BFF5916 · International Banking
International Banking
One idea runs through this whole chapter: a bank's legal and physical location decides which business it may write, which rules bind it, and how much loss the parent must wear. The international ladder climbs from domestic (residents only, local currency) to international (non-residents and foreign currencies, but no operational presence overseas) to multinational (an operational presence abroad via foreign direct investment). Banks expand abroad for named reasons — factor prices and trade barriers, cost of capital and regulatory arbitrage, ownership advantages, diversification and the product life cycle — through four entry modes ranked by commitment (correspondent → representative office → branch → subsidiary), where the key contrast is that a branch is cheaper but the parent is on the hook, while a subsidiary is costly but limits the parent's loss. The chapter then prices the offshore world: the Eurocurrency / offshore market exists because it escapes onshore frictions, the LIBOR→SOFR benchmark switch ('LIBOR looks forward, SOFR looks back'), and a Euro-loan's effective annual rate, which sits above the quoted rate once an up-front fee shrinks the proceeds. It closes with operational lending — syndicated loans and project finance through a limited-recourse SPV — and the cross-border risk taxonomy, where sovereign risk (can they pay?) is distinct from transfer risk (are they allowed to remit?), read off three 'higher = riskier' ratios.
What this chapter covers
- 01Domestic → international → multinational; FDI vs FPI
- 02Five reasons to expand abroad — including regulatory arbitrage
- 03The four entry modes — branch vs subsidiary (cost vs loss-limitation)
- 04Trade finance — the letter of credit
- 05Eurocurrency / offshore markets and LIBOR → SOFR
- 06Pricing a Euro-loan — the effective annual rate with an up-front fee
- 07Syndicated loans, project finance / SPV, and sovereign vs transfer risk
Worked example: the effective annual rate on a Euro-loan with an up-front fee
- +1(a) All-in rate = 5.00% + 1.50% = 6.50%; net proceeds = 400 × (1 − 0.02) = $392m — the 2% fee ($8m) never reaches the borrower, but interest is still charged on the full $400m.
- +1(b) Semi-annual service = 400 × 0.065 / 2 = $13.0m per half-year.
- +2EAR = (period service / net proceeds) × n = (13.0 / 392) × 2 = 0.06633 = 6.633%.
- +1(c) Read it: the quoted all-in rate was 6.50% but the EAR is 6.63% — the fee added ~13 bp because it shrank the proceeds without shrinking the interest base. Fees always raise the EAR; the EAR denominator is net proceeds P(1−f), not P.
Key terms
- Multinational bank (MNB)
- A bank with an operational presence overseas via foreign direct investment — branches, affiliates or M&A abroad. Every MNB is international, but not every international bank is multinational; the defining extra is operating through foreign offices, not merely transacting across the border from home.
- Branch vs subsidiary
- A foreign branch is legally part of the parent, so it is cheaper to run but the parent must support it. A subsidiary is a separate legal entity under host law with its own capital, so it is costly but the parent's loss is limited to that subsidiary's capital. Cost versus loss-limitation is the examinable contrast.
- Eurocurrency / offshore market
- A deposit held in a bank located outside the currency's home country (a Eurodollar is a USD deposit in a bank outside the USA). 'Offshore' means regulatory, not geographic — it escapes reserve requirements, rate ceilings, deposit-insurance levies and some tax, so the bank can pay more on deposits and charge less on loans.
- Effective annual rate (Euro-loan)
- The true annual cost of a Euromarket loan once an up-front fee shrinks the cash received: interest is charged on the full principal P, but the borrower only receives net proceeds P(1−f), so the EAR sits above the quoted benchmark + margin. The EAR denominator is net proceeds, not P.
- Sovereign vs transfer risk
- Sovereign (country) risk is about ability — can the borrower/country service the debt, judged on economic, political and social fundamentals. Transfer risk is about permission — the borrower can pay but capital controls or FX restrictions block remittance. A solvent firm blocked by suspended FX outflows is transfer risk, not sovereign default.
International Banking FAQ
What is the difference between a foreign branch and a foreign subsidiary?
A branch operates as a local bank but is legally part of the parent, so it is cheaper and simpler to set up — but the parent is on the hook for its losses. A subsidiary is a separate legal entity under host law with its own capital, so it costs more (independent capitalisation) but limits the parent's loss to that subsidiary's capital. The trade-off to recite is cost and complexity versus loss-limitation.
Why does an offshore (Eurocurrency) rate beat the onshore one?
Because an offshore deposit escapes the onshore frictions — no reserve requirement, no rate or lending ceilings, no deposit-insurance levy, lower tax, no exchange controls — plus it operates at wholesale scale. That lowers the bank's cost, so it can pay more on deposits and charge less on loans and still widen its margin. The whole Eurodollar market grew out of this regulatory arbitrage.
Why is a Euro-loan's effective rate higher than the quoted rate?
Because an up-front fee shrinks the cash the borrower actually receives while interest is still charged on the full principal. If the loan is $400m at 6.50% with a 2% fee, the borrower only gets $392m but pays interest on $400m, so the effective annual rate works out above 6.50% (about 6.63%). The trap is dividing the service by the full principal — the EAR denominator is the net proceeds, not P.
Sovereign risk or transfer risk — what's the difference?
Sovereign (country) risk is a question of ability: can the country or borrower actually service the debt, judged on economic, political and social fundamentals. Transfer risk is a question of permission: the borrower can pay, but capital controls or FX restrictions stop it remitting the money out. 'Solvent firm, but the central bank suspends FX outflows' is transfer risk, not a sovereign default. The three sovereign-risk ratios (debt-service, debt-to-GDP, debt-to-exports) are all 'higher = riskier'.
Exam move
Anchor on the rule that where you stand decides what you may book. Memorise the international → multinational ladder (the multinational step is an operational presence abroad via FDI) and the four entry modes by commitment, with the branch-vs-subsidiary contrast (cost vs loss-limitation) ready to recite. Be able to do two calculations cleanly: the Euro-loan EAR (divide the service by net proceeds, not the full principal — fees always raise the EAR) and a syndicated-loan cost (the commitment fee is on the undrawn balance only). Keep the benchmark switch crisp — 'LIBOR looks forward, SOFR looks back'. For cross-border lending, follow the reflex classify → structure → risk-rate, and name the risk precisely: FX, sovereign (ability), transfer (permission), reading the three ratios as 'higher = riskier'.
