Introduction
The evolution of the International Banking took place because of the fact the businesses were growing far and wide and as the hypothetical companies which were situated in a country where the domestic capital market was limited or perhaps even non – existing. Hence to be able to cope up with the competition in the world market companies were required to make large investments and if they were not able to borrow enough capital funds to finance these investments then they would have to suffer restricted growth, losses and even contraction. So just to overcome these problems companies decided to borrow money from the international capital markets. The advantages of international borrowing may be used by companies based within domestic economies and by multinational firms with many foreign subsidiaries.
Evolution of International Banking
International Banking developed with the world trade expansion since the Second World War. In those days traders relied on trust that the goods would be delivered and the payment would be received. The big and well known merchants were considered the most trustworthy and so had an advantage in international trade over smaller competitors. The small traders would draw a bill of exchange of the similar value of goods being exported in order to cover the risk of not getting paid. These bills were then sold to the local banks to a slightly lesser value and this is how they use to receive a large sum in advance of the delivery of the goods.
Banks then use to charge higher discounts (discounts on price represents an interest charge by the bank) to small merchants so these small merchants started turning towards big and well known merchants to accept their bills or act as a guarantor to the banks and if the small merchants did not repay the amount to the bank then the big and well known merchants became liable for the complete outstanding sum. As this practice increased some of these large merchants found this acceptance of bills to be more profitable than original trading activities and thus started to act as merchant banks. Over the years they became so specialized in the finance of international trade that they formed their own corporate finance banks and other investment corporations. This is how International Banking evolved.
Exports
In economics, an export is any good or commodity, transported from one country to another country in a legitimate fashion, typically for use in trade. Export is an important part of international trade. British business has always looked overseas for opportunity, and foreign trade is vital to the UK economy. The UK is the world’s sixth largest exporter of goods and services; business which is worth around £200 billion every year, equating to 17% of the country’s total GDP. In terms of investment, the UK is second only to the USA as the world’s largest investor in overseas markets.
Functions of International Banking in exports
The commercial side of the international monetary system is represented by international banking industry. This industry provides the liquid capital required by the countries and firms performing multinational trade. It also helps by financing the imbalances between countries when they participate in international trade.
Below mentioned are few points mentioning the functions performed by international banking,
- Traditional way of financing imports and exports
- Dealing in ever increasing amounts of foreign exchange
- Borrowing and lending Eurocurrencies
- Underwriting issues of Eurobonds, Euro notes and foreign bonds
- Setting up or joining syndicated loan schemes
- Providing capital for projects
- International fund management and rapid transfer of funds
- Accepting and completing for local currency deposits and advancing local currency loans
- Providing for a fee, advice and information to other customers like multinational companies. [Demirag and Goddard (1994): 31]
These are few key points that the banks get engaged in to support exports and help in smooth functioning of exports.
Procedure for export finance:
There are different types of institutions which finance the international trade namely commercial banks, factors, commercial finance companies and government institution etc.
- Commercial banks: Commercial banks dominate the financing of the world trade. Banks have different alternatives available that allow them to complete for any type of financing deals. These alternatives include short term unsecured loans with a borrowing period of upto one year, letter of credit which are guarantees that an importer will make payment to an exporter, financing of foreign receivables whereas exporters receive financing by pledging the money to be received from importers as collateral and longer term loans wherein repayment is to be made in installments over time.
- Factors: Factors are firms that buy accounts receivables from a trading firm and then take responsibility for collecting the funds. A factor is not a bank but can be a subsidiary of a bank. It is a mixture of lender and collection agency. Only to overcome the lack of credit information on foreign firms, domestic factors have foreign affiliation or an agreement with foreign factors. Exporters benefit by selling their accounts receivables to the factor by transferring credit and collection problems to the factor. This reduces administrative cost, related to carry out accounts receivables and eliminate foreign exchange risk if the receivables are in foreign denomination. The exporter receives payment immediately rather than waiting for importer to make the payment and also enjoys the benefit of concentrating on sales and product development and allows the factor to deal with his credit issues.
- Commercial finance companies: Commercial finance companies specialize in back to back letter of credit for companies lacking in financial strength required to deal with commercial banks. They also provide exporter with funds to go ahead with production and acquisition of goods to be traded but demand that goods are stored in an independent warehouse prior to export so that the exporter does not have access to the goods in warehouse. They also require the export contract and account receivable to be pledged as collateral for the loan issued. They do not collect receivables without recourse as a factor does, if the importer default in making the payment to the exporter then the exporter has to make the payment from their end. Finance companies deal with riskier loans so they charge a higher rate of interest than a bank.
- Government Institutions: International trade financing involves government agencies and private lenders. The role of government is mainly to motivate exports. There is a special type of bank which is formed by every country called as Exim Bank (full name: The Export – Import Bank). The role of Exim Bank is to provide financial assistance to exporters and importers, and to function as the principal financial institution to coordinate the working of institutions engaged in financing export and import of goods and services with a view to promote the country’s international trade. The Exim Bank is not in competition with the other types of lending institutions. They believe in supplementing private credit and allowing companies to compete with foreign companies receiving subsidies from their governments. This small diagram will explain the role of Exim Bank.
Money exchange:
This is the very important part of any trade that takes place. When the importer agrees to buy goods from the exporter then a sale contract is written. A sale contract contains the obligation of each party and will have details about the goods sold, price and method of payment, shipping date and who is responsible for shipping charges, insurance and taxes. The important issue in a sale contract is when the possession of goods takes place. This is purely based on “International Commercial Terms” or commonly known as “Incoterms” as specified by International Chamber of Commerce. Below are mentioned few common delivery terms used by International Chamber of Commerce,
- Ex works (EXW): The buyer takes possession of goods at the seller’s warehouse where the goods are not cleared for exports nor loaded in delivery vehicles. The buyer bears all the cost and risk of damage from this point onwards. This term involves the minimum obligation for the seller.
- Free on board (FOB): The title of goods is handed over to the buyer when the goods are loaded aboard ship. The seller is responsible for all the cost until the goods are on board. The buyer then pays all the further cost. This term is only used for exports taking place via waterway transport.
- Free alongside ship (FAS): The seller delivers the goods alongside the ship that will transport the goods, and then the buyer is the responsible for goods beyond this point. This term is only used for exports taking place via waterway transport.
- Cost and freight (CFR): The seller pays for the transportation to the destination point. When the goods are lifted to transport then the buyer is responsible for the goods. This term is only used for exports taking place via waterway transport.
- Cost, insurance and freight (CIF): This is similar to CFR but it also includes ocean marine insurance of the goods which the seller has to pay for using waterway transport for sending goods away. It covers the goods if damaged or if the ship sinks while in transit.
- Carriage paid to (CPT): The seller bears all the cost of carrying the goods to the required destination.
- Delivery duty paid (DDP): The seller bears all the cost and risk of delivering the goods to the buyer cleared for import at the required destination. The seller also takes cares of all the duty levied on the import of the goods into the destination country. This term involves maximum obligation for the seller.
Letter of credit
A letter of credit (LOC) is a written instrument issued by a bank at the request of an importer that obligates the bank to pay a specific amount of money to an exporter. The time at which payment is due is specified along with the documents required prior to payment.
The LOC may specify that the bill of lading be presented as evidences for no damaged goods. Some minimum level of damage around 2% is acceptable. Such conditions in an LOC allow importer to retain some quality control to payment. There are two types of LOCs namely revocable and irrevocable LOCs. Irrevocable LOC means that the agreement cannot be modified and altered without the permission of both the parties. Most of the LOCs are of this type.
A revocable LOC may be changed and altered by the importer. In this type of an LOC the exporter is free to call the issuing bank of the importer before the shipment to make sure that LOC is not altered or withdrawn so that they can present relevant documents to collect payment as soon as possible. The revocable LOC is a safer than shipping goods only on importers promise to pay without any bank’s support to the whole transaction. Revocable LOC are only used when there is no question of revocation. The fees of the bank for the revocable LOC are much lesser than the irrevocable LOC.
The importer has to apply for the LOC from the bank and has to set few instructions while making the LOC such as no payment should be made until the exporter presents relevant and correct documents to the bank. These documents submitted cannot violate the sale contract since the bank is at risk till the payment is made. If the bank allows that the importer an acceptable credit risk then the Letter of Credit (LOC) is issued to the importer and is then sent to the exporter to dissolve it in the bank.
Once the exporter fulfills all the commitment in delivering the goods then the relevant documents are submitted to the bank for examination and if they are valid then the payment is made to the exporter. If the importer does not pay the bank where is had applied for the LOC, still the bank is obligated to make the payment to the exporter keeping the issue open between the importer and the bank.
Bank charge a flat fees for issuing the LOC. A percentage of the amount paid is charged at the time payment is made. These charges are paid by the importer, unless both the parties to agree to pay.
Role of international banks in money exchange
Every international trade needs the use of banker’s acceptance. A banker’s acceptance (BA) is a time draft drawn and is accepted by a particular bank to be paid at maturity. A bank creates a BA by approving a line of credit for the customer. If an importer issues a bank draft payable to the exporter’s bank at a future date only then the exporter’s bank will make the payment to the exporter for a small amount which is less than the face value of the draft. Once the draft is accepted by the exporter’s bank then the BA is sold in the acceptance market to an investor.
Thus the investor gets introduced in this transaction. The investor will pay less than the face value of the draft but little more than the amount that a bank may pay to the exporter. At maturity the BA is cleared up when the bank receives the full face value of the draft from the importer and pays the full face value to the investor who is holding the BA. BAs are generally created only by major banks. These methods provide a market for safe, short term investments for other investors.
When the BAs are sold large amount of dollars are involved in the transaction, so usually wealthy individual participate and the market is dominated by institutional buyers. The total cost of the BA to the importer includes the discounts on face value already mentioned. These discounts are determined by the interest rate on other short term things like treasury bills or certificate of deposit. There is a acceptance fees which is charged to the customer who request for acceptance. Some customers are required to hold deposit at the bank before a BA is created. There is also a forgone interest charged on the deposit while creating the BA.
Risk faced by international banks:
International banks are multinational companies and face similar risk as that of other multinationals. International lending exposes the bank to commercial risk and country specific risk which can be further sub divided as political and currency risk. Commercial risk to an international bank is the risk of debts from the foreign based clients to whom the funds are given as a loan. This is totally different from the domestic commercial risk as it is very expensive to access and predict the business results in a foreign country. This may be due to various reasons such as different regulations, different culture, lack of information and different economic background and methods.
Thus they face more of a complex risk in international lending than in domestic lending. Country risk is a chance that an unexpected economic or political change in a country may affect like its government or companies repaying loans to international banks. Political risk is a chance that the government of that country may not repay so that the domestic companies are not able to repay their debts back. Currency risk is a change in exchange rates that will change the value of loan and its repayments either in favor of the bank or against it. These are few of the risk and threats faced by the international banks when they lend money to international companies.
Benefits of international lending
International lending by banks performs an essential service and here are some of the benefits enjoyed by international banks. International lending is a very profitable business and a very important source of growth for various banks. Syndication of loans helps in diversifying risks which we have just seen. The largest international lenders are the banks who have great experience and ability to access country’s risk.
The majority of loans which are granted to third world countries go in projects which generate income by which the repayment of the debts can be done. This trend is seen in the developing countries that experience growth due to this act. In other words international development funds from world institutions can be concentrated on the poorest and uncreditworthy nations.
Conclusion
References
Istemi Demirag and Scott Goddard (1994): Financial Management for International Business (McGraw-Hill)
Michael Melvin (2004): International Money and Finance 7th edition (Addison-Wesley)
International Standard Banking practice. New York: International Chamber of Commerce, 2003.
http://www.chamberonline.co.uk/aNnOaTQ.html