Defining International Banking

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Defining International Banking

International banks typically have headquarters located in an area reknowned forfinancial operations. Fundamentally, their structure can be defined by businessdivisions, premises, interests and affiliates. International banking typically aimsto provide services brokered by the company on a global scale.

Structure of Services

An international banking corporation will strive to provide its services first and foremostin order to increase its profits. Consequently, it is not always necessary for aninternational bank to structure its business around locating premises in differentcountries; affiliation with native businesses can often prove more beneficial.

Brokering Services

An international bank may find brokering services through a native business or

company to be more beneficial. This can allow the bank to avoid costs required inbuilding infrastructure in a new location and may utilize important localknowledge. Crucially, it also encourages compliance with legislation that governsinternational banking.

International Banking

When a bank undertakes activities in other countries then that bank is said to be aninternational bank. Not all banks are or want to be international banks due to the risksattached in doing international banking. The emphasis is on the theory and practiceof international banking, because of its critical importance in the modern banking

framework. In this topic we understand the difference between Indian banking andinternational. International banking helps us to know how important internationalbanking for the progress of India and also for the counter. It is one of the most importantfactors responsible for economic growth of the nation.

Banks in many nations have internationalized their operation since 1970. The quantumof operation has increased in such a manner that the concept evolved into a subject initself. The term multinational banking signifies the presence of banking facilities in morethan one country. Aiber defines International banking as a subset of commercialbanking transactions and activity having a cross border or cross currency element.Domestic operation such as the currency of denomination of the transaction, theresidence of the bank customer and location of the banking office the range of

transactions comprised by International banking can be easily distinguished. A depositor a loan transacted in local currency between a bank in its home country and a residentof that same country is termed as pure domestic banking.

History

The origin of international banking dates back to the 2nd century BC when Babyloniantemples safeguarded the idle funds and extended loans to merchants to finance the


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movements of goods. The loans extended by the Florentine banking houses were thefirst instance of international lending.

During the nineteenth century many innovations were witnessed in the internationallending, leading to trade financing and investment banking. Trade financing started asshort term lending. Of the two investments banking accounted further great bulk of the

international lending and financial companies acted as agents or underwriters for theplacement of funds.

By 1920, American banking institutions dominated international lending, and theEuropean nations were the major borrowers. There was perfect internationalbanking system existing till the time of First World War. The Bretton system had installeda secured financial framework and revolutionized the economic life by creating a globalshopping center. International banking speeded up after the first oil crisis in 1973.Progress in the telecommunications sector across the world supplemented the growthof international banking.

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Reasons for the Growth of International Banking

There are number of explanations or theories provided to support the growth ininternational banking operations. International banking theories explain the reasonsbehind the banks choice of a particular location for their banking facilities, maintaining aparticular organizational structure, and the underlying causes of international banking.Certain theories are as such:-

Follow the leader, explanations suggests that banks expand across nationalborders to continue to serve customers by establishing branches or subsidiariesabroad.

Expansion abroad has a pervasive effect on competition.

Banks use management technology and marketing knowhow developedcountries for domestic uses at very marginal cost abroad.

Banks can take ownership-specific and location-specific advantages whileoperating abroad.

Market imperfections due to domestic rules, regulations and taxations along withthe drastic reduction in the cost of communications prompt the banks to set up

operations abroad.

Inter-country differences in the cost of capital attract banks to set up theiroperations in different countries.

The multi-lateral system of payments came into existence after the creation ofthe IMF and the World Bank. Resources were new raised through financialmarkets for financing the development projects in member countries. Effectively it
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was the commercial banks which mobilized savings and channelized them tothese institutions for development use.

With the introduction of the flexible exchange rate system, exchange rates weredetermined by market demand- supply forces. Since all transactions wentthrough the banking system involved with International Banking were ideally

placed to establish the demand supply equilibrium. The role of establishingexchange rate was therefore transferred from central banks to commercialbanks.

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Characteristics and Dimensions

Though international banking concept is quite old, it has acquired certain newcharacteristics and dimensions.

The maturities have risen considerably and now the average maturities are about tenyears. Banks have started diversifying their sources of funds along with the assets.

Apart from the above, two kinds of overseas bank operations characterized internationalbank expansion in the late 1960s and 1970s.

A multinational consortium bank, was created by several established by parentbanks, and;

The shell branch, which is not really a bank but a device to get around thedomestic government regulation, was created.

Features of International Banking

International banks are organized in various formal and informal ways from simplyholding account with each other to holding common ownership.

CORRESPONDENT BANKING This represents an informal linkage betweenbanks and its customers in different countries. The linkage is setup when banksmaintain correspondent accounts with each other and facilitates internationalpayments and collections for customers.

BANK AGENCIES The agencies mostly deal in the local currency markets andin the foreign exchange markets, arrange loans and clears cheques.

FOREIGN BRANCHES These are operating banks and are subject to localbanking rules and the rules at home. These branches most of the time offerquality services and safety that are provided by a large bank to the customers insmall countries.

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Recent Trends
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In the past two decades, people around the world have come across complexdevelopments in the financial sector which have evolved gradually.

The increasing domination of securities of markets by financial institutionsmanaged by professional bankers has led to the institutionalization of markets.Globalization has affected the financial markets in the world almost entirely.

Foremost among the global trends in the worlds financial industry areconsolidation and convergence. These two encompass financially driven mergerswithin domestic market.

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International Monetary SystemTOP

The Gold and Gold Bullion Standards

The gold standard was the first modern international monetary system. The goldstandard facilitated the free circulation between nations of gold coins of standardspecification. Under this system, gold was the only standard of value.

One of the major advantages of the system was in its stabilizing influence. Gold wasreceived in payment in balance by those countries that exported more than it imported.

As a result of such an injection of gold raised prices, and thus lowered the value of thedomestic currency. Further, higher prices resulted in decreasing the demand for exports,a depletion of gold to pay for the relatively cheap imports, and eventually return to theoriginal price level.

This system was not free from defects. It lacked liquidity since the world's supply ofmoney would be limited by the world's supply of gold. Moreover, any unusual increase inthe supply of gold, like the discovery of a rich deposit of gold, would cause prices to risesuddenly. Then eventually, in 1914, the international gold standard broke down.

Later during the 1920s the gold bullion standard took the place of gold standard. Underthe gold bullion nations no longer issued gold coins but backed their currencies with goldbullion and agreed to buy and sell the bullion at a fixed price. But this system toocouldnt see the day-light and was abandoned in the 1930s.

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The Gold-Exchange System

This system came into existence after World War II. Under such a system, nations pegthe value of their currencies some foreign currency instead of gold, which is in turn fixedto and redeemable in gold. Many nations fixed their currencies against U.S. dollar andpreserved dollar reserves in the United States, which was known as the key currencycountry. At the Bretton Woods international conference in 1944, a system of fixedexchange rates was adopted, and the International Monetary Fund (IMF) was created forthe task of maintaining stable exchange rates on a global level.
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TOPThe Two-Tier System

The 1960s saw the fall of the gold-exchange system because the U.S. commitmentsabroad drew gold reserves from the nation, confidence in the dollar diluted, causingsome dollar-holding countries and speculators to exchange their dollars for gold. As a

result gold reserves in U.S. started depleting and in order to correct the situation, thetwo-tier system was created in 1968.

In this system there were two tiers: -

The official tier, consisting of central bank gold traders, the value of gold was setat $35 an ounce, and gold payments to non-central bankers were prohibited.

In the free-market tier, gold was completely demonetized, with its price set bysupply and demand.

Gold and the U.S. dollar remained the major reserve assets for the world's centralbanks, although Special Drawing Rights were created as a new reserve currency. Inspite of such measures, the drain on U.S. gold reserves continued and eventually in1971 the United States was forced to abandon gold convertibility.

TOPFloating Exchange Rates and Recent Developments

After the fall of the gold convertibility the IMF was compelled to agree on a system offloating exchange rates. By this method the gold standard became obsolete and thevalues of various currencies were to be determined by the market forces. In the late 20thcentury, the Japanese Yen and the German Deutschmark strengthened and became

increasingly important in international financial markets, whereas the U.S. dollarweakened with respect to them and diminished in importance. Moreover, the Euro wasintroduced in financial markets in 1999 as replacement for the currencies of 11 countriesbelonging to the European Union (EU). The euro replaced the European Currency Unit,which had become the second most commonly used currency after the dollar in theprimary international bond market.

TOPEuropean Monetary System

It is an arrangement by which most nations of the European Union (EU) associated theircurrencies in order to prevent fluctuations relative to one another. It came into existence

in 1979 to stabilize foreign exchange and counter inflation among members. In the early1990s this system was stressed due to the differing economic policies and conditions ofits members.

In 1994 the European Monetary Institute was formed as intermediary in establishing theEuropean Central Bank (ECB) and a common currency. The ECB is responsible forsetting a single monetary policy and interest rate for the adopting nations, in line withtheir national central banks.
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At the beginning of 1999, the same EU members adopted a single currency called theEuro. It was regarded as a major step toward European political unity. A commoneconomic policy helped the nations to put a constraint on excessive public spending,reduce debt, and make a strong attempt at soaring inflation. However, many members ofthe Union violated the ceilings established on the budget and deficit ceilings in partbecause of national government measures to stimulate economic growth. In 2003, EU

finance ministers, faced with the fact that economic downturns had put France andGermany in violation of the ceilings, temporarily suspended the pact. The EuropeanCommission challenged that move, however, and the EU high court annulled the financeministers' decision in 2004.

Euro coins and notes began circulating in Jan., 2002, and local currencies were nolonger accepted as legal tender two months later. The European Currency Unit (ECU),which was established in 1979, was the forerunner of the euro. Derived from a basket ofvarying amounts of the currencies of the EU nations, the ECU was a unit of accountingused to determine exchange rates among the national currencies.

Of the European Union members, Denmark, Great Britain, and Sweden did not adopt

the euro when it was introduced. Britain is the most notable, which continues to regarditself as separate from Europe. In all three nations there has been strong public anxietythat dropping their respective national currencies would give up too much independence.

TOPBretton Woods System

The Bretton Woods system of monetary management established the rules forcommercial and financial relations among the world's major industrial states in the mid20th century. The Bretton Woods system was the first example of a fully negotiatedmonetary order intended to govern monetary relations among independent nation-states.

Preparing to rebuild the international economic system as World War II was still raging,730 delegates from all 44 Allied nations gathered at the Mount Washington Hotel inBretton Woods, New Hampshire, United States, for the United Nations Monetary andFinancial Conference. The delegates deliberated upon and signed the Bretton Woods

Agreements during the first three weeks of July 1944.

Setting up a system of rules, institutions, and procedures to regulate the internationalmonetary system, the planners at Bretton Woods established the International MonetaryFund (IMF) and the International Bank for Reconstruction and Development (IBRD),which today is part of the World Bank Group. These organizations became operational in

1945 after a sufficient number of countries had ratified the agreement.

The chief features of the Bretton Woods system were an obligation for each country toadopt a monetary policy that maintained the exchange rate of its currency within a fixedvalueplus or minus one percentin terms of gold and the ability of the IMF to bridgetemporary imbalances of payments. In the face of increasing financial strain, the systemcollapsed in 1971, after the United States unilaterally terminated convertibility of thedollars to gold. This action caused considerable financial stress in the world economy


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and created the unique situation whereby the United States dollar became the "reservecurrency" for the states which had signed the agreement.

After World War I most countries wanted to return to the old financial security and stablesituation of pre-war times as soon as possible. Discussions about a return to the goldstandard began and by 1926 all leading economies had re-established the system,

according to which every nations circulating money had to be backed by reserves ofgold and foreign currencies to a certain extent. But several mistakes in implementing thegold standard (mainly that a weakened Great Britain had to take the leading part andthat a number of main currencies where over- or undervalued) led to a collapse of theeconomic and financial relations, peaking in the Great Depression in 1929. Every singlecountry tried to increase the competitiveness of its export products in order to reduce itspayment balance deficit by deflating its currency. This strategy only led to success aslong as a country was deflating faster and more strongly than all other nations. This factresulted in an international deflation competition that caused mass unemployment,bankruptcy of enterprises and the failing of credit institutions.

In the 1930s several conferences dealing with the world monetary problems caused by

the Great Depression had ended in failure. But after World War II the need for astabilizing system that avoided the mistakes, which had been made earlier, becameevident. Plans were made for an innovative monetary system and a supervisinginstitution to monitor all actions.

TOPCrisis of The System

In the 1960s and 1970s enduring imbalances of payments between the Westernindustrialized countries weakened the system of Bretton Woods. One substantialproblem was that one national currency (the U.S. dollar) had to be an internationalreserve currency at the same time. This made the national monetary and fiscal policy ofthe United States free from external economic pressures, while heavily influencing thoseexternal economies.

To ensure international liquidity the USA was forced to run deficits in their balance ofpayments, otherwise world inflation would have been caused. However, in the 1960sthey ran a very inflationary policy and limited the convertibility of the U.S. dollar becausethe reserves were insufficient to meet the demand for their currency. The other membercountries were not willing to accept the high inflation rates that the par value systemwould have caused and the dollar ended up being weak and unwanted, just as predictedby Greshams law: Bad money drives out good money. The system of Bretton Woodscollapsed.

Another fundamental problem was the delayed adjustment of the parities to changes inthe economic environment of the countries. It was always a great political risk for agovernment to adjust the parity and each change in the par value of a major currencytended to become a crisis for the whole system. This led to a lack of trust anddestabilizing speculations.

Defining International Banking

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