Solution manual bank management and financial services 9th edition by rose, peter chap020

Chapter 20 - International Banking and the Future of Banking and Financial Services CHAPTER 20 INTERNATIONAL BANKING AND THE FUTURE OF BANKING AND FINANCIAL SERVICES Goal of the Chapter: The purpose of this chapter is to learn the different types of services international banks offer to their customers and to discover the various forms of organizational structures; a bank may adopt to conduct international business Key Topics in This Chapter        Types of International Banking Organizations Regulation of International Banking Foreign Banking Activity in the United States Services Provided by International Banks Managing Currency Risk Exposure Challenges for International Banks in Foreign Markets The Future of Banking and Financial Services Chapter Outline I Introduction II Types of International Banking Organizations A Representative Offices B Agency Offices C Branch Offices D Subsidiaries E Joint Ventures F Edge Act Corporations G Agreement Corporations H International Banking Facilities (IBFs) I Shell Branches J Export Trading Companies (ETCs) III Regulation of International Banking A Goals of International Banking Regulation B U.S Banks’ Activities Abroad C Expansion and Regulation of Foreign Bank Activity in the United States The International Banking Act of 1978 The Foreign Bank Supervision Enhancement Act of 1991 D New Capital Regulation for Major Banks Worldwide IV Services Supplied by Banks in International Markets A Making Foreign Currencies Available to Customers B Hedging Against Foreign Currency Risk Exposure Forward Contracts Currency Futures Contracts C Other Tools for Reducing Currency Risks 20-1 Chapter 20 - International Banking and the Future of Banking and Financial Services The Development of Currency Options Currency Swaps D Supplying Customers with Short- and Long-Term Credit or Credit Guarantees Note Issuance Facilities Europaper Issuing and Managing Depository Receipts E Supplying Payments and Thrift (Savings) Instruments to International Customers Payments Services Savings (Thrift) Services F Underwriting Customer Note and Bond Issues in the Eurobond Market G Protecting Customers against Interest Rate Risk Interest-Rate Swaps Interest-Rate Caps Financial Futures and Options H Helping Customers Market Their Products through Export Trading Companies V Challenges for International Banks in Foreign Markets A Growing Customer Use of Securities Markets to Raise Funds in a More Volatile and Risky World B Developing Better Methods for Assessing Risk in International Lending International Loan Risks Possible Solutions to Troubled International Loans International Loan Risk Evaluation Systems C Adjusting to New Market Opportunities Created by Deregulation and New International Agreements Opportunities Created by NAFTA and CAFTA Opportunities in the Expanding European Community Opportunities in Asia as Barriers Erode VI The Future of Banking and Financial Services A Convergence B Consolidation C Survival of Smaller Community Financial-Service Institutions D Reaching the Mass Media E Invasion by Industrial and Retailing Companies F The Wal-Mart Challenge G Fighting for Ultimate Survival in a Global Financial System VII Summary of the Chapter Concept Checks 20-1 What organizational forms international banks use to reach their customers? There are various forms of organizations that banks use to set up offices internationally These forms include representative offices, agency offices, branch offices, subsidiaries, joint ventures, Edge Act corporations, agreement corporations, IBFs, shell branches, and ETCs Representative offices generally not provide conventional banking services but serve as a channel to market the services supplied by the home office and identify new customers, while branch offices 20-2 Chapter 20 - International Banking and the Future of Banking and Financial Services generally offer a full line of banking services acting as a local office of a large full-service providing corporation Agency offices are more complete than representative offices which both accept deposits and extend credit Subsidiaries are separate legal entities that are owned by a banking firm, while joint ventures are shared business operations usually jointly owned by a foreign bank or bank holding company and a domestic firm, sharing both profits and expenses Edge Acts are operated inside the United States by both domestic and foreign banks and must, by regulation, devote the bulk of their service activities to providing international banking services to offshore customers Agreement corporations are similar to Edge Acts providing bulk of their services to international customers IBFs are international banking facilities located in U.S territory that reflects transactions carried out on behalf of international customers Both foreign and domestic U.S banks may operate these computerized sets of account records known as IBFs Shell branches are merely offshore offices that record the receipts of deposits and other transactions of a bank’s international operations They are usually formed by banks to escape the burden of regulations in their home country Finally, ETCs are export trading companies that provide trade financing, export insurance coverage, research into markets abroad, and other similar services needed by businesses exporting goods and services abroad 20-2 Why are there so many different types of international organizations in the financial institutions’ sector? Different organizational forms are used for several reasons These different organizational forms often serve different functions The form of institution is usually selected based on a bank’s goals and objectives which may include profitability, cultural fit, availability of qualified personnel, operating costs, among others Also, the laws in one country may restrict or prohibit the use of a particular type of organizational form Additionally, there may be tax advantages of one form over another as also there may be differing abilities to raise capital and other funds 20-3 What are the principal goals of international banking regulation? The principal goals of international banking regulation include: protecting the safety of depositor funds, promoting stable growth in money and credit, protecting a nation against loss of its foreign currency reserves, restricting the outflow of scarce capital, and protecting domestic financial institutions and markets from foreign competition 20-4 What were the key provisions of the U.S International Banking Act of 1978 and the International Lending and Supervision Act of 1983? The U.S International Banking Act of 1978 brought foreign banks operating in the United States under federal regulation for the first time It required all foreign banks operating in the United States to secure a federal license, abide by the laws of the states in which the bank is registered, and subjected them to same reserve requirements as a domestic bank in case their deposits exceeded $1 billion The International Lending and Supervision Act of 1983 required American banks to restrict the size of fees charged for rescheduling payments on loans made overseas in 20-3 Chapter 20 - International Banking and the Future of Banking and Financial Services order to avoid excessive burdens on debtor countries, report their foreign loan exposures to bank examiners, and hold adequate reserves to protect depositors against possible losses on foreign loans 20-5 Explain what the Basel Agreement is and why it is so important The Basel Agreement is a negotiated agreement between bank regulatory authorities in the G-20 economies as well as some of the other major financial centers like Singapore and Hong-Kong to set common capital requirements for all banks under their jurisdiction The importance of the Basel Agreement is twofold: (1) to strengthen international banks, thereby strengthening public confidence in them, and (2) to remove important inequalities in banking regulation between nations that contribute to competitive inequalities between banks 20-6 Describe the principal customer services supplied by international banks serving foreign markets The principal customer services supplied by international banks are: (1) making foreign currencies available to customers (2) helping customers hedge their currency risk exposure through the use of forward contracts, currency futures contracts, currency options, currency swaps, and other financial derivative instruments, (3) supplying customers with short and long-term credit or credit guarantees, (4) supplying payments and thrift (savings) instruments to international customers, (5) underwriting customer note and bond issues in the Eurobond market, (6) protecting customers against interest rate risk, and (7) helping customers market their products through export trading companies 20-7 What types of risk exposure international banks strive to control in order to aid their customers? International banks strive to control currency risk exposure and interest rate risk exposure in order to aid their customers 20-8 What is an NIF? A DR? A note issuance facility (NIF) is a medium-term credit agreement between an international bank and its larger corporate and governmental customers, where the customer is authorized to periodically issue short-term notes, each of which usually comes due in 90 to 180 days, over a stipulated period (such as five years) International banks pledge to either buy up any notes not bought by other investors or grant supplemental loans A depository receipt or DR is a negotiable instrument representing an ownership interest in the stock or debt securities of a foreign institution This instrument usually arises when a broker purchases securities issued by a foreign entity and delivers them to a custodian who, in turn, instructs a depository bank to issue DRs representing the securities Through the use of a DR, the 20-4 Chapter 20 - International Banking and the Future of Banking and Financial Services denomination of a foreign security can be converted to the currency of the country where the receipts are being issued, thereby reducing the currency risk for international investors 20-9 Of what benefit might NIFs and DRs be to international banks and their customers? Both NIFs and DRs provide fee income to international banks, and allow the banks to offer additional services to their customers NIFs provide credit guarantees for customers' borrowings in the open market A DR makes it easier for a foreign business borrower to sell its securities in the global market place Moreover, an investor usually can recover his or her funds more quickly by liquidating DRs than by attempting to sell a foreign-issued security 20-10 What are ETCs? What services they provide, and what problems have they encountered inside the United States? An ETC is an export trading company usually owned and operated by large banks The purpose of these ETCs is to research foreign markets, identify firms in those foreign markets that could distribute products, and then provide or arrange the funding, insurance, and transportation needed to move goods to market 20-11 What the terms Europaper and Eurobonds refer to? Why are these instruments important to international banks and to their customers? Europapers consist of commercial papers issued by multinational corporations in the international markets to finance their short-term credit needs Eurobonds, on the contrary, are longer-term debt securities issued by companies in global financial markets Both these instruments are issued by the companies outside the country of their origin and are denominated in currencies other than currencies of their home country These instruments allow companies that are unable to crack their domestic markets due to lower credit ratings, to issue foreign currency denominated debt In addition, Eurobonds are also used by many companies to finance their foreign investments International banks often underwrite these securities to earn fee-based incomes Additionally, they also buy these securities to support the funding needs of their customers 20-12 What types of tools have international banks developed to help protect themselves and their customers against currency and interest rate risk? How does each tool accomplish its purpose? Two of the most popular tools to hedge against currency risk include forward contracts and currency futures contracts While forward contracts are customized contracts, currency futures contracts are standardized instruments Both of these instruments allow for buying or selling a currency at a predetermined price at a specified point in time, and can be used to take a longhedge or a short-hedge position, depending on the need Typically an importer who will have to buy foreign currency at a later date may enter into a long-hedge while an exporter who expects to receive a foreign currency denominated payment in future may enter into a short-hedge to protect himself against the exchange rate risks Thus, it can help in protecting the customer from risks arising due to changes in the exchange rate 20-5 Chapter 20 - International Banking and the Future of Banking and Financial Services Banks also frequently use currency options to hedge exchange rate risks Currency options give the buyer the right but not the obligation to buy or sell a currency at a predetermined price, thus giving the customer the chance to benefit from possible gains in the exchange market Currency swaps on the other hand, allow two parties to exchange cash flows in one currency with cash flows in a different currency at a specified price on or before a terminal date This can help a company match the currencies of their inflows and outflows and thereby help reduce the risk of losses due to exchange rate movements Tools used to protect against interest rate risks include interest rate swaps and financial futures and options, which work similar to their currency counterparts Additionally, banks also offer to impose caps (maximum rates) on loans, thus protecting the customer from increases in interest costs due to rise in interest rates 20-13 This chapter focuses on several major problem areas that international banks must deal with in the future What are these problem areas? The major areas that international banks must deal with in the future are: Growing customer use of securities markets to raise funds in a more volatile and risky world Developing better methods for assessing risk in international lending Adjusting to New Market Opportunities Created by Deregulation and New International Agreements 20-14 What different approaches to country-risk evaluation have international banks developed in recent years? New approaches to country risk evaluation developed by international banks in recent years include: (1) the checklist approach, which lists economic and political factors believed to be significantly correlated with loan risk, (2) the Delphi method, which uses consensus view of various business analysts, economists, and expert opinions to make an assessment of country risk, and (3) using market interest rates attached to deposits traded in the Eurocurrency markets to develop implied risk premium measures for bank loan rates Recently advanced statistical models have been used which are based on changes in selected key variables, including growth of the domestic money supply, the ratio of real investment to gross national product, and the ratio of a nation's imports to foreign exchange reserves Many analysts also follow the Euromoney Index, the Institutional Investor Index as well as the International Country Risk Guide published by leading financial magazines that can help assess the risk of a loan in a particular country 20-15 What different regions around the globe today appear to offer the greatest opportunities for expansion for international banks? Why you think this is so? 20-6 Chapter 20 - International Banking and the Future of Banking and Financial Services The most promising areas for expansion lie in Asia, especially in fast growing countries like China, India, and South Korea, just to name a few The large population size of these countries represents opportunities for international banks, securities dealers, insurance companies, and other financial service providers alike Some of these countries are amongst the fastest developing economies in the world A rising middle class, higher disposable incomes, reducing entry barriers, and scores of trade agreements resulting in opening up of the previously ‘closeddoor’ economies are some of the key reasons to believe that these nations offer the greatest opportunities for expansion for international banks 20-16 In looking at the future of the banking and financial-services industry, does it appear likely that the powerful trends of convergence and consolidation will continue into the future? Why or why not? Is this likely to occur at the same pace as in the past? Empirical evidences suggest that convergence and consolidation will continue into the foreseeable future Convergence is relatively new in the U.S and many firms are looking to expand into new markets because of lower profit potentials in their traditional markets and possibilities for economies of scope and diversification effects Consolidation has been a long run trend and is expected to continue as financial service firms look for economies of scale However, these trends may continue at a slower pace in the future Consolidation is speculated to have slowed because the best targets have already been taken Convergence may be slower because not all of the mergers that have taken place have worked well and financial service firms may want to be more careful entering into these new markets in the future Also, these past trends may not necessarily hold, particularly in the light of recent financial crisis, where a lot of smaller and lesser diversified companies have performed much better than some of their larger and well diversified counterparts 20-17 What appears to be the future of community banking? What significant threats does community banking seem to face? The biggest impact on the expansion of large international banks is borne by smaller sized community banks and credit unions The future of community banks much depends on the speed at which these smaller banks adapt to the competition, become more efficient, more cost conscious, and more customer focused Although, it is likely that they may well survive and thrive because economies of scale appear to be modest in banking Since, community banks have a relatively narrow menu of services (such as loans, credit cards, deposits, and investment advice) and not have global services capacity, they may not be able to effectively serve all the possible needs of a customer Presence of a large boutique banks in such a scenario may attract these customers resulting in loss of business for community banks Also, due to increasing mobile population, retaining of customers migrating into distant markets adds to the threat for community banking 20-18 Are banking and commerce—financial and nonfinancial firms—on a collision course for the future? What challenges companies like Wal-Mart pose for small community banks? For the largest financial firms? For regulation? For ongoing efforts to maintain a safety net to protect the public’s deposits and preserve public confidence in the financial system? 20-7 Chapter 20 - International Banking and the Future of Banking and Financial Services It is very likely that financial and non-financial firms may be on the collision course in the future Nonfinancial companies have been exploring several avenues for expanding their current beachhead in the financial-services industry for decades and this may be become the biggest competition in the future Wal-Mart, with numerous neighborhood stores offers limited array of financial products at competitive pricing Availability of financial products with the daily needs under one roof is turning out to be very convenient for consumers and poses a serious threat to smaller bank’s business Currently, American laws segregate financial and nonfinancial firms to protect financial firms from affiliations with more risky ventures It is possible that banks affiliated with industrial firms may make unprofitable loans to the parent company leaving them vulnerable to losses and potential bankruptcy Also, losses from the industrial firm could be transferred to the banking firm These potential losses could therefore, have serious consequences for the deposit insurance system designed to protect small depositors It may possibly force the government to subsidize losses in industrial firms through their bank affiliates There are strong laws in place today to prevent this from happening but some firms are continuously looking for ways around regulations because of the profit potential in this huge market Problems and Projects 20-1 Pacific Trading Company purchased Canadian dollars yesterday in anticipation of a purchase of electric equipment through a Canadian supply house However, Pacific was contacted this morning by a Japanese trading company that says equipment closer to its specifications is available in 48 hours from an electronics manufacturer in Osaka A phone call to Pacific’s bank this morning indicated that another of the bank’s customers, a furniture importer located in San Francisco, purchased a comparable amount of yen in order to pay for an incoming shipment from Tokyo, only to discover that the shipment will be delayed until next week Meanwhile, the furniture company must pay off an inventory loan tomorrow that it received 30 days ago from Toronto-Dominion Bank Which of the instruments described in this chapter would be most helpful to these two companies? Construct a diagram that illustrates the transaction you, as an international banker, would recommend to these two firms to help solve their current problems A San Francisco importer with yen needs Canadian dollars to retire a loan taken out with a Toronto bank In this case Pacific Trading Company and the import firm in San Francisco need to agree on a currency swap of yen for Canadian dollars At the termination of the swap Pacific Trading Company will need to return yen to the importer who will reciprocate with a counterpayment of Canadian dollars 20-8 Chapter 20 - International Banking and the Future of Banking and Financial Services 20-2 Art’s Sporting Goods ordered a shipment of soccer equipment from a manufacturer and distributor in Munich Payment for the shipment (which is valued at $3.5 million U.S.) must be made in Euros that have changed in value in the last 30 days from 0.6423 euros/$ to 0.6673 euros/$ If this trend is expected to continue, would you as Art's banker recommend that this customer use a currency futures hedge? Why or why not? Since the payment by Art’s needs to be made in euro, the firm will need to purchase euro Given, the value of euro relative to dollar has weakened in the last 30 days, and the trend being expected to continue, the firm will need to spend lesser amount of dollars to buy euros in future Therefore, Art’s does not need to hedge this position 20-3 Pinochio Corporation will import new wooden toys from a French manufacturer this week at a price of 200 Euros per item for eventual distribution to retail stores The current Eurodollar exchange rate is 0.6423 Euros per U.S dollar Payment for the shipment will be made by Pinochio next month, but Euros are expected to appreciate significantly against the dollar Pinochio asks its bank, Southern Merchants Bank, N.A., for advice on what to What kind of futures transaction could be used to deal with this problem faced by Pinochio? Futures contracts calling for delivery of Euros next month are priced currently at 0.6418 Euros per dollar and are expected to be priced next month at 0.6012 Euros per dollar The risk of a rising euro can be hedged by a long hedge in currency futures transactions Pinochio's bank could assist its customer by brokering a purchase of Euro futures contracts on the Chicago Mercantile Exchange, where Pinochio agrees to take delivery of euros next month at a fixed price of 0.6418 euros per U.S dollar This will lock-in the purchase price of euros for Pinochio The following month, close to the payment date, the purchased futures contracts will be squared off by selling the futures contracts at the market price, which is expected to be 0.6012 Euros per dollar The resulting profit from the purchase and subsequent sale of Euro futures will help offset the loss to Pinochio due to purchase of euros at a higher spot market price 20-4 Watson Hardware Corporation regularly ships tools to the United States to retail outlets from its warehouse in Stuttgart, Germany Its normal credit terms call for full payment in U.S 20-9 Chapter 20 - International Banking and the Future of Banking and Financial Services dollars for the hardware it ships within 90 days of the shipment date However, Watson must convert all U.S dollars received from its customers into Euros in order to compensate its local workers and suppliers Watson has just made a large shipment to retail dealers in the United States and is concerned about a forecast just received from its local bank that the U.S dollar-euro exchange rate will fall sharply over the next month The current Euro-U.S dollar exchange rate is 0.64 Euros per dollar However, the local bank’s current forecast calls for the exchange rate to rise to 0.70 Euros per dollar, so that Watson will receive substantially less in euros for each U.S dollar it receives in payment Please explain how Watson, with the aid of its bank, could use currency futures to offset at least a portion of its projected loss due to the expected change in the Euro-dollar exchange rate This situation can be addressed with the use of a short hedge in currency futures contracts Anticipating a decline in the dollar's purchasing power in terms of Euros, Watson, working through its bank, can sell 90 day dollar futures contracts Then, on or before the expiration date of these contracts, Watson, with its bank's assistance, will purchase dollar futures contracts at a lower price Thus, a profit will result from this short hedge to help offset the potential loss from converting dollar payments into Euros 20-5 Johanna International Mercantile Corporation has made a $15 million investment in a stamping mill located in northern Germany and fears a substantial decline in the Euro's spot price from $1.56 to $1.50, lowering the value of the firm's capital investment Johanna's principal U.S bank advises the firm to use an appropriate option contract to help reduce Johanna's risk of loss What currency option contract would you recommend? Explain why the contract you selected would help to reduce the firm’s currency risk Johanna International can purchase a put option on euro at a price close to the current spot value of $1.56 per euro Thus, if the dollar per euro rate drops to $1.50 as feared, the firm can purchase euros at $1.50 from the market and deliver those at $1.56 per euro by exercising the put option contract The resulting profit will help to offset Johanna's loss due to a decline in the investment’s value 20-6 Ebi International Bank of Japan holds U.S dollar denominated assets of $475 million and dollar-denominated liabilities of $469 million, has purchased U.S dollars in the currency markets amounting to $75 million, and sold U.S dollars totaling $50 million What is Ebi’s net exposure to risk from fluctuations in the U.S dollar relative to the bank’s domestic currency? Under what circumstances could Ebi lose if dollar prices change relative to the yen? Net currency exposure for Ebi International bank can be calculates as:  Dollar denominated assets - Dollar denominated liabilities   (Dollars bought - Dollars sold) or  $475 - $469  -  $75 - $50   $31 million Since the bank has a net long position in dollar, the bank stands to lose if the value of U.S dollar falls relative to Japanese yen 20-7 Suppose that Canterbury Bank has a net long position in U.S dollars of $12 million, dollar denominated liabilities of $125 million, U.S dollar purchases of $300 million, and dollar sales of $220 million What is the current value of the bank’s dollar-denominated assets? 20-10 Chapter 20 - International Banking and the Future of Banking and Financial Services Suppose the U.S dollar’s exchange value rises against the pound Is Canterbury likely to gain or lose? Why? Net currency exposure for Canterbury Bank is be calculates as:  Dollar denominated assets - Dollar denominated liabilities   (Dollars bought - Dollars sold) or $12   Dollar denominated assets - $125  ($300 - $220) Therefore, dollar denominated assets for the bank is worth $57 million Since Canterbury has a net long position in U.S dollars, the bank stands to gain if the value of U.S dollar appreciates relative to pound 20-11 ... International Banking and the Future of Banking and Financial Services It is very likely that financial and non -financial firms may be on the collision course in the future Nonfinancial companies... International Banking and the Future of Banking and Financial Services order to avoid excessive burdens on debtor countries, report their foreign loan exposures to bank examiners, and hold adequate... benefit might NIFs and DRs be to international banks and their customers? Both NIFs and DRs provide fee income to international banks, and allow the banks to offer additional services to their