Risk Management Manual of Examination Policies - FDIC

INTERNATIONAL BANKING Section 11.1
differences between internal country exposure reports and
the Form 009.
INTERNATIONAL ACTIVITIES
Lending
Banks engaged in international lending are both
geographically concentrated and numerically limited. A
large percentage of international credits originate at New
York City institutions, with most of the remainder are
negotiated in secondary money-market centers including
Chicago, Miami, and San Francisco.
A bank's major source of profit, both internationally and
domestically, remains interest received from lending and
securities instruments (either sovereign or corporate sector
debentures). Other international department activities,
such as cable and foreign exchange operations, are
necessary adjuncts to international banking and are part of
the capability to service correspondent relationships.
However, few of these activities produce income after
expenses, and if these were the only services of
international banking, few banks would be attracted to the
field.
Among those banks that have made a substantive
commitment to international activity, international loans
have increased considerably in size, complexity, and
geographical scope in recent years. Such loans are
variously extended to foreign governments, foreign banks,
foreign companies, multinational corporations, and U.S.
importers and exporters.
International Lending Risks
Few bank loans are completely without risk and bank
lending officers must assess the degree of risk in each
extension of credit. Foreign loans share most of the same
characteristics of domestic credits but, in addition, include
several other risks unique to international lending. For
convenience, these risks are considered under three
categories: credit risk, currency (foreign exchange) risk,
and country risk.
Credit Risk refers to the potential inability of a borrower
to comply with contractual credit terms and bears the
closest resemblance to the primary risk in domestic
lending. Evaluation of this risk is similar to any credit
decision and involves analysis of appropriate factual
information, including credit volume requested, loan
purpose, anticipated term and proposed repayment source.
In addition, standard credit file information such as
financial statements covering several years and the
borrower's performance history on previous loans would be
reviewed. The difference in international lending is that
applicable information is usually less readily available and
less detailed. Foreign financial statements are more likely
to be unaudited and their format varies from country to
country. Moreover, there are often barriers to acquiring
such information from foreign sources. Thus, in the
financial evaluation of international loans, the credit
decision must frequently be based on information inferior
to that available in domestic applications.
Currency Risk pertains to the vulnerability of
international lenders to variations in rates of currency
exchange, and in every international extension of credit,
someone has a currency conversion exposure. U.S. banks
attempt to reduce the risk by lending and requiring
repayment in U.S. dollars, but the effectiveness of this
technique is limited. If a dollar loan is used in a foreign
borrower's own country, it will be necessary to convert the
proceeds into local currency. Subsequently, when the loan
matures, U.S. dollars will be required for repayment. The
problem arises when, even though the borrower may have
sufficient local currency, the country may not have the
dollars available to sell. Thus, the borrower would be at the
mercy of the country's central bank and might not be able
to make dollar remittance. (Basically, lending and
requiring repayment in dollars gives rise to transfer risk, a
specific component of country risk, which is covered later
in this section.)
Currency risk may manifest itself in credit risk, should
adverse currency movements ensue. In this scenario, a
speculative attack on a foreign currency or other
exogenous economic factors might precipitate foreign
currency depreciation/weakness versus the U.S. dollar.
This can lead to the inability of a foreign borrower to meet
debt service requirements in U.S. dollars, even if U.S.
dollars are available within the local financial system.
For example, say a foreign borrower, while generating
revenue in local currency (Venezuelan Bolivar) must fulfill
its debt service requirement to a U.S. bank in U.S. dollars.
A gradual or protracted weakening of the Bolivar (all other
factors remaining equal) will require a commensurate rise
in revenue, profit margins, and/or reduction in costs to
service the same amount of U.S. dollar debt upon currency
conversion/translation.
This is considered a facet of the credit decision process
that should be factored in under varying currency scenarios
and loans should be priced accordingly given the inherent
degree of uncertainty and risks with regard to currency
movements.
International Banking (12-04) 11.1-6 DSC Risk Management Manual of Examination Policies
Federal Deposit Insurance Corporation