UGB322 International Banking

International banks operations in foreign markets to maximize shareholder value .... Part A: Discuss the income opportunities available to international banks and critically evaluate int

ASSIGNMENT COVER SHEET

UNIVERSITY OF SUNDERLAND

BA (HONS) BANKING AND FINANCE

Student ID: 149078874/1

Student Name: Nguyen Thi Kieu Anh

Module Code: UGB 322

Module Name / Title: International Banking

Centre / College: Banking Academy of Viet Nam

Hand in Date: 15th May 2015 Due Date: 15th May 2015

Assignment Title: Individual assignment

Students Signature: (you must sign this declaring that it is all your own work and all sources

of information have been referenced)

Nguyen Thi Kieu Anh

International Banking

UGB 322

Nguyen Thi Kieu Anh - ID:149078874/1

Submission date: 15th May 2015

Number of words: 3,300

TABLE OF CONTENTS

Part A 4

I Introduction 4

II Main Body 4

1 Income opportunities available to international banks 4

2 International banks operations in foreign markets to maximize shareholder value 5

2.1 The reasons that banks move to abroad 5

2.2 Organizational mechanisms for carrying on international banking 7

2.3 Shareholder value maximization 7

2.4 Determinants of bank operations in international market 8

III Conclusion 9

IV References 10

V Appendices 11

Part B 13

I Introduction 13

II Main body 13

1 The need for regulating international banks 13

2 Regulations applied to international banks 14

3 Difficulties in regulating international banks 14

4 International banking regulation reform 15

III Conclusion 17

IV References 17

V Appendices 19

Part A: Discuss the income opportunities available to international banks and critically evaluate international banks operations in foreign markets to maximize shareholder value

I Introduction

International banking refers to banking services undertaken across borders (Hagendorff,

2010, p.16) By approaching various markets and offering wider range of financial services, international banks have more chances to generate profit as well as maximise shareholder value In order to understand deeply about this, this study aims to discuss the income opportunities available to international banks and evaluate international banks operations in foreign markets to maximize shareholder value

II Main Body

1 Income opportunities available to international banks

In international environment, banks have four principal sources of revenues, namely net interest income (from loans), net fees and commission income (income from setting up deals, providing advice and services), net trading income (from currency and financial instruments), and investment income (from associates or subsidiaries) (Fight, 2004, p.7)

An example is given from income statement of Barclays bank as follows:

Figure 1: Consolidated income statement of Barclays PLC (Barclays, 2010, p.187)

 Net interest income (NII): NII is the difference between interest income and interest

expense: a primary indicator of a bank’s ability to generate profit on its primary

business (Fight, 2004, p.118)

Net interest income (NII) = Interest income - Interest expense

Interest income arises from the loans and represents the largest source of revenue

International banks offer the loans to both domestic and international clients in a

range of currencies and maturities One of the special services of international banking is syndicated lending In a syndicated loan, two or more banks jointly lend to

a business with big amount of money, typically exceed £50 million, which would be

too risky to underwrite by a single lender (Hagendorff, 2010, p.29) Interest expense

usually involves the amount of money (interest) that banks paid to depositors for the use of their money

 Net fees and commission income: Fees and commissions are an increasing important

source of income International banks get the front-end fees for the arrangement of syndicated loans and the fees on issuing letters of credit (L/C)1, documentary collections (D/C)2 to avoid risk of non-payment between trading partners (importers and exporters who engaging in international trade) They get the commission on factoring that allows exporters sell their receivable to the bank (forfaiter) at a discount

to meet its present and immediate cash needs Besides, there are many others fees and commissions such as underwriting commissions, commissions on selling securities to

investors, mergers and acquisitions advice and so on (Fight, 2004, p.120)

 Net trading income: It includes trading profits from the bank’s operations in

securities, investments, and sometimes treasury operations The major part of trading income is foreign exchange or FX trading (Derivatives for hedging, namely forwards, futures, options, swaps), but can also include income from trading in bonds, certificates of deposit, treasury bills, and other marketable securities (Fight, 2004,

pp.119-120)

 Investment income: Interest and dividends earned on securities held as investments

Income from associates is fairly common among European and Asian banks but less

so with US banks due to historical US banking restrictions on crossing state

boundaries and on investing in non-banking subsidiaries (Fight, 2004, p.120)

2 International banks operations in foreign markets to maximize shareholder value

2.1 The reasons that banks move to abroad

Banks move to abroad for a variety of reasons but the biggest motive is to seek growth or

1 A commitment by a bank on behalf of the buyer that payment will be made to the beneficiary (exporter) provided that the terms and conditions have been met, as verified through the presentation of all required documents (Mizan, 2011, p.247)

2 International bank acts as intermediaries between importer and exporter by stipulating the term and conditions under which the importer gains title to the goods purchases (Hagendorff, 2010, p.46)

profit In fact, when domestic banking system is mature, competitive and overly regulated, approaching new potential market can offer better opportunities for growth than domestic market Indeed, there are some evidence shows that it is very difficult for domestic banks as well as foreign banks can earn profit in such a market For example, Stijin Claessens, Asli Demirgiic-Kunt, and Harry Huizinga examined the behavior of banks in eighty mature and emerging markets in the period of 1988 to 1995 to investigate how profitability differed between foreign and domestic banks The results showed that foreign banks were found to have higher profitability than domestic banks in emerging markets, while the opposite was true in mature markets (Litan et al., 2001, p.34) That is also the reasons why banks have a tendency to move to developing countries more than developed countries By going international, banks can offer wider range of products and services, access new customer base and benefit from their brand awareness, economies of scale, and lower their risk through increased opportunities for diversification (G20, 2008, p.262) Specifically, providing products and services in multiple countries reduce the bank’s exposure to possible economic and political instability in a single country (Acevedo, 2015) Financial liberalization and the globalization of finance are the second motive for banks to move abroad Before the 1990s, the liberalization and adoption of the market economy that have occurred worldwide together with the globalization tendencies have led to deregulations in the financial markets One specific outcome is abolishing the restrictions on the entrance of foreign banks into the local banking system Thus in 1990s, foreign banks have started to display their presence in the national economies (KÖSE, 2009) Competitive advantage is also an important factor in driving the decision of banks from specific countries to enter specific countries Competitive advantages mentioned are managerial expertise, technological know-how, sizeable capital and superior products and services, marketing techniques which will outweigh the costs associated with foreign market entry (costs of adapting to new regulatory environment and different customer demand) (Hagendorff, 2010, p.26) Last important motivation mentioned is ‘follow the customer’ In order to prevent multinational corporations from soliciting these local or other foreign competitors, banks are impelled to follow the client by moving abroad themselves in order to defend their unique bank-client relationship (Wezel, 2004, p.7) Further, multinational firms may face additional incentives to continue banking with their home market institution in case they find it harder to borrow funds from local banks in their host market (Hagendorff, 2010, p.28)

2.2 Organizational mechanisms for carrying on international banking

When a bank decides to enter a foreign location, it needs to determine the form of representation Representative office, agency, brand and subsidiary are generally available organizational forms for the bank Each of them involves different level of investment, as well as allows offering a different range of banking services The representative office is the most economical of overseas banking organizational forms It

is relatively inexpensive to establish but these offices are not allowed to participate in the typical banking activities (Blandón, 1998, p.2) Agency requires a higher investment and provides advantages over representative offices in that they can conduct transactions but a certain limit A foreign branch overcome the demerits of the above two modes They can offer a full range of banking services, with restrictions on regards access to liquidity provision in the event of distress However, the branches are not separate entities from their parent unit The parent unit has a full control over the functioning of the branches so the branches have access to the full support, credit rating and capital base of the parent (Sharan, 2012, p.351) Bank subsidiary can engage in a full range of banking activities but the main difference makes it relatively costly compared to branch is that it needs to be capitalized separately from the parent bank (Hagendorff, 2010, p.24) Establishing representation offices can protect shareholder wealth as it is more risk averse, involves less sunk costs However, in fact banks tend to establish branches and subsidiaries abroad

in expectation of increasing shareholder wealth For instance, U.S banking organizations conduct most of their international activities through foreign branches and subsidiaries, in which they conduct an estimated 60 percent of their international business through foreign branches (Houpt, 1999, p.601)

2.3 Shareholder value maximization

Shareholder value maximization implies that the ultimate goal of business is to enrich shareholders by increasing returns in the form of dividends and/or capital appreciation and banking industry is no exception (Hall, 2015) Going abroad is one of the strategic plans helps banks increase shareholders wealth However, in order to achieve such thing, banks need to make wise investment Each market, each country may have different economic environment, different level of financial system structure and different social characteristic, therefore, foreign banks seem to thoroughly consider and evaluate cost and benefit of each market to find the market where the underlying conditions are favorable For example, although China’s CPI is really high and the inflation rate is higher than the

actual saving interest as a result of the non-maturity economy Foreign banks still choose China because Chinese economic began to take off since China’s reform and opening-up Especially after 2001, China have join into WTO, Chinese economic construction is further developed and the cooperation with foreign partners was getting closer and closer through the keeping opening up on different industries The foreign banks come to China

in order to retain the customer resources that are searching for overseas investment opportunities Another reason for foreign banks access is to strive for the enormous market opportunities in China There are a large number of wealthy residents accompanies by Chinese economic development (refer to appendix 1) (Zhao, 2009, p.24) Foreign banks also recognize the challenges they face in these markets, therefore, they make more efforts to enable success by investing in technological innovation and in people (EY, 2014, p.28) Citibank was the first foreign bank in China to launch the smart banking model Citi Smart Banking branch comes equipped with media walls, interactive kiosks and work benches to enable customers to surf through information, learn about products and services and conduct transactions within a few minutes (Citi, 2015) HSBC focuses on training local talent into experts with both banking and international experience which will become key human resources for HSBC in the future Currently they employ about 5,500 staff, around 98% of whom were recruited locally (HSBC, 2009) Besides, banks utilizes Eurocurrency market3 to reduce the cost of capital and minimize the risk as this market can avoid strict regulations imposed on the banking system such as interest rate ceilings and strict reserve requirements and most of the lending in the Eurocurrency market takes the form of syndicated lending (Hagendorff,

2010, p.32)

2.4 Determinants of bank operations in international market

International bank operation is also affected by many risks Due to the limitation of the study purposes, this study only mentions about country risk, operational risk and market risk

 Country risk is the probability that political, social and economic conditions in the

foreign country which will affect the commercial operations of the foreign bank Country risk events could include political unrest, increases in corruption (Hagendorff, 2010, p.68) In order to mitigate country risk, banks need to capture

3 The Eurocurrency markets offer wholesale foreign exchange transactions (loans, deposits) involving residents and non-resident

changes of the market in each period to give appropriate strategy at the right time For example, Standard Bank Group employed internal rating models to assess and manage its country risk exposures (refer to appendix 2) (Standard Bank, 2013, p.56) Besides, banks should start operation with low risk products and services first until they operate stably in host countries Especially they can purchase political and commercial risk insurance to be more safety

 Operational risk is defined at the risk of loss resulting from inadequate or failed

internal processes, people and systems or from external events (Hagendorff, 2010, p.67) To anticipate, mitigate and control operational risk, bank should have a system

of policies and establish a consistent framework for monitoring, assessing and communicating risks Citi bank has established a “Manager’s Control Assessment” program to help managers self-assess key operational risks and controls and identify and address weaknesses in the design or effectiveness of internal controls (Citigroup,

2013, p.119)

 Market risk is the risk of losses overtime due to a number of risk factors such as

changes in interest rates, currencies, and equities It can be understood as a form of trading risk Even banks which are completely focused on lending activities may be exposed to market risk If a particular bank has lent heavily to hedge funds (its business engage in investing a wide range of market instruments such as stocks or derivative securities), the bank becomes indirectly exposed to market risk because those loans may not be repaid if the prices of the stocks or derivative securities held

by hedge funds decline substantially (Hagendorff, 2010, p.66) Commonly, banks measure their exposure to market risk by applying the value-at risk (VaR) method If

a bank determines that its exposure to market risk is excessive, it can reduce its involvement in the activities that cause the high exposure For example, it could reduce the amount of transactions in which it serves as guarantor for its clients or reduce its investment in foreign debt securities that are subject to adverse events in a specific region Alternatively, it could attempt to take some trading positions to offset some of its exposure to market risk by selling some of its securities that are

heavily exposed to market risk (Madura, 2008, pp.537-538)

III Conclusion

Through the analysis above, it is obvious that international bank can generate a lot of profit and each bank has its own way to penetrate and maximize shareholder value in

international environment However, all banks face many risks that require bank give out methods and solutions to manage the business operations for the purposes of existing in fierce competitive market

IV References

Acevedo, L (2015) Why Do Companies Go International? Available at:

http://www.ehow.com/facts_5256365_do-companies-go-international.html (Accessed: 26 April 2015)

Barclays (2010) Financial Statements Available at:

http://reports.barclays.com/ar10/files/pdfs/barcar10_financialstatements.pdf (Accessed:

25 April 2015)

Blandón, J.G (1998) 'The Choice of the Form of Representation in Multinational

Banking: Evidence from Spain', Economics Working Paper 271 , pp.1-17

Citigroup (2015) Citi’s Smart Banking named Service Channel Innovation by IDC

Financial Insights Available at:

http://www.citi.com.cn/html/en/news/11/2011031401.html (Accessed: 27 April 2015)

Citigroup (2013) Annual Report 2013 Available at:

http://www.citigroup.com/citi/investor/quarterly/2014/ar13c_en.pdf (Accessed: 29 April 2015)

Claessens, S and Horen, N V (2008) 'Location Decisions of foreign banks and

institutional competitive advantage', DNB Working Paper No.172, pp.1-32

EY (2014) Banking in emerging markets: Investing for success Available at:

http://www.ey.com/Publication/vwLUAssets/EY_-

_Banking_in_emerging_markets:_Investing_for_success/$FILE/EY-Banking-in-emerging-markets-Investing-for-success.pdf (Accessed: 27 April 2015)

Fight, A (2004) Understanding International Bank Risk England: John Wiley & Sons

Ltd

G20 (2008) Competition in the Financial Sector Available at:

http://g20russia.ru/load/780983084 (Accessed: 26 April 2015)

Hagendorff, J (2010) International Banking UGB 322 United Kingdom: University of

Sunderland

Hall, R (2015) Assignment Revision, [Lecture to International Banking UGB322]

University of Sunderland

Houpt, J.V (1999) International Activities of U.S Banks and in U.S Banking Markets

Federal Reserve Bulletin, pp.599-614

HSBC (2009) HSBC Bank (China) Company Limited Available at:

https://www.hsbc.com.cn/1/PA_ES_Content_Mgmt/content/china/about/docs/factsheeten Jan09.pdf (Accessed: 27 April 2015)