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International Banking
Source: Encyclopedia of Banking & Finance (9h Edition) by Charles J Woelfel
(We recommend this as work of authority.)

Encompasses a variety of services and operations facilitating international trade, money flows for investment and payments, and loans to governments and official institutions as well as to the private sector.

U.S. banks are relative newcomers to international banking, and their volume in these markets is relatively concentrated in a few of the larger banks.  The extent of participation in international operations by U.S. banks has expanded in volume well beyond an elementary level of servicing domestic firms and individuals with such home office "international division" services as issuance and confirmation of letters of credit, creation of acceptance credits, supply of foreign exchange "spot" and forward contracts, and facilitation of remittances and foreign travel.  For such operations carried on at home offices in the U.S., American banks could rely on foreign bank correspondents.

Authorization for national banks to establish foreign branches had appeared in the Federal Reserve Act (Sec. 25) as amended in 1916; and in 1919, U.S. member banks were authorized to organize Edge Act foreign banking corporations (Sec. 25(a), Federal Reserve Act) on approval of the Board of Governors of the Federal Reserve System, with powers to engage in both banking and financing operations abroad (originally an Edge Act subsidiary could not combine both types of operations, but later amendment permits an Edge Act subsidiary to combine both types of operaions).

Despite expansion in the preceding types of operations abroad following the end of World War II, U.S. banks' presence abroad continued to be relatively minor compared with domestic operations.  What led to subsequent major expansion is explained from two viewpoints.

One view, that of a senior officer in a major international American bank, is that starting with the U.S.-led postwar rehabilitation effort, facilitated by the monetary stability provided by establishment of the INTERNATIONAL MONETARY FUND at Bretton Woods and sustained by the activity generated by the Korean and Vietnam wars, the "global economy" was a functioning reality by the early 1960s.  "The instrument that actually forged an integrated global economy out of various conditions and components, however, was the multinational corporation with its supporting financial institutions."  By a rapid acceleration of direct investments in overseas markets, the multinational corporations and their banks created global systems of production, distribution, and finance which "literally stretched the perimeter of the marketplace around the entire world."  What now exists is a financial network that readily handles the world's international requirements for payments and settlements, securities trading, credit and credit accommodation of all kinds, placement of insurance risks, liquidity movements across borders and continents, and an active and expanding foreign exchange market.  This international system created and uses a new marketplace - the Eurocurrency market - which depends on links and flows from domestic financial markets.

Another view is that until early in 1965 when the Board of Governors of the Federal Reserve System issued its Voluntary Foreign Credit Restraint Program (VFCR) as part of the federal government's overall effort to protect the U.S. international balance of payments by limiting capital outflows, U.S. banks' operations abroad were relatively minor.  Under the VFCR, which was terminated effective January 29, 1974, U.S. banks and nonbank institutions were requested to limit both their lending to foreigners and their investments in foreign countries other than Canada.  In this view, promulgation of the VFCR program provided the impetus for U.S. banks to expand their presence abroad in order to continue to participate directly in the many opportunities for banking and financing volume and earnings in host countries as well as crossborder operations from locations abroad, including those in "shell" branches in offshore locations providing "tax havens."

In 1979 the Board of Governors of the Federal Reserve System issued a new Regulation K entitled "International Banking Operations."  The revised regulation governs the establishment of foreign branches of member banks, the organization and operation of Edge Act and agreement corporations, and foreign investments by member banks, bank holding companies, and Edge Act and agreement corporations.

The revision of Regulation K resulted in part from Section 3 of the INTERNATIONAL BANKING ACT OF 1978, which was intended to improve the competitiveness and efficiency of Edge Act corporations in providing international banking and financial services.  The Congress declared in Section 3 of the referenced act that Edge Act corporations are to have powers sufficiently broad to enable them to compete with foreign banks in the United States and abroad; to provide all segments of the economy, especially exporters, financing for international trade; and to foster participation by regional and smaller banks in international banking and finance.  Important new provisions of the revised Regulation K permit domestic branching of Edge Act corporations, permit those corporations to finance the production of goods and services for export, liberalize the approval procedures under which foreign investments may be made and foreign branches established, specify permissible foreign activities, and permit foreign ownership of Edge Act corporations.

International Activities of U.S. Banking Organizations

The board of governors has three principal statutory responsibilities in connection with the supervision of the international operations of U.S. banking organizations:  (1) to issue licenses for foreign branches of member banks and regulate the scope of their activities; (2) to charter and regulate Edge Act corporations; and (3) to authorize and regulate overseas investments by member banks, Edge Act corporations, and bank holding companies.

Under provisions of the Federal Reserve Act and Regulation K, member banks may establish branches in foreign countries, subject in most cases to the board's prior approval.  In reviewing proposed foreign branches, the board considers the requirements of the governing statute, the condition of the bank, and the bank's experience in international business.  In 1981, the board approved the opening of 21 foreign branches.  By the end of 1981, 156 member banks were operating 800 branches in foreign countries and overseas areas of the United States, a net increase of 11 for the year.  A total of 121 national banks were operating 674 of these branches, while 35 state member banks were operating the remaining 126 branches.

International Banking Facilities (IBFs)

Effective December 3, 1981, the Board of Governors of the Federal Reserve System amended its Regulations D and Q to permit the establishment of international banking facilities (IBFs) in the United States.  IBFs may be established, subject to conditions specified by the board, by U.S. depository institutions, and by Edge Act and agreement corporations.  These facilities may also be set up by U.S. branches and agencies of foreign banks.

An IBF is essentially a set of asset and liability accounts that is segregated from other accounts of the establishing office.  In general, deposits from and credit extended to foreign resident or other IBFs can be booked at these facilities free from domestic reserve requirements and limitations on interest rates.

IBFs will be examined along with other parts of the establishing office, and their activities will be reflected in the supervisory reports submitted to the bank regulatory agencies by that office.  By year-end 1981, 270 offices had established IBFs.

Edge Act and Agreement Corporations

Under Section 25 and 25(a) of the Federal Reserve Act, Edge Act and agreement corporations may engage in international banking and foreign financial transactions.  These corporations, which are usually subsidiaries of member banks, provide their owner organizations with additional powers in two areas:  (1) they may conduct a deposit and loan business in states other than that of the parent, provided that the business is strictly related to international transactions; and (2) they have somewhat broader foreign investment powers than member banks, being able to invest in foreign financial organizations, such as finance companies and leasing companies, as well as in foreign banks.  In 1981, the board approved the establishment of 19 Edge Act corporations and 1 agreement corporation and the operation of 47 branches by established Edge Act corporations.

Capitalization and Activities of Edge Act Corporations

The International Banking Act (IBA) removed the statutory limit on liabilities of an Edge Act corporation under which the corporation's debentures, bonds, and promissory notes could not exceed ten times the corporation's capital and surplus.  The board established a new capital requirement of 7% of risk assets for Edge Act corporations engaging in international banking in the United States, to permit these corporations to compete more effectively with other international organizations that are more highly leveraged.  Effective July 29, 1981, the board amended its regulation dealing with Edge Act corporations to provide that, with board approval, subordinated capital notes or debentures, in an amount not to exceed 50% of nondebt capital, may be included for determining capital adequacy in the same manner as for a member banks.

Two other important changes arising from the IBA permitted Edge Act corporations (1) to be owned by foreign banks; and (2) to establish branches within the United States.

Summary

Rapid expansion in international lending to LDCs by the small indicated group of major U.S. banks, both to governments and to the private sector, was fostered by higher interest rates and the expectation that simultaneous default by a number of such countries could not conceivably occur except in worldwide depression.  Such international lending includes purely domestic lending in host countries where U.S. banks have branch offices and subsidiaries.  The danger to developing countries, in the view of the World Bank staff, is not that banks will stop lending to LDCs but rather than lending growth will slow because individual banks or banking group have to restrain their lending.

Assets of foreign offices of U.S. banks grew from less than $5 billion in 1960 to more than $500 billion at the end of 1987.  However, it is estimated that international lending and the expansion of foreign offices by U.S. banks have slowed, partly because of excessive foreign debt of many nations.  The assets of U.S. banking offices of foreign banks and foreign nonbank investors have also increased rapidly, but the growth shows little sign of slowing.  From less than $30 billion in 1970, these assets have increased to $229 billion within a decade and to more than $6,500 billion by the end of 1987.  The share of all domestic banking assets controlled by foreigners grew from 3.6% in 1972 to almost 20% in 197.

Foreign banks have not penetrated the domestic consumer market to any considerable extent.  Branching is the preferred form of market entry for both U.S. and foreign banks.  Legal and regulatory restrictions, tax laws, and market practicalities must be dealt with to make international banking successful.

The trend in international banking laws, regulations, supervisory policies of the United States and its banking agencies, market practices and structures have generally been to grant U.S. banks slightly broader powers to compete abroad with institutions that can offer a wider range of financial services.  The most significant U.S. legislation directed toward foreign banks has limited their authority to operate in the United States by reducing earlier advantages they held over domestic banks.

BIBLIOGRAPHY

BANK ADMINISTRATION INSTITUTE.  International Bank Operations.  Bank Administration Institute, Rolling Meadows, IL, 1983.

KHOURY, S.J., and GHOSH, A.  Recent Developments in International Banking and Finance.  Lexington Books, Lexington, MA, 1988.

MARINE MIDLAND BANK.  International Banking Services.  Seafirst Bank, Settle, WA, 1988.

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