PART 7: INTERNATIONAL BANKING

AND FINANCIAL INSTITUTIONS

CHAPTER 22: International Bankin
FOCUS OF THE CHAPTER
The main focus of the chapter is on international !ankin. Following a brief discussion
of international banking and international "inan#ial #entre$, an introduction to the
#%rrent an& #a'ital a##o%nt$ of the !alan#e o" 'a()ent$ is presented. The )onetar(
an& a!$or'tion a''roa#*e$ to the balance of payments and the concept of t+in &e"i#it$
are introduced. The history and evolution of E%ro#%rren#( )arket$ are discussed. The
need for and the difficulties of re%latin international !ankin are highlighted. The
chapter ends with a discussion of the international &e!t #ri$i$ and #o%ntr( ri$k.
Learnin O!,e#ti-e$:
Describe how international banking activities and their regulations have evolved
Describe the interaction between public and private sector borrowing and balance of
payments developments
Discuss the history and evolution of the Eurocurrency market and analyze how its
presence affects a typical bank's balance sheet
ist the ma!or developments in the area of risk, especially international debt
crisis
"dentify the essentials of how country risk is determined
SECTION SU..ARIES
International Bank$ an& Finan#ial Centre$
The growth of international trade and capital flows, especially since #orld #ar "", has led
to the growth of international banking. The international banks have international
sections and operate offices in other countries, or have branches in other countries. The
$%, &apanese, and %wiss banks top the list of the largest international banks in the world.
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/uch of international !ankin 4international lending and borrowing, interbanking
operations, and foreign currency transactions5 is conducted in the cities that have become
international "inan#ial #entre$. ondon, 6ew 7ork, and Tokyo are the prime
international financial centres. ondon is the largest banking centre.
"nternational banking centres that cater to non1residents, provide ta8 havens, and
sometimes offer secrecy in financial dealings, are called off1shore banking centres 4e.g.,
*ayman "slands, u8embourg, 2ong 9ong, and :ahamas5.
*anadian chartered banks have long had an international presence in the $%, $9,
and the *aribbean. They have a network of correspondent banks. %ince the (;<- :ank
=ct, various foreign banks have opened chartered banks in *anada.
T*e E%ro#%rren#( .arket
Financial instruments deposited or traded in a country that are denominated in currencies
of other countries are called E%ro#%rren#( /or E%ro&ollar$0.
Some History: The Eurodollar market originated after #orld #ar "" when world trade
resumed and the *old #ar was setting in. The growth of Eurodollars was assisted by
some special ta8es introduced in the $%. The main centre for Euromarket trading is
ondon, and the Lon&on Inter!ank O""er Rate /LIBOR0 is the basic interest rate.
=ctually, many ":>3s e8ist, depending on the currency and the maturity of the
instrument.
The Creation of Eurocurrency: The size of the Eurocurrency market is believed to
e8ceed several trillion dollars. "ts e8istence enhances world li?uidity. %uppose that a
*anadian depositor transfers @(-- million from a *anadian bank to a Eurobank. The
*anadian dollar deposits in the *anadian bank decrease by @(-- million, while the
Eurodeposits of the bank increase by the same amount. The Eurobank has received
additional reserves which can be used to create additional deposits through multiple
e8pansion.
Is It Safe? "f the Eurodollars 4or foreign currencies traded5 suddenly return to their home
countries, both the money supply and inflation can increase.
International Bankin Re%lation$
"nternational banking offers not only benefits, but also the possibility of losses and
scandals. 2owever, banking is regulated solely at the domestic level. 6o international set
of rules e8ists with sanctions that apply to all international banks. The regulation of
international banking has been difficult due to various problems such asA a5 national
treatment of international banksB b5 structural changes that led to the dominance of banks
in international bankingB c5 uncoordinated and inconsistent waves of deregulation in
financial marketsB and d5 the e8istence of more than one model of the banking system
4such as the universal banking model, the unitary system, and the dual banking system5.
The ?uestions raised in relation to the regulation of international regulation include the
followingA #ho will provide deposit insuranceC 2ow can competition be ensuredC 2ow
can regulations be harmonized across different countriesC 2owever, efforts are being
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made by the :ank for "nternational %ettlements 4:"%5 and the "nternational /onetary
Fund 4"/F5 to develop a convergence in international banking.
The =sian crisis 4(;;D1;<5 revealed that weakly regulated banking systems in
many countries did not adhere to :"% standards. =s a result, moral hazard has been a
clear factor. =s technological changes force convergence in banking functions across the
globe, differences in culture and tradition in various parts of the world 4e.g., Europe and
6orth =merica5 are being reduced. 3ecent evidence suggests that the Ehomefield
advantageF in banking is disappearing in the face of globalization.
T*e International De!t Cri$i$
=n international debt crisis which originated with the oil price shocks of the (;D-s has
been going on since the (;<-s, when several countries could not fulfill their foreign debt
obligations, due in part to high interest rates. %ome believe that the profit1seeking
behaviour of #estern banks pushed Third #orld countries into a debt crisis. :y the mid1
(;<-s some countries had negotiated debt rescheduling with banks and international
agencies. =s a result of the crisis, banks began swapping the debt of one country for the
debt of another country. Following the /e8ican peso devaluation in (;;., there was fear
of another debt crisis.
How a Debt Crisis Can Affect a Bank: The e?uity of a bank can be reduced or even
wiped out completely as the result of a loan default. = bank can list defaulting loans as
Gnon1performingG loans for some time, but eventually this can lead to insolvency.
Approaches to the Debt Crisis: The Bra&( Plan /12230 proposed a buyback of debt from
secondary markets as a way to reduce the debt burden of some countries. %uch a scheme
can give rise to a potential moral hazard problem, as countries deliberately may become
highly indebted and default, with the hope of buying back in the secondary market
relatively cheaply. The scheme, however, has been successful in restructuring the debt of
highly indebted countries. De!t4e5%it( $+a'$ 4e8changing debts for shares of the
institutions of developing countries5 and &e!t "ori-ene$$ 4writing off loans5 are two
other methods proposed as solutions to the debt crisis.
*anada makes large loans to the Third #orld, and borrows e8tensively from other
nations. "n the late (;;-s, *anada's debt10D' ratio was relatively high among the >E*D
countries. %ubse?uently, growing surpluses and strong economic growth helped lower the
debt10D' ratio. /any countries still suffer from high debt loads. /any developing
countries continue to call for debt forgiveness while industrialized countries are
concerned that the resulting moral hazard problem is too great. 0overnments in emerging
markets have devised sophisticated ways of borrowing. =s a result, the resolution has
become far more comple8 and costly in the event of a crisis. *onse?uently, international
organizations like "nternational /onetary Fund and various governments have been
grappling with ways to alleviate problems that arise in the event of a debt crisis.

A$$e$$in Co%ntr( Ri$k
The risk that a national government will default on its debt is referred to as the #o%ntr(
ri$k, consisting of two partsA (5 tran$"er ri$k6 and ,5 $o-erein ri$k. The transfer risk is
the possibility that the borrower may not be able to convert the loan made into the
lender's currency. The sovereign risk is the possibility of the borrower's inability or
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unwillingness to repay principal, or interest, or both. =ssessing country risk re?uires an
assessment of many social, economic, and political factors. The &e!t4$er-i#e ratio
4principal plus interest payments as a percentage of e8port earnings5 is the most
commonly used indicator.
.ULTIPLE4CHOICE 7UESTIONS
(. The largest international banking centre in the world is
a5 6ew 7ork.
b5 Toronto.
c5 Tokyo.
d5 ondon.
,. = bank that handles affairs of another bank which has no legal standing in the
!urisdiction is called
a5 a merchant bank.
b5 a client bank.
c5 an off1shore bank.
d5 a correspondent bank.
H. #hich of the following sets of countries include ta8 and regulatory havens for banksC
a5 $nited %tates, *anada, and 0reat :ritain
b5 0ermany, France, and 3ussia
c5 &apan, =ustralia, and *hina
d5 :ahamas, *ayman "slands, and 2ong 9ong
.. The key Eurocurrency interest rate is called
a5 Euro1E8change 3ate 4EE35.
b5 Euro1'rime 3ate 4E'35.
c5 ondon "nterbank >ffer 3ate 4":>35.
d5 6ew 7ork :ank 3ate 467:35.
I. $nder national treatment in international banking,
a5 a $% bank in *anada is sub!ect to the $% rules and regulations.
b5 a $% bank in *anada is sub!ect to the *anadian rules and regulations
c5 a $% bank in *anada is sub!ect to both $% and *anadian rules and regulations.
d5 a $% bank in *anada is not sub!ect to rules and regulations of the $% or *anada.
). "f a client of a *anadian chartered bank transfers @,-- million from an account in
*anada to a Eurobank
a5 the assets of the *anadian bank are unaffected.
b5 the liabilities of the *anadian bank are unaffected.
c5 both the assets and the liabilities of the *anadian bank increase by @,-- million.
d5 both the assets and the liabilities of the *anadian bank decrease by @,-- million.
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D. The markets for funds traded in currencies other than the currency of the trading
country are referred to as
a5 off1shore banking centres.
b5 international financial centres.
c5 the world market.
d5 Eurocurrency markets.
<. The international debt crisis originated
a5 in the bank failures of the 0reat Depression.
b5 in the destruction of Europe during #orld #ar "" .
c5 in the oil price shocks of the (;D-s.
d5 in the =sian *risis of the late (;;-s.
;. The debt1service ratio is
a5 the percentage of e8port earnings needed to pay interest and principal on foreign debt.
b5 the percentage of 06' spent on servicing foreign debt.
c5 the foreign debt e8pressed as a percentage of 06'.
d5 the foreign debt e8pressed as a percentage of merchandise e8ports.
(-. The country risk relating to international lending
a5 has a component of transfer risk and a component of sovereign risk.
b5 consists of foreign e8change risk and inflation risk.
c5 has components of market risk and interest rate risk.
d5 consists only of systematic risk.
PROBLE.S
(. #hat is an international banking centreC #hat are the factors contributing to the
development of such a centreC
,. a5 E8plain what is meant by the country risk in international lending.
b5 *onsider the following data, reported in millions of dollars for two countriesA
*ountry = *ountry :
E8ports (--- (.--
=nnual interest payment on Foreign Debt I- )-
=nnual payment 4principal5 on Foreign Debt ,-- ,.-

*ompare the two countries in terms of country risk.

H. #hat is the international debt crisisC #hat is the potential moral hazard problem
created by the :rady 'lanC
ANS8ER SECTION
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An$+er$ to )%lti'le4#*oi#e 5%e$tion$:
(. d 4see page .-I5
,. d 4see page .-)5
H. d 4see page .-)5
.. c 4see page .-D5
I. b 4see pages .-<5
). b 4see page .-D5
D. d 4see page .-)5
<. c 4see page .(-5
;. a 4see page .(.5
(-. a 4see page .(.5
An$+er$ to 'ro!le)$:
(. =n international financial centre is a city that has become a convergence point for
international banking activities such as international lending and borrowing, interbank
operations, and foreign currency transactions. Jarious factors, such as advantages in
geographical locationB the availability of communication and other infrastructure
facilitiesB the availability of human resources, such as skilled labour and entrepreneurial
resourcesB a history as a centre of international trade and financeB and the economic and
political stability of the country are some of the factors that can contribute to the
development of an international financial centre.
,. a5 The country risk of international lending is the risk that a national government will
default on its debt. The likelihood of such a default is generally high in countries whose
debt1service ratios are very high.
b5 The debt1service ratios of the two countries calculated as followsA
Debt1service ratio 4D%35 K Debt1service paymentsLE8ports
*ountry =A 4I-M,--5L(--- K -.,I or ,IN
*ountry :A 4)-M,.-5L(I-- K -.,- or ,-N
The relatively higher debt service ratio for *ountry = indicates that the country risk is
relatively higher in *ountry =.
H. The international debt crisis refers the difficulties faced by many developing countries
in meeting their foreign debt1service obligations 4obligations to pay principal and interest
on foreign debt5 since the early (;<-s. The :rady 'lan 4(;;-5 proposed a buyback of
debt from secondary markets as a way to reduce the debt burden on some countries.
$nder such a scheme, countries may deliberately become highly indebted and default,
with the hope of buying back in the secondary market relatively cheaply, thus creating a
potential moral hazard problem.
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