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."