International Banking

What is International Banking

With the rapid expansion of international
networks, the banking sector occupies a pivotal
position in the global economy as it has access
to the capital, the technological capabilities, and
the international network to facilitate these
activities.
The industry was transformed in the 1970s. Until
then most banks concentrated on their home
markets, considering themselves as domestic
institutions that handled foreign business.

Contd

Banks monitor the business sector through

the evaluation, pricing, and credit-granting
functions. In this context, the operations of
an international trade of services, that
have as a consequence either the creation
and management of financial means, or
the transport of capital from surplus units
of country in an other, or the mediation in
the frame of national financier system are
called International Banking activity.

Contd
Banking
transactions
crossing
national
boundaries
Undertake International Lending
- All claims of domestic banks offices on foreign
residents
- Claims of foreign bank offices on local
residents
- Claims of domestic bank offices on domestic
residents in foreign currency

IBs Services Offered

International Banks do everything domestic

banks do and:

Arrange trade financing.

Arrange foreign exchange.
Offer hedging services for foreign currency
receivables and payables through forward and
option contracts
Offer investment banking services (where
allowed).

Borrow or lend in Eurocurrency market

Underwrite Eurobonds and foreign bonds.

Types of International
Banking Offices
1.

Correspondent bank
Banks located in different countries
establish accounts in other bank
Provides a means for a banks MNC clients
to conduct business worldwide through his
local bank or its contacts.
Provides income for large banks

Smaller foreign banks that want to do business

,say in the U.S., will enter into a correspondent
relationship with a large U.S. bank for a fee

Contd..
Advantages of Correspondent Banking
a.
Low cost market entry
b.
Minimal staffing expense
c.
Multiple business sources
d.
Local banking opportunities
e.
Network of local contacts

Contd..
Disadvantages of Correspondents
a.
Local customers may be given lower
priority
b.
Some credit forms prohibited
c.
Irregular, not extensive credit results

Contd.
2. Representative office
A small service facility staffed by parent bank personnel
that is designed to assist MNC clients of the parent bank
in dealings with the banks correspondents.

No traditional credit services provided

Looks for foreign market opportunities and serves as a liaison
between parent and clients

Useful in newly emerging markets

Representative offices also assist with information about

local business customs, and credit evaluation of the
MNCs local customers.
It is useful when the bank has many MNC clients in a
country

ORGANIZATIONAL FORMS AND

STRATEGIES IN BANK EXPANSION
OVERSEAS
Advantages of Representative
Offices
a.
b.
c.
d.

Low-cost market entry

Efficient delivery
Attracts additional business
Maintains existing business

ORGANIZATIONAL FORMS AND

STRATEGIES IN BANK EXPANSION
OVERSEAS

3.
Disadvantages of

Representative
Offices
a.
Inability to more
effectively
penetrate markets
b.
Expensive
c.
Qualified personnel
difficult
to attract

Contd.
3. Foreign Branch

A foreign branch bank operates like a local bank,

but is legally part of the parent, not a separate
entity.
Subject to both the banking regulations of home
country and foreign country.
Reasons for establishing a foreign branch

12

More extensive range of services (faster check clearing,

larger loans)
Compete with host country banks at the local level

Most popular means of internationalizing bank

operations

ORGANIZATIONAL FORMS AND

STRATEGIES IN BANK EXPANSION
OVERSEAS
Advantages of Foreign Branches
a.
Greater control over foreign operations
b.Greater ability to offer direct, integrated
customer services
c.Better customer relations
Disadvantages of Foreign Branch
a.
High-cost
b.
Difficult and expensive to train managers.

Contd.
4. Subsidiary
and Affiliate Bank

A subsidiary bank is a locally incorporated bank

that is either wholly owned or owned in major part
by a foreign parents.
An affiliate bank is one that is only partially
owned, but not controlled by its foreign parent.
Both subsidiary and affiliate banks operate under
the banking laws of the country in which they are
incorporated.
They are allowed to underwrite securities.

14

Contd.
5. Offshore Banking Center

A country whose banking system is organized to

permit external accounts beyond the normal scope of
local economic activity.
The host country usually grants complete freedom
from host-country governmental banking regulations.

Banks operate as branches or subsidiaries of the parent bank

Primary credit services provided in currency other than host
country currency
Reasons for offshore banks

15

Low or no taxes, services provided for nonresident clients, few or

no FX controls, legal regime that upholds bank secrecy

What is Asset Liability Management??

The process by which an institution manages its

balance sheet in order to allow for alternative
interest rate and liquidity scenarios

Banks and other financial institutions provide

services which expose them to various kinds of
risks like credit risk, interest risk, and liquidity risk

Asset-liability management models enable

institutions to measure and monitor risk, and
provide suitable strategies for their management.

Asset Management

Asset Management: the attempt to earn the

highest possible return on assets while
minimizing the risk.
1.
2.
3.
4.

Get borrowers with low default risk, paying high

interest rates
Buy securities with high return, low risk
Diversified portfolio
Manage liquidity

Asset Management - Credit Risk:

Overcoming Adverse Selection and Moral Hazard

Screening and information collection

Specialization in lending (e.g. energy sector)

Diversification - by industry and geography

Monitoring and enforcement of restrictive

covenants

Long-term customer relationships

Collateral and compensating balances

An effective Asset Liability Management Technique aims to

manage the volume, mix, maturity, rate sensitivity, quality and
liquidity of assets and liabilities as a whole so as to attain a
predetermined acceptable risk/reward ratio

It is aimed to stabilize short-term profits, long-term earnings

and long-term substance of the bank. The parameters for
stabilizing ALM system are:

1.

Net Interest Income (NII)

2.

Net Interest Margin (NIM)

3.

Economic Equity Ratio

3 tools used by banks for ALM

ALM Information Systems

Usage of Real Time information system to gather the

information about the maturity and behavior of loans and
advances made by all other branches of a bank

ABC Approach :
analysing the behaviour of asset and liability products
in the top branches as they account for significant
business
then making rational assumptions about the way in which
assets and liabilities would behave in other branches
The data and assumptions can then be refined over time
as the bank management gain experience

The spread of computerisation also help banks in

accessing data.

ALM Organization

The board should have overall responsibilities and should set the
limit for liquidity, interest rate, foreign exchange and equity price risk

The Asset - Liability Committee (ALCO)

ALCO, consisting of the bank's senior management (including

CEO) should be responsible for ensuring adherence to the limits
set by the Board
Is responsible for balance sheet planning from risk - return
perspective including the strategic management of interest
rate and liquidity risks
The role of ALCO includes product pricing for both deposits and
advances, desired maturity profile of the incremental assets
and liabilities,
It will have to develop a view on future direction of interest rate
movements and decide on a funding mix between fixed vs
floating rate funds, wholesale vs retail deposits, money market
vs capital market funding, domestic vs foreign currency funding
It should review the results of and progress in implementation
of the decisions made in the previous meetings

ALM Organisation

Board should have overall responsibility for management of risk

ALCO

Board should decide risk management policy and procedure, set

prudential limits, auditing, reporting and review mechanism in respect of
liquidity, interest rate and forex risk
Consisiting of banks senior management including CEO
Responsible for adherence to the polices and limits set by Board
Responsible for deciding business strategies (on asset liability side) in
line with banks business and risk objectives

ALM Support Group

Consisting of operating staff

Responsible for analysing, monitoring and reporting risk profiles to ALCO
Prepare forecasts showing effects of various possible changes in market
conditions affecting balance sheet and suggesting action to adhere to
banks internal limits

10/10/16

ALM Organisation

(Contd.)

ALCO decision making unit responsible for

Balance Sheet planning from risk-return perspective which includes

management of liquidity, interest rate and forex risks
Pricing of deposits and advances, desired maturity profile etc.
Monitoring the risk levels of the bank
Review of the results and progress of implementation of decisions made
in previous meeting
Future business strategies based on banks current view on interest rates
To decide on source and mix of liabilities or sale of assets
To develop future direction of interest rate movements
To decide on funding mix between fixed and floating rate funds,
wholesale vs. retails deposits, short term vs. long term deposits etc.

10/10/16

ALM Process

Categories of Risk

Risk is the chance or probability of loss or

damage

Credit Risk

Market Risk

Operational Risk

Transaction Risk
/default risk
/counterparty risk
Portfolio risk
/Concentration risk
Settlement risk

Commodity risk

Process risk

Interest Rate risk

Infrastructure risk

Forex rate risk

Model risk

Equity price risk

Human risk

Liquidity risk

But under ALM risks that are typically

managed are.

Liquidity Risk

Liquidity risk arises from funding of long term assets by

short term liabilities, thus making the liabilities subject to
refinancing

Liquidity Risk Management

Banks liquidity management is the process of generating

funds to meet contractual or relationship obligations at
reasonable prices at all times

Liquidity Management is the ability of bank to ensure that

its liabilities are met as they become due

Liquidity positions of bank should be measured on an

ongoing basis

A standard tool for measuring and managing net funding

requirements, is the use of maturity ladder and
calculation of cumulative surplus or deficit of funds as
selected maturity dates is adopted

Statement of Structural Liquidity

All Assets & Liabilities to be reported as per their
maturity profile into 8 maturity Buckets:
i.

1 to 14 days

ii. 15 to 28 days
iii. 29 days and up to 3 months
iv. Over 3 months and up to 6 months
v. Over 6 months and up to 1 year
vi. Over 1 year and up to 3 years
vii. Over 3 years and up to 5 years
viii. Over 5 years

Statement of structural liquidity

Places all cash inflows and outflows in the maturity ladder as

per residual maturity

Maturing Liability: cash outflow

Maturing Assets : Cash Inflow

Classified in to 8 time buckets

Mismatches in the first two buckets not to exceed 20% of

outflows

Shows the structure as of a particular date

Banks can fix higher tolerance level for other maturity buckets.

Addressing the mismatches

Mismatches can be positive or negative

Positive Mismatch: M.A.>M.L. and Negative Mismatch

M.L.>M.A.

In case of +ve mismatch, excess liquidity can be deployed in

money market instruments, creating new assets &
investment swaps etc.

For ve mismatch, it can be financed from market

borrowings (Call/Term), Bills rediscounting, Repos &
deployment of foreign currency converted into rupee.

Interest Rate Risk

Interest Rate risk is the exposure of a banks financial

conditions to adverse movements of interest rates

Though this is normal part of banking business, excessive

interest rate risk can pose a significant threat to a banks
earnings and capital base

Changes in interest rates also affect the underlying value

of the banks assets, liabilities and off-balance-sheet item

Interest rate risk refers to volatility in Net Interest Income

(NII) or variations in Net Interest Margin(NIM)

NIM = (Interest income Interest expense) / Earning

assets

Maturity gap method (IRS)

THREE OPTIONS:
A)
Rate Sensitive Assets>Rate
Liabilities= Positive Gap
B)
Rate Sensitive Assets<Rate
Liabilities = Negative Gap
C)
Rate Sensitive Assets=Rate
Liabilities = Zero Gap

Sensitive
Sensitive
Sensitive

Reasons for Interest Rate Risk

On account of asset transformation

Many deposits are used for one big loan

Periodical review of assets and liabilities

Due to mismatches between maturity /
repricing dates as well as maturity amounts
between assets and liabilities
Depositors and borrowers may pre-close their
accounts

College of Agricultural Banking, RBI, PUNE

10/10/16

Currency Risk

The increased capital flows from different nations following

deregulation have contributed to increase in the volume of
transactions

Dealing in different currencies brings opportunities as well as risk

To prevent this banks have been setting up overnight limits and

undertaking active day time trading

Value at Risk approach to be used to measure the risk associated

with forward exposures. Value at Risk estimates probability of
portfolio losses based on the statistical analysis of historical price
trends and volatilities.

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