BWBB 3033

INTERNATIONAL BANKING

TOPIC 5:
INTERNATIONAL LENDING AND
PORTFOLIO MANAGEMENT

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 COURSE OUTLINE
 Theory and Practices
 Types of Lending
 Evaluation and Risk Control

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 International Lending
 FOREIGN LENDING has:
 Played a key role in financing expansion of the
world economy
 Strengthened foreign banks needs of “lender of
last resort” support
 Provided credit in countries where banking
facilities and loan funds are inadequate relative
to need.

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 INTERNATIONAL LENDING ACTIVITIES

 Borrowing/lending funds between banks,

across borders based on domestic surpluses
and shortages of funds
 Borrowing/lending funds to nonbanks across
borders
 Interbank redepositing (Eurocurrency and
offshore banking activities)

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 TYPES OF LENDING
1) Development Loans
 To finance infrastructure (highway, schools,
utilities etc)
 Banks give bridging loan: repaid when
borrower obtain permanent loans from World
Bank, ADB
2) Eurocredits
 Long-term loans offered by banks in the
Eurocurrency market.
 The loans tend to be extended by a syndicate
of banks that share the risk of the loans.
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  Typically issued at floating interest rates.
 The rate charged is typically LIBOR plus a
spread that reflects the credit risk of the
borrower.
 2 main types of Eurocredits:
i) Term loan
ii) Revolving credits

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 3) Trade finance
 Is the great granddaddy of international
banking and an important revenue source for
many international banks.
 Primary instrument of trade finance is the
Letter of Credit (L/C). L/C definition:
 An instrument drawn by a bank.
 known as the credit issuing bank (and
eventually the drawee bank)
on behalf of one of its customers (or on behalf
of a customer of one of its domestic
correspondents known as principal, who
guarantees the payment to the credit issuing
bank).
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  authorizing another bank at home or abroad,
known as the credit notifying or negotiating
bank (and usually the payer bank)
 to make payments or accept drafts drawn by a
fourth party, known as the beneficiary, when
such beneficiary has complied with the
stipulations contained in the letter.
 Other types of financing to facilitate trade
finance operations include overdraft, trust
receipt, banker’s acceptances, syndicated
loans, commercial paper, note issuance
facilities, and project finance.

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 4) Overdraft
 This is a working capital facility, which allows
the importer to draw in excess of their current
account balance up to the limit that has been
approved.
 The importer can choose to utilize their
overdraft facility for the purpose of payment for
the import by authorizing the bank to debit
their account.

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 5) Trust receipt
 This is a short-term facility whereby the bank
(entrustor) releases the goods to the buyer
(trustee) who acknowledges his undertaking to
hold the documents, or the goods or any proceed
from that in trust for the bank.
 Good must be properly stored in the buyer’s
warehouse – able to dispose of the goods and
receive payment before he is called upon to pay
the bill. The bank remains as the legal owner of
the goods.

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 6) Banker’s acceptances
 This is a very popular and cheap way of financing
purchases, sales, import and export.
 It is a usance bill of exchange drawn by the
customer on the bank and accepted by the bank.
 BA may be discounted with the accepting bank
and proceed utilized to pay for sight purchases or
import bills.
 The rate, which is discounted, is normally based
on the money market rate, which is normally
much lower than the OD or TR rate.
 This is because BA can be sold down in the
secondary market by the financing bank to other
financial institution or fund managers.
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 7) Syndicated Loans
 Loans participated in by multiple banks and
other institutions where the overall credit
involved exceeds an individual lender’s legal
lending or other limits.
 One bank in the syndicate usually acts as
agent for the other institutions.
 In simple word, A few bankers joint together
to give loans of big amount to a borrower on
same terms and conditions

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 8) Commercial Paper
 Unsecured promissory notes, issued by
corporations that mature in no more than 270
days.
 Most commercial paper actually matures in 25
to 45 days.
 It is negotiable instruments and interest rates
on commercial paper are lower than bank
loan rates, which make the commercial paper
market attractive alternative to issuers.
 Because commercial paper is unsecured, only
the largest and most creditworthy
corporations issue commercial paper.

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 9) Note Issuance Facilities
 Medium-term credit agreements between
international banks and their larger corporate
and governmental customers.
 A credit facility provided by a bank or group
of banks under which the borrower/customer
may issue short-term notes, each of which
usually comes due in 90 to 180 days, over a
stipulated period.
 The underwriting banks are committed to
either purchase unsold notes or to provide
guarantees that the notes will be repaid or
grant supplemental loans.
 In most cases, the customers’ notes are in
large denomination (e.g., $1 million U.S. or
larger).
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 10) Project finance
 To finance specific large-scale, long-term and
high risk project e.g. Oil pipeline project, gas
power station etc
 Pure project financing - Debt is serviced only by
cash flows attributable to the project itself,
without recourse to the project’s sponsors
(owner)
 The borrower is the project itself. E.g Elco Gas
power station (Spain), Universal Studio (Japan)
 Repayment:
 future stream of income
 asset value of the project in case of liquidation
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 Risks involved:
Resource risk: resource might not sufficient to
service the debt i.e oil, gas or minerals expected
to be in the ground will not be present sufficient
quantities to service the debt.
Input risk: unavailability or high prices of key
input (energy or raw materials)
Completion risk: delayed project
Market risk: future demand of the product
would decline

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 Operating risk: Risk occurred even after the
project- change in costs or disrupted by other
elements (labour or transportation)
Force majeure (superior force): “acts of
gods” –Warfare or weather
Political risk: adverse political conditions
Regulatory risk: changed in government rules
and regulation on certain industry – Tax hikes,
prohibition of certain activities, opening market
(additional competition)

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 SYNDICATED LOANS
 A few bankers joint together to give loans of big
amount to a borrower on same terms and conditions
 Members of syndicate:
1. Lead Banks
2. Co-Manager
3. Participating Banks
4. Agent Banks

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 SYNDICATED LOANS
1) LEAD BANKS (4S’s):
 Sourcing the loan - Inviting a number of banks to
participate in the loan
 Structuring the loan - Balance between borrowers
and participating banks’ needs
 Selling the loan - Consider loan size, market response
and borrower’s preference
 Servicing the loan - Handle loan payments, fixing
interest rate (if floating rate loan), collect interest and
other payments, distribute management fees, update
changes on borrower’s situations

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  CO-MANAGER - Large sum participation
 PARTICIPATING BANKS
 AGENT BANKS
 Intermediary between syndicate and borrower
 Acts on behalf of all banks who provided funds
 Supervising and handling the payment of
interest and the amortization of the loan
 Administers the collateral and acts on behalf of
the other banks when legal remedies become
necessary to collect on time what is due
 Receive compensation from the borrower at
the end of the syndication period or annually
in large syndicated credits

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  http://www.maybank2u.com.my/mbb_info/m2u/public/p
ersonalDetail04.do?channelId=Personal&cntTypeId=0&cntK
ey=AU00.08.01&programId=AU02.02-
ArchiveNews&newsCatId=/mbb/AU-AboutUs/AU02-
Newsroom/2000/08&chCatId=/mbb/Personal
 http://asia.nikkei.com/Business/Deals/M-A-activity-has-
Southeast-Asia-lending-record-amounts
 https://www.ocbc.com.my/business-banking/large-
corporates/investment-banking-capital-markets.html

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 Why Syndication?
 Permits banks of different sizes to participate in
international lending
 Borrower can obtain big loan from one source
 One bank cannot afford to give (too risky)
 Cheaper loan to borrower (can finance trade
deficits or development projects)
 Lender can spread the risks and still can obtain
good return on loans

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Advantages to borrowers:
 Provides larger amount of funds than may be
available from any single lender
 Credit terms might be better than for a large
number of smaller loans
Advantages to lenders:
 Means for diversifying some of the risks in
foreign lending
 Provides the lead bank with off-balance sheet
income for that portion of loan that is sold to
other participants
 Lead and participating banks receive fee income
 Helps enhance relations with foreign government
(help financing their domestic economic activity)
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 2 Types of Syndicated Loans
Direct loan syndicate Participation syndicate
 multilateral loan  deals with 3 levels of
agreement banks: lead banks,
 agreement between the managing banks and
borrower and each participating banks
lender
 a lead bank executes a loan
 in which participating
banks, having signed a agreement with the
common loan document, borrower and then forms
advance funds to the the syndicate by entering
borrower (obligation of into a participation
the each participant agreement with other
banks rather than joint) banks
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 Common features of loan syndication process:

 Lead manager assemble the syndicate by inviting a

number of banks to participate in the loan
 One or more banks are designate as reference banks
 Loan pricing:
 Need to establish the LIBOR/SIBOR used as reference rate
 Lending rate = LIBOR + spread
 LIBOR = London interbank offered rate; the rate at which
banks lends funds to other banks in the Euromarket
 SIBOR = Singapore intermarket offered rate; widely used in
Asian trade
 The loan spread is added to LIBOR to determine floating rate
paid by borrowers
 The interest rate is adjusted every three to six months based
on changes in market rates
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 Cont’d….
 The manager appoint an agent bank to take care of
treasury aspects of the loan - Receipt of loan
interest, amortization, and distribution to
participating banks
 Fee structure:
 Management fee:
 for lead bank or managing bank
 1/3 to lead manager
 2/3 divided between lead manager and other managing banks
 normally paid at the time the loan is made
 Commitment fee:
 charged on unused amount
 between 0.25% to 0.5

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 Cont’d….
 Participation fee:
 paid at agreement date or at the drawdown date to banks
participating the loan
 usually within 30 days of signing
 Agent’s fee:
 Paid to agent bank as compensation from the services
rendered
 0.1% of the loan amount
 Syndicated eurocurrency credit may take several forms:
 Revolving: ST facilities renewable for specified number of
years
 Final repayment = single payment
 Changing market conditions can influence the maturity of
eurocurrency loans and the loans spread
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  A loan can be syndicated by a broadcast
basis – lead manager informs a great many
banks by telex about the conditions of the loan
and invites offers of participation (works best
when the credit is well known, loan is
uncomplicated,the market very liquid).
 Alternatively , participation is negotiated –
lengthy process especially when the deal is
complicated called Straight syndication –
number of banks tends to be smaller.

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 Evaluation and Risk Control
 International banks must deal with several types of
risks in the management of international loan
portfolios.
 Types of risk:
 Credit risk
 Systematic risk
 Country risk
 Currency risk
Not generally encountered
in domestic lending

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 Credit Risk
 Inability of borrower to service loan due to
financial situation or status (inability or
unwillingness of borrower to make debt service
payment i.e. to generate cash or liquidate other
assets to service the loan).
 Foreign lending is not necessarily regarded as
exposing commercial banks to higher degree of
credit risk.
 Concentrated in corporate borrowers.
 Banks selectively lend to the larger corporate
borrowers, where credit risk can be judged to be
lower than in case of domestic lending.

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 Currency Risk
 Kept at a relatively low level insofar as
international loan portfolios are concerned.
 Severity of currency risk is high, bank practice is
to avoid heavy exposure.
 U.S bank head offices lend primarily in dollars,
which results in shifting the foreign currency risk
to the overseas borrowers.

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 Country Risk
 Possibility that country will be unable to
service external loan due to political and
economic condition.
 Several elements to country risk:
 Political side – government action may prevent
borrowers from paying foreign currency abroad.
 Economic side – the country of the debtor may
experience deterioration in balance of payment
conditions, creating a scarcity of foreign currency to
make debt service payments.
 Wide variations between nations in the
severity of country risk.
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  Often country risk is confused with sovereign
risk – a special type of hazard that bank lenders
may face when providing credit to governments.
 It occurs because under international law,
foreign governments are sovereign and cannot
be sued without consent.
 Courts of one country cannot sit in judgment on
the acts of another country.
 Generally the property of a government and its
agencies is immune from legal process resulting
from court decision.

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 Systematic Risk
 Possible changes in market conditions across an
entire financial market sector (related to
changes in market conditions or credit quality).
 E.g : Syndicated Euro loan market was severely
impacted by a series of oil and interest rate
shocks during the 1970s and 1980s.
 Banks have followed two approaches:
 Substitutes credit services for direct lending
 Sought to keep exposure under control.

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 BANK CREDIT CONTROL AND SUPERVISION
 As international banks experienced an increase in
absolute and relative importance of international
loan portfolio, they sought to improve their
organizational structures and credit evaluation
procedures:
 Introduced new organizational structures to provide
more effective review and control over foreign
lending
 Example: regional loan review committees,
centralized files and records of multinational
borrowers, special economic analysis and review
units, special account review officers to estimate the
overall value of the account relationship
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  Reallocated work functions and responsibilities
between units
 Established new territorial officers and country
desks also delegated overseas branches to increase
latitude and loan limits
 Enlarged head office staffs and support facilities

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 CREDIT ANALYSIS AND CONTROL
 Application of the 4cs of international credit
making. Analysis of:
1) Customer
2) Credit
3) Country
4) Currency risk factor

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 CREDIT ANALYSIS AND CONTROL
 Establishment of loan limits for each lending
officer assigned to the head office or foreign
branch based on: prior lending experience, rank
and level of responsibility, type of clientele &
size of international loan portfolio relative to
size of bank
 Setting procedures for centralized record
keeping and credit review
 Periodic evaluation and reassessment of the
bank’s overall system of loan review process

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 RISK SHARING AND REDUCTION
 Loan selection and structuring - Analysis of
credits to screen out inferior loans, application of
loan limits, emphasis on booking higher quality
credits and adherence to the country, customer &
currency limits
 Participation in loans - to diversify risks
(syndication)
 Use of guarantees and insurance - loan
guarantees from parent and affiliate companies,
central government, central banks, commercial
banks
 Floating rate loans - to protect from fluctuation in
40 interest rate risk
 Credit Analysis in International Lending
 Banks usually have a well-oiled mechanism for
assessing the creditworthiness of their borrowers.
 Credit analysis model vary from bank to bank,
but most would include the following elements:
 Collateral – quality of collateral, its liquidity
level etc.
 Cash flow projections – ability of the
customers to service the debt, reliability of the
projections.

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 Credit Analysis in International Lending
 Covenants – has the bank been able to insist
on strict covenants?Will the bank be able to
adequately assess the customer’s adherence to
these covenants in a timely fashion?What
happen if customer fall out of compliance?
 Character – personal integrity of the borrower
is the most important characteristic that they
assess.

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  International credit analysis is much more
difficult than domestic credit analysis.
Why?

 Different accounting conventions make foreign

financial statements difficult to read and
understand.

 In many emerging market countries,

standards of transparency and accountability
may be much lower, creating unreliable and
even misleading financial statements.

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  Conventional tools such as credit reporting
bureaus and credit histories may be
nonexistent in foreign markets, making the
banker’s job much more difficult.

 Creditors must consider the absence of

adequate bankruptcy laws and settlements
procedures in many countries.

 The process of evaluating foreign credits in

immeasurably complicated by the presence of
ever-changing currency rates.

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 Noncredit Services
 Bankers have increasingly turned their attention
to fee-based, noncredit services in overseas
markets.
 These are activities that generate income, but
do not require bank to put its own capital at
risk.
 Most banks consider this is a key growth area,
and focused a large chunk of their resources on
improving technology and services.

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  Example of noncredit services:
 Global custody – the business of processing trades
and keeping shares safe on behalf of fund managers.
As financial assets worldwide soar and the pace of
technological innovations accelerates, the
international custody market is expected to grow by
corresponding amounts over the next decade.
 Cash management – the art of keeping corporate
cash balances at the lowest level possible (ideally
zero), since cash is nonproductive asset, without
jeopardizing short-term liquidity.
 Clearing agents in the various payments and
clearing systems around the globe - A payment
systems may be defined as the system of
instruments and rules which permit agents to meet
payments obligations and to receive payments owed
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