Liquidity Risk

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International Banking
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Overview

• Although many FIs can diversify domestically, the
  benefits to global diversification are available
  only to large firms. This section explores the
  potential risk-return advantages and
  disadvantages of international expansion and the
  trends toward globalization of FI franchises. As
  countries such as the U.S. expand, some
  countries, Japan in particular, are contracting
  their overseas operations.

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International Expansions

• Three ways to establish global presence
• Sell financial services from domestic offices to
  foreign customers
• Sell financial services through a branch, agency,
  or representative office in foreign customers
  country
• Sell financial services through subsidiary
  company in foreign customers country.

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Global Expansion of FIs

• U.S. insurance companies and securities firms
  recent expansion
• 12 banks in the world with over 50 percent of
  assets in foreign countries
• No single country dominates
• Japanese banks absent in spite of their size

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Top Global Banks
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U.S. Banks Abroad

• J.P. Morgan/Chase have had offices abroad since
  beginning of century.
• Major growth began in 1960s
• Overseas Direct Investment Control Act, 1964.
• Offshore funding and lending in dollars forged
  beginnings of the Eurodollar market.
• Assets of U.S. bank activities abroad increased
  from 353.8 billion in 1980, to 745 billion in
  2001. Declined in percentage terms.

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Factors Encouraging U.S. Bank Expansions Abroad

• Dollar as international medium of exchange
• Effects of Euro
• Political risk
• Encouraged flows to U.S. branches and
  subsidiaries in Cayman Islands and Bahamas.
• USA Patriot Act of 2001 prohibited services to
  shell banks and increased focus on money
  laundering

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Factors Encouraging U.S. Bank Expansions Abroad

• Domestic activity restrictions
• Fed regulations permitting banks to engage in
  activities permitted by foreign host.
• Diversification benefits.
• Technology and communications improvements
• CHIPS
• Decreasing operating costs

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Factors Deterring Expansion

• Capital constraints
• BIS 2001 reforms
• raise capital requirements for loans to non-OECD
  sovereigns rated below B-
• raise capital requirements for loans to OECD
  countries rated below AA-
• zero risk weights for OECD countries rated above
  AA-

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Factors Deterring Expansion

• Emerging markets problems
• Increased caution due to Korea, Thailand,
  Indonesia despite improved regulatory environment
  (NAFTA, for example).
• WTO reduction of barriers to global expansion
• China as a recent noteworthy example

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Factors Deterring Expansion

• Competition
• During 1990s, extensive competition from Japanese
  banks
• Japan had 9 of the 10 largest banks
• European Community Second Banking Directive
  resulted in significant consolidation of European
  banks.

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Foreign Banks in the U.S.

• Organizational form
• Subsidiary
• Branch
• Agency
• Edge Act Corporation
• Representative Office

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Trends and Growth

• Rapid expansion of foreign banks in U.S.
• In 1980, foreign banks had assets of 166.7
  billion (10.8 percent of total U.S. bank assets)
• 1992, 514.3 billion (16.4 percent)
• 1994, 471.1 billion (13.8 percent)
• Retrenchments due to several factors including
  competitive and regulatory effects.
• Recent growth in foreign bank operations in U.S.

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Regulation of Foreign Banks in U.S.

• Prior to 1978, foreign branches and agencies were
  licensed mostly at state level.
• No access to discount window
• No direct access to Fedwire/fed funds markets
• No FDIC coverage

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Regulation of Foreign Banks in U.S. (post 1978)

• Passage of International Banking Act, 1978
• National treatment to level the playing field
• Accelerated expansion of foreign banks in U.S.
• Japanese bank entry into California, and
  subsequent sales notable

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Regulation of Foreign Banks

• Foreign Bank Supervision Enhancement Act 1991,
  increased federal control.
• Triggered by three events
• collapse of BCCI
• issuance of 1 billion in unauthorized letters of
  credit to Iraq by Atlanta agency of Banca
  Nazionale del Lavoro
• unauthorized taking of deposit funds by U.S.
  representative of Greek National Mortgage Bank of
  New York.

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Features of FBSEA

• Feds approval required for entry
• Closure under control of Federal Reserve
• Daiwa Bank ordered to cease operations.
• Examination by Fed
• Deposits Only foreign subsidiaries with FDIC
  coverage can take deposits under 100,000.
• Activity powers restricted to activities
  permitted to federal branch.

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Advantages to International Expansion

• Risk diversification
• Economies of scale and scope
• Innovations
• generate extra returns from selling new products
  abroad.
• Funds source
• Customer relationships
• Regulatory avoidance

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Diversification of Risk

• Correlations across countries vary
• Examples Integrated economies such as Canada and
  the USA.
• Lower correlations between USA and

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Disadvantages

• Information/monitoring costs
• Example differences in accounting standards
• Nationalization/expropriation.
• Fixed costs may be high
• Tokyo real estate prices for example.

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Challenges of Globalization

• Increased competition
• Implications regarding efficiency
• Differentials in Regulatory Burden
• Flight to Least Regulated Countries
• Importance of leveling the field
• Exchange Rate Controls and Other Sovereign Risks

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Special Regulatory Concerns

• Bank Holding Companies create special concerns
  for regulators
• Ownership structure (preference for widely held
  ownership structures)

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Bank Holding Company Structure

• Hierarchical Structure

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Bank Holding Company Structure

• Pipeline Structure

Holding Co.
Subsidiaries
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Regulation of BHCs

• Double gearing
• Quality of capital
• Contagion
• Poor performance of affiliate or subsidiary could
  affect the bank
• Abuse of safety net
• Reduced cost of capital for commercial entity at
  taxpayer expense