Because learning changes everything.

Chapter Eleven
International Banking and
Money Market

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 Chapter Outline 1

International Banking Services. International Money Market.

• The World’s Largest Banks. • International Money Market.
• Alternative Risk-Free Rates
Reasons for International Banking.
• Eurocredits.
Types of International Banking Offices. • Forward Rate Agreements.
• Correspondent Bank. • Euronotes.
• Representative Offices. • Eurocommercial Paper.
• Foreign Branches. • C M E S O F R Futures Contracts.
• Subsidiary and Affiliate Bank.
International Debt Crisis.
• Edge Act Banks. • History.
• Offshore Banking Centers. • Debt-for-Equity Swaps.
• The Solution: Brady Bonds.
• International Banking Facilities. The Asian Crisis.
Global Financial Crisis.
Capital Adequacy Standards.

© McGraw Hill LLC 2

 International Banking Services 1

International banks can be characterized by the types of services they provide

that distinguish them from domestic banks:
• Facilitate the imports &exports of their clients by arranging trade financing.
• Serve their clients by arranging for foreign exchange necessary to conduct
cross-border transactions and make foreign investments.
• Assist their clients in hedging FX risk through forward and options
contracts.
• Trade foreign exchange products for their own account.
Major features that distinguish international banks from domestic banks are
the types of deposits they accept and the loans and investments they make.
• Large international banks both borrow and lend in the Eurocurrency
market.
Banks are frequently structured as bank holding companies so that they
can perform both traditional commercial banking functions and engage
in investment banking activities.

© McGraw Hill LLC 3

 The World’s 30 Largest Banks 1

Exhibit 11.1 The World’s 30 Largest Banks (in billions of U.S. dollars, as of March
2022).
Rank Bank Country Total Assets Net Income Market Value
1 ICB C China 4,914.7 45.8 249.5
2 China Construction Bank China 4,301.7 39.3 210.4
3 Agricultural Bank of China China 4,159.9 31.3 140.1
4 Bank of China China 3,731.4 27.9 116.7
5 Mitsubishi UFJ Financial Japan 3,406.5 5.2 69.7
6 BNP Paribas France 3,044.8 7.6 79.1
7 HSBC Holdings United Kingdom 2,984.2 4.0 120.3
8 Bank of America Unites States 2,832.2 17.9 336.3
9 Credit Agricole France 2,399.5 2.6 41.0
10 Sumitomo Mitsui Financial Japan 2,256.8 4.9 48.9
11 Wells Fargo United States 1,959.5 7.4 181.5
12 Postal Savings Bank of China China 1,736.2 9.3 112.4
13 Bank of Communications China 1,635.8 11.1 47.9
14 TD Bank Group Canada 1,358.6 9.1 120.6
15 Royal Bank of Canada Canada 1,308.2 8.8 135.0

© McGraw Hill LLC 4

 The World’s 30 Largest Banks 2

Rank Bank Country Total Assets Net Income Market Value

16 China Merchants Bank China 1,278.5 14.1 192.8
17 Intesa Sanpaolo Italy 1,226.7 3.7 53.3
18 Shanghai Pudong China 1,215.7 8.5 47.4
Development
19 Industrial Bank China 1,207.2 9.7 66.5
20 UB S Switzerland 1,125.8 6.5 57.3
21 Bank of Nova Scotia Canada 911,2 5.1 75.3
22 Commonwealth Bank Australia 816.2 5.7 120.7
23 Bank of Montreal Canada 761.8 4.1 59.4
24 State Bank of India India 638.1 3.1 40.8
25 US Bancorp United States 553.4 6.1 86.9
26 Truist Bank United States 517.5 4.9 77.8
27 SberBank Russia 486.9 10.4 85.7
28 PNC Financial Services United States 474.4 8.4 75.8
29 Itau Unibanco Holdings Brazil 389.7 3.7 48.5
30 HDFC Bank India 233.6 4.1 105.9

Source: Compiled from The Global 2000, www.forbes.com.

© McGraw Hill LLC 5

Reasons for International Banking
1. Low marginal costs
– Managerial and marketing knowledge developed at home can be used
abroad with low marginal costs
2. Knowledge advantage
– Foreign bank subsidiary can draw on parent bank’s knowledge of
personal contacts and credit investigations for use in that foreign
market
3. Home nation information services
– Local firms in a foreign market may be able to obtain more complete
information on trade and financial markets in the multinational bank’s
home nation than is obtainable from foreign domestic banks
4. Prestige
– Very large multinational banks have high perceived prestige, which can
be attractive to new clients
5. Regulation advantage
– Multinational banks are often not subject to the same regulations as 11-6
© McGrawdomestic
Hill LLC banks.
Reasons for International Banking (Cont.)
6. Wholesale defensive strategy
• Banks follow their multinational customers abroad to avoid losing
their business at home and abroad
7. Retail defensive strategy
• Multinational banking operations help a bank prevent the erosion
of its traveler’s check, tourist, and foreign business markets from
foreign bank competition
8. Transactions costs
• Multinational banks may be able to circumvent government
currency controls
9. Growth
• Foreign markets may offer opportunities for growth not found
domestically
10.Risk reduction
• Greater stability of earnings with diversification
Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved. 11-7
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 Types of International Banking Offices

Correspondent bank.
Representative offices.
Foreign branches.
Subsidiary and affiliate banks.
Edge Act banks.
Offshore banking centers.
International banking facilities.

© McGraw Hill LLC 8

 Correspondent Bank
A correspondent bank relationship is established when
two banks maintain a correspondent bank account with one
another.
• Beneficial because a bank can service its MNC clients at a
low cost, without the need of having bank personnel
physically located in many countries.
• Disadvantage is that the bank’s clients may not receive the
same level of service.
Correspondent banking allows a bank’s MNC client to
conduct business worldwide through his local bank or its
contacts

© McGraw Hill LLC 9

Network of large international banks having "correspondent"
relationships with other banks around the world facilitates FX
transactions.

Importer: Invoice : € Exporter:

200,000

CIBC : Air Canada’s Local bank ING: CIBC’s Correspondent bank

Debit importer’s DD account for $1.30/€ Debit CIBC’s correspondent bank a/c:
the purchase of euros : $ ? €

Credit its books as an offset to Credit to Exporter’s account: €

the debit to Importer’s account.
Also to reflect the decrease in
its correspondent bank account
balance with ING.

© McGraw Hill LLC

 Representative Offices
A representative office is a small service facility staffed by
parent bank personnel that is designed to assist MNC clients
of the parent bank in dealings with the bank’s
correspondents.
• Serves as a way for the parent bank to provide its MNC
clients with a level of service greater than that provided
through a correspondent relationship.
Representative offices also assist MNC clients with
information about local business practices, economic
information, and credit evaluation of the MNC’s foreign
customers.
• JP Morgan Chase have operations in 50 countries to serve Ford

© McGraw Hill LLC 11

 Foreign Branches
A foreign branch bank operates like a local bank but is
legally a part of the parent bank
• Subject to both the banking regulations of home country and the
country in which it operates
Banks are more likely to operate as branches in countries that
have higher taxes and lower regulatory restrictions on bank entry.
Advantages:
• Can provide a much fuller range of services for its MNC customers
than can be provided through a representative office
• Faster check clearing
• Large loans since the branch bank is part of the parent company,
subject to the loan limits of the parent company.
• Foreign branch banks are NOT subject to deposit insurance and
reserve requirements, making them more competitive in terms of
cost structure.
• Books of a foreign branch are part of the parent bank’s books
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© McGraw Hill LLC
 Subsidiary and Affiliate Banks
Both subsidiary and affiliate banks operate under the banking laws
of the country in which they are incorporated
• A subsidiary bank is a locally incorporated bank that is either
wholly owned or owned in major part by a foreign parent
• An affiliate bank is one that is only partially owned but not
controlled by its foreign parent
Subsidiary operations are preferred by banks seeking to penetrate
host markets by establishing large retail operations.
But the amount of loans that the bank can make is much less than
what a foreign branch bank can make
Parent banks find subsidiary and affiliate banking structures
desirable because they can underwrite securities
Foreign-owned subsidiary banks in Canada tend to locate in major
centers of financial and commercial activity such as Vancouver,
Toronto and Montreal.
Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved. 11-13
© McGraw Hill LLC
 Edge Act Banks
Edge Act was a 1919 amendment to Section 25 of the 1914
Federal Reserve Act.
Edge Act banks are federally chartered subsidiaries of U.S.
banks that are physically located in the United States and
can engage in a full range of international banking activities.
• Edge Act banks are typically located in a state different
from that of the parent to get around the prohibition on
interstate branch banking.
• Edge Act banks are not prohibited from owning equity in
business corporations, unlike domestic commercial banks.

© McGraw Hill LLC 14

 Offshore Banking Centers
An offshore banking center is a country whose banking system is
organized to permit external accounts beyond the normal economic
activity of the country
• Offshore banks operate as branches or subsidiaries of the parent
bank
Principal features that make a country attractive for establishing an
offshore banking operation are virtually total freedom from host-
country governmental banking regulations.
The primary activities of offshore banks are to seek deposits and
grant loans in currencies other than the currency of the host
government.
The IMF recognizes the following as major offshore banking centers:
• The Bahamas, Bahrain, the Cayman Islands, Hong Kong, the
Netherlands Antilles, Panama, and Singapore.
HK and SG have developed into full-service banking center that now
rival London, NY and Tokyo.
Offshore banks are usually the largest and most reputable
international banks, contrary to popular opinion about "offshore
banking" (shady or weak banks).
© McGraw Hill LLC
Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved. 11-15
 International Banking Facilities
An international banking facility (I BF) is a separate set of
asset and liability accounts that are segregated on the parent
bank’s books, though it is not a unique physical or legal entity
• Any U.S.-chartered depository institution, a U.S. branch or
subsidiary of a foreign bank, or a U.S. office of an Edge Act
bank may operate an IBF.
Originally established largely as a result of the success of
offshore banking.
• Have been successful in capturing a large portion of
Eurodollar business previously handled offshore.

© McGraw Hill LLC 16

 Organizational Structure of International
Banking Offices from the U.S. Perspective
Type of Bank Physical Accept Make Loans Subject to FDI C Separate
Location Foreign to Foreigners Fed Reserve Insured Legal
Deposits Requirements Deposits Equity from
Parent
Domestic bank U.S. No No Yes Yes No
Correspondent Foreign N/A No No N/A
bank N/A
Representative Foreign No No Yes Yes No
office
Foreign branch Foreign Yes Yes No No No
Subsidiary Foreign Yes Yes No No Yes
bank
Affiliate bank Foreign Yes Yes No No Yes

Edge Act bank U.S. Yes Yes No No Yes

Offshore
Technically Yes Yes No No No
banking
Foreign
center
International
banking U.S. Yes Yes No No No
facility

© McGraw Hill LLC 17

 Capital Adequacy Standards
Bank capital adequacy refers to the amount of equity capital
and other securities a bank holds as reserves against risky
assets to reduce the probability of a bank failure
Three pillars of capital adequacy:
• Minimum capital requirements.
• Supervisory review process.
• Effective use of market discipline.
Basel III was announced on September 12, 2010
• Designed to substantially strengthen the regulatory capital
framework and increase the quality of bank capital.

© McGraw Hill LLC 18

 Capital Adequacy Standards
Bank capital adequacy refers to the amount
of equity capital and other securities a bank
holds as reserves against risky assets to
reduce the probability of a bank failure
Three pillars of capital adequacy:
• Minimum capital requirements
• Supervisory review process
• Effective use of market discipline
Basel III was announced on September 12,
2010
• Designed to substantially strengthen the regulatory
capital framework and increase the quality of bank
© McGraw Hill LLC
11-19
 Capital Adequacy Standards
Bank capital adequacy refers to the amount of equity
capital and other securities a bank holds as reserves against
risky assets to reduce the probability of a bank failure
The Bank for International Settlements (BIS) and three Basel
Accords are key parts of the international standards that
govern how much bank capital is “enough” to ensure the
safety and soundness of the banking system.
•Basel Accord 1 (1988): Rules-based approach
•Basel Accord 2 (2006) – Risk focused approach….3 pillars
1. Minimum capital requirements
2. Supervisory review process
3. Effective use of market discipline
•Basel Accord 3 (2010)
– Strengthens bank capital requirement and introduces new
regulatory requirements on bank liquidity and bank leverage
11-20
© McGraw Hill LLC
 Rule based approach
1. The constant 8% min capital assigned to risk-weighted assets
regardless of
• Degree of credit risks throughout the business cycle.
• Bank’s location in a developed vs. developing country.
• Types of risks (traditional vs. market focused derivative risks) in
which banks were engaged.
A new Tier III capital composed to short term subordinated debt
could be used to satisfy the
2. Supervisory review process: designed to ensure that each bank
has a sound internal process in place to properly assess the
adequacy of its capital based on a thorough evaluation of its
risks. Exp: conduct Stress Test (estimates the extent to which cap
requirements could increase in adverse economic scenario).
3. Effective use of market discipline: Complements the other two.
Public disclosure of key information will bring greater market
discipline to bear on banks and supervisors to better manage risk
and improve bank stability.
cap requirement on market risk.
© McGraw Hill LLC
Minimum bank capital adequacy ratio of 8% of risk-weighted assets for
internationally active banks. Divides bank capital in two tier
• Tier I Core Capital: S/H Equity and Retained Earnings
• Tier II Supplemental capital: Preferred Stock, subordinated bonds (no
more than 50% of bank’s cap or no more than 4% of risk-weighted
assets)

Risk weighted Assets: Four categories

• Government Obligation 0%
• Short term interbank assets 20%
• Residential mortgages 50%
• Other assets (L/T) 100%

Example: A bank with $100 M in each of the four asset categories.

Risk-weighted Assets = $ 170
Minimum cap requirement = $ 13.6 of which
Tier II capital = $ 6.8
They need to hold 8% equity against risk weighted long-term loans; but
only 4% against mortgages, 1.6% against short-term loans, and 0%
against treasury bills.
The capital adequacy ratio is the percentage of a bank’s min capital to its
risk-weighted assets.
© McGraw Hill LLC
 Basel III
Builds on the Basel I and Basel II: seeks to improve the banking sector's
ability to
• Deal with financial and economic stress,
• Improve risk management and
• Strengthen the banks' transparency.
Focuses on:
• Fostering greater resilience at the individual bank level in order to reduce
the risk of system wide shocks.
• Strengthening bank capital requirement and introduces new regulatory
requirements on bank liquidity and bank leverage.
Introduces:
• A minimum of 3% leverage ratio and
• Two required liquidity ratios (Liquidity Coverage Ratio and Net Stable
Funding Ratio)
Require:
• Banks to hold 4.5% of common equity (up from 2% in Basel II) and 6% of
Tier I capital (up from 4% in Basel II) of risk-weighted assets (RWA).
• Banks to introduce additional capital buffers;
• A mandatory capital conservation buffer of 2.5% and
• A discretionary countercyclical buffer, which allows national regulators
© McGraw Hill LLC
 International Money Market
Eurocurrency is a time deposit in an international bank
located in a country different from the country that issued the
currency
• For example, Eurodollars are deposits of U.S. dollars in banks
located outside of the U.S., while Eurosterling are deposits of
British pound sterling in banks outside of the U.K.
Eurocurrency market is an external banking system that runs
parallel to the domestic banking system of the country that
issued the currency
• The foreign bank doesn’t have to be located in Europe. Or the
deposits don’t have to be in dollars.
• Banks accepting the Eurocurrency deposits are called Eurobanks
• Euro-deposits are not subject to reserve requirements or
deposit insurance. Cost advantage!
• $1m deposit in U.S. bank: Bank would have to maintain reserves of
$100,000 (10% reserve ratio), and pay FDIC (as much as $2300/year).
• If the $1m was at a foreign branch outside the U.S., no FDIC and no 11-24

© McGraw Hill LLC

 Eurocurrency Market
Eurocurrency market operates at the interbank and/or wholesale
level, with most transactions being interbank transactions in the
amount of $1,000,000 or more
Example: Bank A in France has $1m of funds to lend for one year,
but no retail loan customers. Bank B in Germany has a borrower
who needs $1m but the bank has no funds available. Bank B
borrows $1m from Bank A for one year, in a Eurocurrency
transaction. The rate charged by bank with excess funds is referred
to as the interbank offered rate.
LIBOR (London Interbank Offered Rate) was a common
reference rate.
Beginning on January 1, 2022, a new series of reference rates,
known collectively as Alternative Risk-Free Rates (RFRs), went
into effect for the various Eurocurrencies.
• These RFRs are based on overnight wholesale transactions that
are unsecured or secured repurchase or “repo” transactions and
representative of actual market transactions.
© McGraw Hill LLC
11-25
 Eurocurrency Market 2

Exhibit 11.4 Alternative Risk-Free Rates

Currency (Symbol) RF R
U.S. Dollar (USD) Secured Overnight Financing Rate (SOFR)
Sterling (GBP) Sterling Overnight Index Average (SONIA)
Euro (EUR) Euro Short Term Rate (€STR)
Swiss Franc (CHF) Swiss Average Overnight Rate (SARON)
Japanese Yen (JPY) Tokyo Overnight Average Rate (TONAR)

© McGraw Hill LLC 26

 Eurocredits
Eurocredits are short- to medium-term loans of Eurocurrency extended by
Eurobanks
Loans are denominated in currencies other than the home currency of the
Eurobank
• Because the loans are often too large for one bank to handle, Eurobanks
will band together to form a bank lending syndicate to share the risk
Credit risk on these loans is greater than on loans to other banks in the
interbank market
• Interest rate on Eurocredits must compensate the bank for the added
credit risk

The lending rate = Reference Rate + X percent

X is the lending margin charged depending on the creditworthiness of
borrower.
Credit risk on Eurocredits > risks on loans to other banks in the interbank
market
Thus the application of X% to compensate the bank or banking syndicate.
And also rollover pricing is created on these loans so that Eurobanks do not
11-27
© McGraw Hill LLC
 Forward Rate Agreements
A major risk Eurobanks face in accepting Eurodeposits
and in extending Eurocredits is interest rate risk
resulting from a mismatch in the maturities of the
deposits and credits
• An interbank contract that allows the Eurobank to
hedge the interest rate risk in mismatched deposits
and credits is a forward rate agreement (FRA)
• FRA involves two parties:
• Buyer agrees to pay seller the increased interest cost on a
notational amount if interest rates fall below an agreed rate
• Seller agrees to pay buyer the increased interest cost if
interest rates increase above the agreed rate
FRAs can be used to:
• Hedge assets that a bank currently owns against interest rate
risk.
• Speculate on the future course ofCopyright
interest rates.
© 2021 by the McGraw-Hill Companies, Inc. All rights reserved. 11-28
© McGraw Hill LLC
 FRA Payoff Profile

Access the text alternative for slide images

.
© McGraw Hill LLC 29
 Forward Rate Agreements 2

FRAs are structured to capture the maturity mismatch in

standard-length Eurodeposits and credits
• Example: The FRA might be on a six-month interest rate
for a six-month period beginning three months from today
and ending nine months from today.
• This would be a “three against nine” FRA .

Access the text alternative for slide images.

© McGraw Hill LLC 30

 Forward Rate Agreements 3

Payment amount under an FRA is calculated as the absolute

value of:

Notional Amount ( SR  AR) days 360

1  ( SR days 360)

Days denotes the length of the FRA period.

At the end of the agreement period, the loser pays the winner
an amount equal to the present value of the difference
between the settlement rate (SR) and the agreement rate
(AR), sized according to the length of the agreement period
and the notational amount.
© McGraw Hill LLC 31
 Settling an FRA
A €5,000,000, 4%, 3 against 9 FRA entered into
August 1, 2023 has the following terms:

1 2 4 5 6 7 8 24
/23

23
/
/ /1
/1
8 /1

5
11

184 days
Payment

If on 11/1/23 the SR = 5%

If on 5/1/23 the SR = 3%
Copyright © 2018 by the McGraw-Hill Companies,
Inc. All rights reserved. 11-32
© McGraw Hill LLC
 Settling a FRA
A €5,000,000, 4%, 3 against 9 FRA entered into
August 1, has the following terms:

1 2 4 5 6 7 8 24
/23

3
/

/2
1
4/
/1
8 /1

10
On 10/1/23 if the 184 days
actual rate is 4% Payment
there is no payment. 184
€5,000,000 × (SR – 0.04) ×
360
If on 10/1/23 the SR = 5% 184
1 + SR ×
the seller pays the buyer €24,918.74. 360
If on 10/1/238 the SR = 3% the buyer pays the seller €25,169.62.
11-33

© McGraw Hill LLC

 Proof of FRA as a Hedge
FRAs are designed so the buyer will have the same
future value of interest expense (i.e., a perfect hedge at
the agreed-up rate) for any value of LIBOR at maturity of
the FRA.
Calculate the FV of interest expense
• If LIBOR at expiration
€5,025,169.62 x (1 + .03isx 3 percent:
184) = €5m x ( 1 + .04 x 184)
360 360
€5,102,222.22 = €5,102,222.22

• If LIBOR at expiration is 5 percent:

(€5m - €24,918.74)x(1 + .05 x 184) = €5m x ( 1 + .04 x 184)
360 360
€5,102,222.22 = €5,102,222.22
11-34

© McGraw Hill LLC

 Problem
A “three-against-nine” FRA has an agreement rate of
4.75 percent. You believe six-month LIBOR in three
months will be 5.125 percent. You decide to take a
speculative position in a FRA with a $1,000,000
notional value. There are 183 days in the FRA period.
Determine whether you should buy or sell the FRA and
what your expected profit will be if your forecast is
correct about the six-month LIBOR rate.
days
Notational Amount × (SR – AR) ×
360
days
1 + SR ×
360

© McGraw Hill LLC

 Euronotes
Euronotes are short-term notes underwritten by a group of
international investment or commercial banks called a
“facility”
• Client-borrower makes an agreement with a facility to issue
Euronotes in its own name for a period of time, generally 3
to 10 years.
• Sold at a discount from face value and pay back the full
face value at maturity.
• Maturity is typically three to six months.
• Attractive to borrowers because interest expense is usually
slightly less in comparison to syndicated Eurobank loans.

© McGraw Hill LLC 36

 Eurocommercial Paper
Eurocommercial paper, like domestic commercial paper, is
an unsecured short-term promissory note issued by a
corporation or a bank and placed directly with the investment
public through a dealer
• Sold at a discount from face value, like Euronotes.
• Maturities typically range from one to six months.
• Vast majority of Eurocommercial paper is denominated in
the euro and the U.S. dollar.
• Eurocommercial paper issuers tend to be of much lower
quality than their U.S. counterparts.
• As such, yields tend to be higher.

© McGraw Hill LLC 37

 CME SOFR Futures Contract
One-Month and Three-Month SOFR interest rate futures
contracts traded on the CME Group are two important
contracts.
• The CME Three-Month SOFR futures contract is written on a
hypothetical risk-free deposit of dollars with quarter year
maturity.
• Contract trades in the March, June, September, and
December cycle.
• Contract is a cash settlement contract.
• Contracts trade out 39 quarters into the future.

© McGraw Hill LLC 38

 Reading CME SOFR Futures
Quotes
SOFR (CME)—$1 million; pts of 100%

Open High Low Settle Chg Yield Open

Settle Change Interest

July 94.69 94.69 94.68 94.68 -.01 5.32 +.01 47,417

Eurodollar futures prices are stated as an index number of three-

month SOFR calculated as F = 100 – R.
The closing price for the July contract is 94.68 thus the implied yield
is 5.32 percent = 100 – 94.68
The change was .01 percent of $1 million representing $100 on an
annual basis. Since it is a 3-month contract one basis point corresponds
to a $25 price change. 39

© McGraw Hill LLC

 International Debt Crisis
International debt crisis was caused by lending to the sovereign
governments of some less-developed countries (L DCs).
• Crisis began on August 20, 19 82, when Mexico asked more
than 100 U.S. and foreign banks to forgive its $68 billion in
loans. Soon after, Brazil, Argentina, and more than 20 other
developing countries announced similar problems in making the
debt service on their bank loans.
• At the height of the crisis, Third World countries owed $1.2
trillion.
• Source of the international debt crisis was oil.
• U.S. banks claimed there was official arm-twisting from
Washington to assist the economic development of the Third
World countries.

© McGraw Hill LLC 40

 Debt-for-Equity Swaps
A debt-for-equity swap is the sale of sovereign debt for U.S.
dollars to investors desiring to make equity investment in the
indebted nation
• As part of debt rescheduling agreements among the bank
lending syndicates and the debtor nations, creditor banks would
sell their loans for U.S. dollars at discounts from face value to M
NCs desiring to make equity investment in subsidiaries or local
firms in the LDCs.
• LDC central bank would buy the bank debt from a M NC at a
smaller discount than the MNC paid, but in local currency.
• The MNC would use the local currency to make preapproved
new investment in the L DC that was economically or socially
beneficial to the LDC and its populace.

© McGraw Hill LLC 41

 Debt-for-Equity Swap Illustration

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.
© McGraw Hill LLC 42
 The Solution: Brady Bonds
U.S. Treasury Secretary Nicholas F. Brady of the first Bush
administration is largely credited with designing a strategy in the
spring of 1989 to resolve the international debt crisis
Creditor banks were offered one of three options:
1. Convert their loans to marketable bonds with a face value
equal to 65% of the original loan amount
2. Convert the loans into collateralized bonds with a reduced
interest rate of 6.5% (i.e., Brady bonds)
3. Lend additional funds to allow the debtor nations to get on
their feet
Brady bonds are loans converted into collateralized bonds with a
reduced interest rate devised to resolve the international debt
crisis in the late 19 80s.
• Called for extending the debt maturities by 25 to 30 years and
the purchase by the debtor nation of zero-coupon U.S. Treasury
bonds with a corresponding maturity to guarantee the bonds and
make them marketable.
• By August of 19 92, 12 of 16 major debtor nations had reached
refinancing agreements accounting for 92% of their outstanding11-43
© McGraw Hill LLC
 The Asian Crisis
Crisis began in mid-1997 when Thailand devalued the baht.
Consequently, other Asian countries devalued their
currencies by letting them float.
• Crisis followed a period of economic expansion in the
region financed by record private capital inflows.
• Bankers from the G-10 countries actively sought to finance
growth opportunities in Asia by providing businesses with a
full range of products and services, leading to domestic
price bubbles in East Asia, particularly in real estate.
• Close interrelationships common among commercial firms
and financial institutions in Asia resulted in poor investment
decision making.

© McGraw Hill LLC 44

 Global Financial Crisis: Credit Crunch
Credit crunch, (inability of borrowers to easily obtain credit) began in U.S. in
summer of 2007
Origin of credit crunch can be traced back to three key contributing factors:
• Liberalization of banking and securities regulation
• Global savings glut
• Low interest rate environment created by the Fedin the early part of this
Global
decade
Financial Crisis: Impact and Economic Stimulus
Dramatic changes have taken place in the financial services industry, the auto
industry, and in financial market worldwide
The Fed lowering interest rates to such a low level and keeping them there for
such a long period of time was a mistake
• Lowering the Fed Funds rate only added additional liquidity to the U.S.
economy and exacerbated American’s unsustainable buying binge
New initiatives were made in 2008 to spur U.S. and world economic activity
Global Financial Crisis: Aftermath
World economy has slowly recovered from the global economic crisis
Many lessons should be learned from this crisis, but two important ones are as follows:
• Bankers seem not to scrutinize credit risk as closely when they serve only as mortgage
originators and then pass it on to MBS investors rather than hold the paper themselves
• Decision to allow the CDS market to operate without supervision of the CFTC or some
other regulatory agency was a serious error in judgement
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