IF2103 International Banking Notes, for City University London students, contain an overview of every topic covered within the module.
Summarised into a 29-page single document, the notes were prepared using both lecture notes, in-class discussions and core textbook (ISBN: 4633, 8130)
Lecture 1...
The Economics of Banking and Finance - Summary - Tilburg university - Economics
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Lecture 1 – INTRODUCTION TO INTERNATIONAL BANKING
Recent changes in banking: financial innovation (has led to introduction of sophisticated financial
instruments, including swaps & options), M&A, conglomeration, globalization, internationalization (in
order to improve efficiency, expand output, reach economies of scale and save costs).
INTERNATIONAL BANKING – refers to business undertaken by banks across national borders and/or
activities that involve the use of different currencies.
MULTINATIONAL BANKING – refers to banks having some element of ownership and control of banking
operations outside their home market. The main feature of multinational banking is that it requires
some form of FDI (foreign direct investment) by banks in overseas markets reflecting a physical
presence. But multinational banking and international banking terms are interchangeably used and refer
to banks that have global activities.
GLOBAL (UNIVERSAL BANKS) – are institutions with the widest reach that is either through subsidiaries
or branches. They provide services in several countries and have a presence in all continents. It is the
most international bank.
INTERNATIONAL BANKS – are institutions that provide cross-border services, but operate in few
countries, or are relatively small to be defined as global. A bank is international: if it has
branches/subsidiaries overseas; if it conducts business in a foreign currency irrespective of its location
(but it involves currency risk).
LOCAL BANKS – are institutions providing services only in the country where they are headquartered
THE 7 THEORIES/RATIONALE THAT DESCRIBE WHY BANKS GO OVERSEAS:
1) FACTOR PRICE DIFFERENTIALS AND TRADE BARRIERS (that blocks exports) – 2 main motives:
(1) to take advantage of international factor price differences, referred to as vertical FDI.
Companies become multinational to establish production in lower labour cost countries and
headquarters where skilled labour costs are low. (2) the other motivations for the existence of
multinationals relates to trade barriers. The firm establishes in countries to access markets and
this is referred to as horizontal FDI. Regulations governing many areas of business are also
country-specific (strict in one country and less strict in another country) and act as substantial
trade barriers, and in banking it may be difficult to undertake cross-border activity without a
physical presence within a country due to difference in tax, consumer protection, marketing
rules and so on. So horizontal FDI is more important for cross-border activity in banking
(because of the regulation in foreign country, the bank has no choice but to establish the
physical presence in a foreign country in order to fully operate in that foreign country).
Factor price – the price at which the means of production (land, labour, capital) are sold.
2) ARBITRAGE AND THE COST OF CAPITAL (COC) – companies that raise their finance in strong
currency markets can borrow relatively cheaply (lower COC) and they can invest their proceeds
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, in markets where currencies are weak and firms can be acquired relatively cheaply. Example: if
the Euro is strong compared with Dollar then the Euro-based firm can raise funds for acquisition
more cheaply than their US counterparts, and therefore can acquire stakes or make purchases in
the US financial market more cheaply. The substantial 20-30% depreciation of the US dollar
against the Euro and British sterling during 2003 meant that European investors could acquire
US banks for 20-30% cheaper than they could do previously. All other things being equal, this
means that overseas banks can be purchased cheaper due to currency depreciation.
3) OWNERSHIP ADVANTAGES – although there are some disadvantages for international banks
entering overseas markets such as: domestic banks are likely to be better informed regarding
the demand feature of the local markets as well as the legal and institutional framework under
which business in conducted (international banks therefore can only acquire this expertise at a
cost) while foreign banks have to incur costs associated with operating at a distance such as
management, regulatory, the argument goes that banks that go overseas must have some type
of compensating advantages that enable them to compete with domestic firms on equal terms,
which in general referred to as ownership advantages. These advantages may relate to
technological expertise, marketing know-how, production efficiency, managerial expertise,
innovative product capability and so on.
4) DIVERSIFICATIONS OF BUSINESS ACTIVITY (EARNINGS) – by expanding into different markets,
banks expose their operations to the risk and return. The investment decisions of banks stems
from a conscious effort by managers to diversify earnings and reduce risk. Example: If a
German bank believes the prospects for retail banking in the US are more attractive than retail
banking in its home market then it makes sense to consider expansion in the US. This will
diversify earnings and make the German bank less exposed to its home market. Diversification
of banks earnings and risk reduction can be brought about by expansion into foreign markets
and risk will be reduced the less correlated earnings in the foreign country are to those in the
home market (in finance, investors construct diversified portfolios of shares so that all their
investments are not exposed to the same adverse shocks – hence they construct portfolios by
choosing an array of investments looking for low correlations between the price movements of
the stock in order to maximize diversification benefits to yield a given expected return and risk;
and this principle is same for banks when they expand overseas). Banks can diversify earnings by
doing similar business activity in different countries and also by expanding into new areas such
insurance, mutual funds, investment banking and so on both at home and abroad.
5) EXCESS MANAGERIAL CAPACITY – a bank may have a highly specialized management team
which it may not getting the best use of this team if it only focuses on business in one particular
geographical market – hence companies extend their scale of operations overseas into new
markets and these managerial resources are more efficiently utilized.
6) LOCATION AND THE PRODUCT LIFECYCLE – the focus is on the nature of the product produced
and the changing demand and production costs in different markets. The product lifecycle has 3
main stages: innovative/new product (is when a good/service is produced to meet a new
consumer demand or when a new technology enables the creation of innovative goods; and a
new product is likely to be produced and sold in the home market before any international
consideration is considered), maturing product (is when the product becomes more
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, standardized; and both home/foreign consumers become aware of the new good and demand is
likely to grow, so investments usually take place first in high-income countries and then to less-
wealthy markets. Example: This feature is common to many retail financial services, such as
credit cards, that originated in the US in the 1960s, spread to Europe in the 1970s and 1980s and
in the 1990s became commonplace in many developing countries. And finally, the standardized
product (is when the product is uniform and competition between producers bases solely on
price, so the main issue for the producer is to find the lowest cost of production and production
is transferred to the lowest cost country so the firm can maintain competitive advantage).
7) OTHER – (1) FIRM-SPECIFIC ADVANTAGES: size of the bank – large banks typically have a wide
range of financing resources and may benefit from economies of scale/scope and have more
expert management and system that make foreign expansion easier, they also are more likely to
have the relevant financial resources to undertake large scale overseas activity; (2) LOCATION
ADVANTAGES: location benefits relate to a variety of production, distribution and selling
attributes of the product, for example, many banks like to group together in financial centres
(London, New York) to benefit from foreign exchange market. Example: The liquidity of
London’s foreign exchange market (the largest in the world) attracts foreign banks and other
service firms (such as accountants, lawyers, consulting firms and so on) because of the business
available.
THE 7 STRATEGIES FOR A BANK EXPANDING OVERSEAS: (expanding overseas involves risks so choosing
which strategy to adopt is important)
1) CUSTOMER SEEKING STRATEGIES – banks seek to undertake overseas expansion in order to
obtain new customers or follow established clients. The reason why banks are more likely to
seek new customers through foreign establishment (either through M&A activity or establishing
new operations themselves) relates to the barriers associated with the cross-border selling of
products and services without a physical presence. Typically, this view suggests that the decision
to invest overseas is associated with the higher costs associated with meeting clients’ needs
from a distance as opposed to investment in the foreign market. For example, the rush of banks
into the Chinese market with a customer base of 22% of the world’s population shows how the
world’s largest firms have been motivated by the commercial opportunities afforded by an
underdeveloped retail and commercial banking market
2) OBTAINING A FOOTHOLD STRATEGIES – banks expand overseas in an attempt to establish
presence in order to test the market. Information can be obtained by making experimental
foreign investment and over time banks can decide on whether to expand or contract their
activities. For example, various US and European investment banks have made relatively modest
acquisitions of securities firms in the Japanese market in order to see if they can develop their
private banking business.
3) FOLLOW THE LEADER STRATEGIES – when a large bank undertakes investment in a foreign
market it may encourage other banks to follow (including other large banks too)
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