CHAPTER 6 INTERNATIONAL BANKING AND MONEY MARKET
SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER
QUESTIONS AND PROBLEMS
1. Briefly discuss some of the services that international banks provide their customers and the market
Answer: International banks can be characterized by the types of services they provide that distinguish
them from domestic banks. Foremost, international banks facilitate the imports and exports of their clients
by arranging trade financing. They also serve their clients by arranging for foreign exchange necessary to
conduct cross-border transactions and make foreign investments and by assisting in hedging exchange
rate risk in foreign currency receivables and payables through forward and options contracts. Since
international banks have established trading facilities, they generally trade foreign exchange products for
their own account.
Two major distinguishing features between domestic banks and international banks are the types of
deposits they accept and the loans and investments they make. Large international banks both borrow and
lend in the Eurocurrency market. Moreover, depending upon the regulations of the country in which it
operates and its organizational type, an international bank may participate in the underwriting of Eurobonds
and foreign bonds. In Canada and the United States, only investment banks and the investment banking
operations of bank holding companies are allowed to participate in the underwriting of international bonds.
International banks frequently provide consulting services and advice to their clients in the areas of
exchange hedging strategies, interest rate and currency swap financing, and international cash
management services. Not all international banks provide all services. Banks that do provide a majority
of these services are known as universal banks or full service banks.
2. Briefly discuss the various types of international banking offices.
Answer: The services and operations of an international bank are a function of the regulatory
environment in which the bank operates and the type of banking facility established.
A correspondent bank relationship is established when two banks maintain a correspondent bank
account with one another. The correspondent banking system provides a means for a bank’s MNC clients
to conduct business worldwide through his local bank or its contacts.
IM-1 A representative office is a small service facility staffed by parent bank personnel that is designed to
assist MNC clients of the parent bank in its dealings with the bank’s correspondents. It is a way for the
parent bank to provide its MNC clients with a level of service greater than that provided through merely a
A foreign branch bank operates like a local bank, but legally it is a part of the parent bank. As such,
a branch bank is subject to the banking regulations of its home country and the country in which it
operates. The primary reason a parent bank would establish a foreign branch is that it can provide a much
fuller range of services for its MNC customers through a branch office than it can through a
A subsidiary bank is a locally incorporated bank that is either wholly owned or owned in major part
by a foreign subsidiary. 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.
Edge Act banks are federally chartered subsidiaries of US banks which are physically located in the
United States that are allowed to engage in a full range of international banking activities. A 1919
amendment to Section 25 of the Federal Reserve Act created Edge Act banks. The purpose of the
amendment was to allow US banks to be competitive with the services foreign banks could supply their
customers. Federal Reserve Regulation K allows Edge Act banks to accept foreign deposits, extend trade
credit, finance foreign projects abroad, trade foreign currencies, and engage in investment banking
activities with U.S. citizens involving foreign securities. As such, Edge Act banks do not compete directly
with the services provided by U.S. commercial banks. Edge Act banks are not prohibited from owning
equity in business corporations as are domestic commercial banks. Thus, it is through the Edge Act that
U.S. parent banks own foreign banking subsidiaries and have ownership positions in foreign banking
An offshore banking center is a country whose banking system is organized to permit external
accounts beyond the normal economic activity of the country. Offshore banks operate as branches or
subsidiaries of the parent bank. The primary activities of offshore banks are to seek deposits and grant
loans in currencies other than the currency of the host government.
3. How does the deposit-loan rate spread in the Eurodollar market compare with the deposit-loan rate
spread in a domestic American banking system?
Answer: The deposit-loan spread in the Eurodollar market is narrower than in virtually all domestic
banking systems. That is, in the Eurodollar market the deposit rate is greater than the deposit rate of
IM-2 dollars in, say, the Canadian banking system and the lending rate is less. The Eurodollar market can
operate at a lower cost than can a domestic banking system because the Eurodollar it is not subject to
reserve requirements on deposits or deposit insurance.
4. What is the difference between the Euronote market and the Eurocommercial paper market?
Answer: Euronotes are short-term notes underwritten by a group of international investment or
commercial banks called a “facility.” A client-borrower makes an agreement with a facility to issue
Euronotes in its own name for a period of time, generally three to 10 years. Euronotes are sold at a
discount from face value, and pay back the full face value at maturity. Euronotes typically have maturities
of from three to six months. Eurocommercial paper is an unsecured short-term promissory note issued by
a corporation or a bank and placed directly with the investment public through a dealer. Like Euronotes,
Eurocommercial paper is sold at a discount from face value. Maturities typically range from one to six
5. Briefly discuss the cause and the solution(s) to the international bank crisis involving less-developed
Answer: The international debt crisis began on August 20, 1982 when Mexico asked more than 100 U.S.
and foreign banks to forgive its $68 billion in loans. Soon Brazil, Argentina and more than 20 other
developing countries announced similar problems in making the debt service on their bank loans. At the
height of the crisis, Third World countries owed $1.2 trillion!
The international debt crisis had oil as its source. In the early 1970’s, the Organization of Petroleum
Exporting Countries (OPEC) became the dominant supplier of oil worldwide. Throughout this time
period, OPEC raised oil prices dramatically and amassed a tremendous supply of U.S. dollars, which was
the currency generally demanded as payment from the oil importing countries.
OPEC deposited billions in Eurodollar deposits; by 1976 the deposits amounted to nearly $100
billion. Eurobanks were faced with a huge problem of lending these funds in order to generate interest
income to pay the interest on the deposits. Third World countries were only too eager to assist the
equally eager Eurobankers in accepting Eurodollar loans that could be used for economic development
and for payment of oil imports. The high oil prices were accompanied by high interest rates, high
inflation, and high unemployment during the 1979-1981 period. Soon, thereafter, oil prices collapsed and
the crisis was on.
Today, most debtor nations and creditor banks would agree that the international debt crisis is
IM-3 effectively over. U.S. Treasury Secretary Nicholas F. Brady of the Bush Administration is largely
credited with designing a strategy in the spring of 1989 to resolve the problem. Three important factors
were necessary to move from the debt management stage, employed over the years 1982-1988 to keep the
crisis in check, to debt resolution. First, banks had to realize that the face value of the debt would never
be repaid on schedule. Second, it was necessary to extend the debt maturities and to use market
instruments to collateralize the debt. Third, the LDCs needed to open their markets to private investment
if economic developmen