im16 - Chapter 16 Banking in the International Economy...

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Chapter 16 Banking in the International Economy Overview This chapter extends the discussion of banks to include international banking. In this area, as in most others, students are likely to have only the vaguest understanding of how the U.S. financial system is linked with those of other countries. The text provides a framework for understanding international banking by demonstrating that it provides the same risk-sharing, liquidity, and information services that domestic banking does. Following up the discussion in Chapter 15, the author makes the point that international financial regulation can lead to innovation in banking products and markets outside a country’s borders. More than 120 U.S. banks operate internationally by having branches abroad, by operating so-called Edge Act corporations—subsidiaries of U.S. banks set up only to conduct international banking services—by having interests in foreign financial firms, or by operating international banking facilities. International banks are involved in managing exchange rate risk. They can do this directly by matching the currency denomination of assets and liabilities or indirectly by using futures and options markets and currency swaps—which involve exchanges of expected future returns on debt instruments denominated in different currencies. International banks reduce transactions costs for their customers engaged in international business dealings by carrying out foreign-exchange trading—usually with other banks. International banks also reduce credit risk for their customers by specializing in solving this type of information problem. One way they do this is through the use of bankers’ acceptances—a service of banks that dates back to the Middle Ages. The chapter includes a discussion of the increasingly important Eurodollar and Eurocurrency markets. The Eurodollar market arose in the years after World War II as the countries of the former Soviet Union and the Eastern Bloc accumulated dollar reserves for use in international trade. For political reasons, they didn’t want to hold these dollar reserves in U.S. banks. In an attempt to circumvent Bank of England restrictions on the use of British pounds in making loans outside of Britain, British banks established a market for Eurodollars. U.S. banks were led to participate in the market to avoid domestic interest ceilings and reserve requirements. Euroloans are made at a markup over the London Interbank Offered Rate (LIBOR), the interest rate at which banks lend Eurodollars to one another. In recent years attention has been increasingly focused on international coordination of banking regulations, and the chapter provides a good summary of recent initiatives. The Basel agreement of 1987 began the attempt to coordinate minimum capital requirements. No agreement has been reached on coordinating deposit insurance programs, although considerable sentiment exists to do so. Discussions among central banks at the Bank for International Settlements in the early 1980s led to the conclusion that
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im16 - Chapter 16 Banking in the International Economy...

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