injects $250 billion into global financial system, helping avert another Great Depression and enabling recovery of global economy.

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Why were there protests against the IMF and the World Bank? ›

Protesters demonstrated against the IMF's austerity policies towards developing nations. Representatives from Third World countries called for debt cancellation, and others advocated for solutions to world hunger and poverty. Due to the protest's high-profile venue, media outlets extensively covered the protests.

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