Chapter 16

Banking in the International Economy

HSBC: Global Bank

• In November 2002, HSBC Holdings buys large US finance company, Household Finance.

• HSBC Holdings owns retail banks in UK, USA, Canada, Argentina, etc.

Objectives

• To become familiar with trends and current situations in important non-Hong Kong banking markets.

• To understand the role of banks in facilitating international trade and finance.

Largest International Banks

Bank Country Assests (US $ Billions)1 Deutsche Bank Germany 742.52 UBS Switzerland 685.93 Citigroup USA 668.94 Bank of America USA 617.75 Bank of Tokyo-Mistubishi Japan 579.86 Bayerische Hypo Germany 538.67 ABN Amro Netherlands 504.18 HSBC Holdings UK 483.19 Fuji Bank Japan 481.1

10 Credit Suisse Switzerland 474 Source: Mishkin

Assets By Country

International Loans - 2001US$ Trillion $7.80By Location %German 18.2French 7.8UK 6.9Other European 24.7North American 7.3Japan 11.9Other 23.2

Frameworks of Banking System

• In the post-war era, there were three basic systems of banking regulation.

1. Universal Banking (prevalent in Continental Europe: France, Germany, Switzerland).

2. Bank Holding Companies (prevalent in UK & Commonwealth countries).

3. Strict Commercial Banking (once prevalent in US & Japan)

Universal Banking

• Universal banks do all sorts of financial activities in one company.

1. Banks are free to engage in banking, securities, real estate, insurance….

2. All businesses done under 1 legal entity. Banking business fully shares risks.

3. Banks Own Securities and may have representatives on board of major borrowers.

Advantages: Banks ownership of securities enables close monitoring/ One stop shopping allows banks to build strong relationships with borrowers.

Bank Holding Companies

• Bank holding companies have a corporate structure in which a parent company owns many subsidiaries in different financial industries.

1. Subsidiaries engage in banking, securities, real estate and insurance business.

2. Subsidiaries are separate legal entities so the bankruptcy of one does not mean losses for the other.

3. Losses at one subsidiary do result in losses for shareholders of the holding company.

4. Banks mostly protected from risk of sister companies.

Advantages: Protects depositors & bank capital from market risk. One stop shopping can help build relationships.

Strict Commercial Banking• In this regime, banks are engage in only commercial

banking (taking deposits and making loans).1. Banks are completely independent companies.2. Banks may not be part of a corporation that also runs

investment banks, insurance etc. 3. In USA, banks could not own equities. In Japan, banks

did own equities.Advantages: Banks protected from stock market risk.• In both Japan and USA, system has switched to bank

holding companies.

U.S. Banking System: Past

• Prior to 1980, U.S. banking system was heavily regulated along a number of dimensions.

• Banks were strictly commercial banks and could not participate in investment banking, insurance, mutual funds, other financial industries.

• Banks were restricted to operation in 1 state (California, New York, etc.)

• Regulation Q put an upper bound on deposit interest rates. This led to development of Eurodeposits and NOW accounts and competition from MMMF.

Breaking Down the Wall

• Since 1980, US banking system and regulatory environment has evolved to something closer to UK universal banking system.

• Regulation Q phased out over 1980-1986 period.• Banks have used holding companies to consolidate

across state lines• Banks are now able to set up brokerages and sell

mutual funds.• In 1999, banks were allowed to be a part of holding

companies that own insurance and investment banks. In 1998, Citibank-Travelers merger was first large merger of financial companies.

Japanese Banking System: Past

• Types of Japanese Banking System:1. City Banks: Large, national banks

A. Keiretsu Banks – Associated with large industrial groups (Fuji, Mitsubishi, Sumitomo etc.)

B. Secondary Banks - (Takugin, Sakura. Tokai..)

2. Regional Banks: Local Banks for small towns3. Long Term Banks – (NCB, IBJ, LTCB) Issue 5 year

debentures and finance in industrial projects 4. Trust Banks – Take only large deposits (Mitsui,

Mitsubishi, Yasuda… 5. Credit Co-operatives: Small banks that specializes in

housing and agricultural lending. 6. Postal Savings Bank – Post office has a savings bank

which directly finances Japanese Government Banks.

Japanese Main Banking

• Japanese banking characterized by long term relationship described as Main Banking.

• Companies in Keiretsu get financing from the bank and the bank owns much of the stock of member companies.

• Virtually all companies had a main bank which closely monitored borrowers for long periods.

Japanese Banking System: Past

• Japan banks were restricted to commercial banking, but could own equity securities.

• Japanese central bank had an official policy of not allowing bank failures. Prior to 1990’s, not much need for a lender of last resort.

• In 1990’s, Japanese banking system suffered large losses due to collapse of equity prices and, most importantly, default on many loans to property speculators. Japanese bank loans constitute up to 7% of Japanese GDP.

• In 1997, Hokkaido Takushoku bank became the first City Bank to be allowed to fail. Long Term Credit Bank and Nippon Credit Bank nationalized.

The Big Bang

• As in the US, liberalization of financial markets has produced new competition for banks and a declining market share of external finance for banks.

• In 1998, announced a further financial liberalization nicknamed the Big Bang. Part of this allowed for bank holding companies and direct sales of mutual funds and insurance by banks.

• Banking industry experiencing consolidation (Dai-Ichi, Fuji, and IBJ will combine) and foreign competition (Ripplewood has bought assets of LTCB).

Chinese Banks

• Chinese savers restricted to bank deposits and equity holdings.

• Dominated by Four State Owned Deposit Money Taking Banks (Industrial and Commercial,

Construction Bank, Agricultural Bank, Bank of China)• Other types of banks:

1. National Commercial Bank (CITIC,Bank of Communications,

Everbright, Huaxia, Minsheng)2. Regional Commercial Bank (Guangdong

Development, Shenzen Development, Merchants, Fujian Industrial, Shanghai Pudong Develompment, etc.)

3. Credit Cooperatives (Collective Banks – Urban and Rural)

1. Deposit Money Taking Banks are operated by the state and direct funds to SOE’s often for policy purposes rather than commercial

2. Commercial banks lend to SOE’s on a commercial basis.

3. Cooperatives lend more to TVE’s and private enterprises.

Liabilities (Billion Yuan) 2001Deposit Money Taking Banks 26312.84Commercial Banks 21211.31Co-operative 4583.66

Banks on the Eve of Reform

• SOE have had declining profitability and have often been used as a way to provide social services.

• Government financed Asset Management Banks have purchased Yuan 1.4 Trillion worth of bad loans from banks.

• Many loans made by Chinese banks will not be repaid. Bank of China uses a modern loan classification system comparable with Hong Kong system. About 40% of BOC loans would fall under Classified status.

• Many loans made by largest WTO will allow greater access to Chinese market to foreign financial services companies presenting competition for deposits.

International Banking: Facilitating International Trade

• Facilitating International Trade– International Banks comprise much of the

foreign exchange market– International Banks Issue Letters of Credit and

Bankers Acceptance for the International Payments.

Facilitating International Trade

International Banking: Lending

• Cross-border lending has risen dramatically over the last thirty years. Prior to 1960’s, international lending was small and mostly sovereign borrowing.

• The UK and Switzerland were the main centers of international banking.

• During 1970’s, oil exporting countries achieved large dollar surplus due to high oil prices. U.S. banks recycled loans to developing countries. By end of 1970’s, international lending reached US$324 billion.

• In the 1980’s, Japanese trade surplus encouraged the entry of Japanese banks into international markets.

• Over the next 20 years, international lending has risen 10 fold.

Syndicated Euroloans

• A Euroloan is a loan not made in the currency of the borrower.

• International bank loans to developing economies are Euroloans.

• The typical Euroloan is a floating-rate obligation of relatively long maturity with LIBOR as the benchmark rate.

• Euroloans usually are quite large. • They are often handled by loan syndication, with

each participating bank holding a fraction of a loan.

Why Syndicate?• Loan syndication is a way to share risks and take

advantage of scale economies on information costs.

• Some banks (called lead managers of loans) specialize in evaluating and monitoring international borrowers. These will typically be large international banks.

• Smaller banks might be willing to absorb risks of international lending but not have advantage in evaluating loans.

• Lead managers find borrowers and share loans with participating banks.

Bank Lending and the East Asian Crisis

• During the early and mid 1990’s, there was dramatic growth in international lending to Korea, Malaysia, Thailand and Indonesia.

• These loans financed boom in investment in these countries

• Much of these loans had very short-term maturities.• In late 1997-1998, many of these loans were recalled

very quickly.• Capital outflows caused severe economic dislocation

in the affected countries.

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1990 1992 1994 1996 1998 2000

INDONESIAKOREA

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Liabilities to International Banks

Financial Crisis

• Bank lending is a key element of financial flows.

• East Asian crisis shows, however, that banking and bank panics may be a source of instability.

International Lending: Deposits• A Eurocurrency deposit is a time deposit denominated

in a currency denominated deposit in a bank outside of the U.S.

• Eurocurrency markets were pioneered by British banks that were trying to avoid rules on the use of pounds in international loans. London still the main Euromarket center.

• Eurocurrency deposits catered to US depositors trying to escape Regulation Q. First Eurocurrency is the Eurodollar.

• Much of international banking is done in banking centers called Euromarkets.

• Half of all Eurocurrency deposits are negotiable CD’s