International Financial Management - Term Paper Example

International Financial Management Table of Contents Executive Summary Proper introduction Body of the Project Conclusions Recommendations Executive Summary International banks offer similar services to domestic banks but have additional features that distinguish them from local banks. Additionally to the services available from local banks, international banks arrange trade financing and foreign exchange, provide hedging services for payables and receivables in foreign currency via option and forward contracts and where allowed, provide investment banking services. This paper acknowledges that international banks are set apart by the types of services they offer and identifies several types that will be discussed. Although international banks offer their services to both individuals and organizations, they tend to prefer conducting business with organizations and relatively wealthy individuals. On its part the money market was primarily introduced for the sake of trading in currency rate futures contracts as well as options. Essentially, currency futures were intended to realize a liberally traded exchange market that would promote trade across national borders. Therefore, the money market serves a number of functions that include lubricating central bank policies, financing trade, enhancing the self-sufficiency of commercial banks and facilitating profitable investments. From their roles and functions, it can be seen that international banking and money market are inextricably linked. With the opportunities and challenges presented by globalization and the global market, there are also benefits and hazards associated with international banking and money market. The purpose of this paper is to discuss the concept of international banking and money market focusing on the reasons for international banking, how international banking and money market functions and also highlight the hazards associated with the concepts. International Financial Management Introduction International banks provide certain services that make a distinction between them and domestic banks. Most significantly, they facilitate export and import services for their clients through their role of arranging trade financing. Further, they not only play the crucial role of arranging the necessary foreign exchange multinationals use to carry out international transactions but also assist in making foreign investments by hedging exchange rate risk. This is typically in foreign currency payables and receivables options and forward contracts. However, the international banks are mainly distinguished from domestic banks by the types of loans they give, investments they make and deposits they accept. From the perspective of international money market, Eurocurrency is described as a time deposit made in an international bank situated in a nation other than the one that issued the currency (Twomey, 2009). For example, Eurodollars are time deposits in dollar denominations made in banks not situated within the US while Euroyen are time deposits made in banks not situated within Japan. However, it is also worth noting that the foreign bank does not necessarily have to be situated in Europe. Through the international money market, there is no reserve requirement or insurance deposit and organizations have the opportunity to grow rapidly particularly in the Eurodollar market. From the way it is structured, the money market is a crucial component in financing both international and domestic trade through which discounted bills of exchange avail commercial finance to traders. This paper will discuss international banking and money market with an emphasis on the reasons and significance of international banking, how international banking and money market functions and the hazards associated with the concepts especially in a globalized business environment. International Banking and Money Market International banks are financial entities through which financial services that include lending opportunities and payment accounts are offered to foreign clients. Every individual international bank has its own policies and rules that outline the clients they do business with but the client base is generally made up of foreign business organizations and wealthy individuals. Foreign business organizations conduct business with international banks mainly to facilitate cross-border business that is usually characterized by costly complexities while individuals usually aim at tax avoidance (Emily, 2009). The most significant service offered by international banks is facilitating the exports and imports for their clients since they arrange trade financing and foreign exchange. They also provide hedging services for payables and receivables in foreign currency via option and forward contracts and where allowed, provide investment banking services. By virtue of having established trading facilities, foreign exchange products will generally be traded by international banks for their own account. The international banks accept certain types of deposits and offer investments and loans that distinguish them from domestic banks (Obringer, 2008). Established and reputable international banks lend and borrow money in the Eurocurrency market and basing on the regulations of the territory they run their business and type of organization, may take part in underwriting foreign bonds and Eurobonds. Most of the clients of international banks seek their services for the purpose of sheltering their money from the estate and income taxes imposed by their home countries. Through international banks, they can access consulting and advice services in areas such as international cash management, hedging strategies in foreign exchange and currency swap interest financing. Notably, most of the international banks are located in countries such as the Isle of Man, Cayman Islands, Panama and Belize that characteristically have low or no estate and income taxes. However, this does not mean that a foreign client will simply bank their income in such territories and not pay their taxes. Rather, their income must be reported and the clients collaborate with their banks to prevent tax avoidance from turning into tax evasion (Obringer, 2008). For instance, individuals can invest in the booming economies of various countries using international banks in a manner similar to that they can use to invest in domestic real estate ventures. Then, by keeping their wealth in international or offshore banks, they protect it from predatory, unexpected or sudden lawsuits (Twomey, 2009). This concept is supported by the fact that international banks are significantly less impacted upon by fluctuations of domestic interest rates since they borrow and lend on international markets. Among the financial services offered by international banks for the purpose of facilitating trade are letters of credit and payroll services. Letters of credit help international business organizations based in different countries ensure that they pay each other for the exchange of goods and services while payroll services are a necessity of businesses with contractors and employees in foreign countries. International banks can also be categorized by their types and they include correspondent bank, representative office, foreign branch, subsidiary and affiliate bank, Edge Act bank, and offshore banking center (Obringer, 2008). The operations and services these banks engage in are functions of the regulatory environment of the jurisdictions in which they are located as well as the banking facility that the banks have established. When banks situated in different nations establish accounts in another bank, they form a correspondent bank relationship. As such, the correspondent bank relationship will provide international clients and businesses to run their activities globally their local banks or the banks’ contacts. From this arrangement, large banks are able to earn income because smaller foreign banks will form correspondent relationships with them for a fee. Representative office is a type of international bank that is especially useful in markets that are newly emerging. Essentially, a representative office is a service facility of which the parent bank staffs with human resources intentionally structured to assist the parent bank’s international clients deal with its correspondent bank (Twomey, 2009). Essentially, traditional credit services are not provided by the representative office but it seeks opportunities in foreign markets and serves as a liaison between the international clients and the parent bank. Through the representative office, international clients are able to get information regarding credit evaluation of local customers and local business regulations and customs of the foreign territories they venture into. The representative office is more significant to the parent bank when it has a large number of multinational clients in a country where they provide them with a greater level of service than they could get from a mere correspondent relationship (Obringer, 2008). International banks need to offer an extensive scope of services such as larger loans and faster and safer clearing of checks more efficiently than was initially being done by the representative office (Twomey, 2009). That perspective gave rise to the foreign bank branch. Although it operates as a local bank, a foreign branch bank is a type of international bank that is legally recognized as part of the parent bank rather than a separate entity. Therefore, a foreign branch bank is governed by the banking rules and regulations of both the home and foreign jurisdiction in which it operates as it competes with local banks in such foreign jurisdictions at the local level. Another type of international bank is the subsidiary and affiliate bank. This type can be viewed from the separate perspectives of subsidiary banks and affiliate banks. On one hand, subsidiary banks are incorporated locally and may be partly or fully owned by a foreign subsidiary. On the other hand, affiliate banks are also incorporated locally but differ from subsidiary banks because they are not controlled by their foreign parent banks. Subsidiary and affiliate banks are subjected to the banking rules and regulations of the jurisdictions in which they operate and are incorporated and can legally underwrite securities. Offshore banking centers form another type of international bank and can be described as countries with banking systems organized in such a way that external accounts which go beyond the normal range of the local economic activities are allowed (Twomey, 2009). Usually, the host country will not subject the offshore banks, which operate as subsidiaries of their parent banks, to its governmental banking rules and regulations. Ideally, an offshore bank’s operations entail granting loans and seeking deposits in different currencies than that of the host country. The main reason multinational corporations seek do business with offshore banks lure of low or no taxes. Offshore banks also offer services to clients who are not residents of the host country and feature minimum foreign exchange controls and the legal regimes uphold the secrecy of the banks to the highest degree. Some key offshore banking centers recognized by the International Monetary Fund (IMF) include Singapore, the Bahamas, Panama, the Cayman Islands, the Netherlands Antilles and Hong Kong. Edge Act banks are subsidiaries of American banks that are chartered federally and located physically within the national borders of the US but are legally permitted to participate in the full range of banking activities available internationally. Edge Act banks were created to enable American banks to compete with foreign banks and they are allowed to engage with US citizens in investment banking activities that involve foreign securities. They also trade in foreign currencies, accept foreign deposits, finance foreign projects and extend credit. In that sense, Edge Act banks are not in direct competition with commercial banks in the US. Rather, parent banks in the US are able to own banking subsidiaries in foreign countries the Edge Act. However, with all the business opportunities international banking offers the parent banks and multinational corporations, there are several hazards associated with the practice. For example, an international bank could be located in a country prone to economic collapse or civil war or one known for its notorious corruption (Fabozzi, 2008). Such are not circumstances that guarantee the safety of an investor’s money in a foreign land. While some banks are reputable for their smart investments and efficiency, others are known for federal bailouts and poor customer relations and services. The value of foreign currency is dynamic in a manner similar to that in which the value of domestic currency fluctuates. Therefore, when investors and multinational corporations put their money in foreign banks and the value of the corresponding foreign currency falls, the investors and the businesses will lose money. Further, it is not cheap to set up an offshore account and depending on the investment goals of a business or individual as well as the chosen jurisdiction, offshore corporations may have to be started. That will mean high legal fees and account or corporate registration fees plus the costs associated with transferring money to offshore accounts. Banking offshore has historically been arguably more risky compare to onshore banking and the term offshore is increasingly becoming synonymous with immoral and illegal tax evasion and money laundering activities. Essentially, any business or individual with an offshore bank account could mistakenly be perceived wrongly by the skeptical eye although their offshore account and banking are fully legitimate. The money market increasingly became a component of financial markets as money became a commodity and featured several instruments such as bills of exchange, treasury bills, certificates of deposit, commercial paper and bankers’ acceptances (Fabozzi, 2008). Basically, the money market is made up of financial institutions and credit or money dealers wishing to lend and borrow. The Eurocurrency market is a money market that features in the external banking system that typically operates parallel to a country’s domestic banking system. International banks lend and borrow in the Eurocurrency market and may even underwrite foreign bonds and Eurobonds depending on the rules and regulations of the country they operate in as well as the type of organization. Most of the Eurocurrency transactions are in the range of $1 million and are usually interbank transactions in which banks seek to offer loans and receive deposits to other Eurobanks (Twomey, 2009). The interest rate for loans is the interbank offered rate while the interest rate for interbank deposit is the interbank bid rate. Some of the common reference rates in the money market are London Interbank Offered Rate (LIBOR), Paris Interbank Offered Rate (PIBOR) and Singapore Interbank Offered Rate (SIBOR). The money market plays several roles that include lubricating central bank policies, financing trade, enhancing the self-sufficiency of commercial banks and facilitating profitable investments. However, a significant function of the money market is financing both international and domestic trade through which traders can access commercial finance through bills of exchange. The money market also finances the growth of industries by helping them to secure short-term loans (DeMaskey, 2007). The short term loans assist the industries towards meeting working capital requirements. Further, the money market determines the ability of the capital market to provide long-term loans to industries because the interest rates of long-term loans will be influenced by the interest rates of short-term loans. It is also through the money market that commercial banks are able to profitably invest their excess reserves since their (commercial banks) key objective is earning from reserves while maintaining liquidity (Fabozzi, 2008). The liquidity will facilitate the fulfilling of depositors’ uncertain demand for cash. Within the money market, commercial banks’ excess reserves are invested in assets such as short-term bill of exchange that are generally near-money assets. Within the US domestic banking system, the spread of the deposit-loan rate has been driven by competition to almost the level of the Eurodollar market (Fabozzi, 2008). Essentially, this means deposit rates in the Eurodollar market are almost equal to those of the dollar deposit rates in the US banking system and, similarly, lending rates are also about the same. Theoretically, it is possible for the Eurodollar market to operate at costs that are lower than those within the banking system in the US because it is not subjected to compulsory and binding reserve requirements on deposits. Further, the Eurodollar market is also not subjected to compulsory deposit insurance on deposits of foreign currency (Fabozzi, 2008). Conclusion International banks have been shown to be financial entities through which financial services that include lending opportunities and payment accounts are offered to foreign clients. Operating under different types of organizational styles depending on their objectives, they are distinct from domestic banks mainly because they facilitate export and import services for their clients through their role of arranging trade financing. Further, they also play the role of arranging the necessary foreign exchange multinational corporations use to carry out international transactions and facilitate foreign investments by hedging exchange rate risk. Most clients seek the services of international banks mainly to protect their money from the estate and income taxes their home countries impose. International banks are, however, also associated with various risks that include being located in politically unstable countries prone to economic collapse or civil war. The fluctuating value of both domestic and foreign currencies also puts investors at the risk of reduced value of their money. The money market has also been shown to have increasingly become a component of financial markets as money became a commodity in the financial markets. The money market is constituted of financial institutions as well as credit or money dealers who wish to lend and borrow. Through the money market, both international and domestic trade is financed. The Eurocurrency market has been described as a money market featuring in the external banking system operating parallel to a country’s domestic banking system. Recommendations International banking has been shown to have several disadvantages amidst the business opportunities it offers. Therefore, it is strongly recommended that investors exercise caution in their choice of an international banker. It is imperative to run a background test on a bank’s history and reputation to avoid getting into business with unscrupulous banks. It is also recommended that investors avoid doing business with international banks located in countries known for corruption or those that are frequently bailed out of financial difficulties. Finally, investors should consider the terms and conditions of offshore bank accounts before arriving at an investment decision. This is in order to determine whether there will be additional or extra charges such as the fees imposed when one fails to maintain a minimum required balance. References DeMaskey, A. (2007). Multinational capital budgeting. New York: Prentice. Emily, P. (2009). Demand for international banking. Journal of Business, 39(4), 119-123. Fabozzi, F. (2008). The global money market. New York: Wiley. Obringer, L. (2008). How Swiss bank accounts work. Retrieved from http://money.howstuffworks.com/swiss-bank-account4.htm Twomey, B. (2009). The international money market. London: London Capital Group. Read More