Risk Management Manual of Examination Policies - FDIC

INTERNATIONAL BANKING Section 11.1
effective methods is a program of regular visitations to
borrowers' countries by bank account officers, obtaining
credit references, followed by preparation of candid reports
which become significant parts of credit files.
Loans to Foreign Banks
Loans to foreign banks represent an important segment of
international credit. Lending to these institutions involves
the same uncertainties as other foreign borrowers,
particularly regarding the usual absence of information
concerning their asset quality. Within this framework, the
key to evaluating a foreign bank is an accurate appraisal of
its management. Other important factors are an
understanding of the country's banking structure, including
method of reporting problem assets, and supervisory
program, the central bank's financial position, the
economic and political condition of the country, and the
position of comparable banks (peer group analysis). As
with international borrowers, generally, there is no
substitute for regular bank account officer visitations in
developing this type of information. Banks may also
consider World Bank and International Monetary Fund
(IMF) Financial Sector Stability Assessments (FSSAs),
which describe a country’s adherence to sound financial
sector principles such as the Core Principles of Banking
Supervision prescribed by the Basel Committee on
Banking Supervision (BCBS).
Another factor in international credit analysis is a
consideration of the type of domestic borrowers with which
international departments do business. Some domestic
borrowers are major companies that enjoy excellent credit
standings, while others may include sole proprietorship
import/export companies operating on modest capital and
narrow spreads. Loans to foreign borrowers are often
directly or indirectly supported by a party of substantial
financial strength such as a domestic parent or affiliate, a
foreign correspondent bank guarantor, or foreign
government. An evaluation of that support will be basic to
a given credit's analysis.
Geographic Limits
Defining geographic loan limits is probably the most
significant component in the establishment of an adequate
international lending policy. It requires bank management
to intelligently estimate where it can lend profitably in
accordance with its strategic objectives, financial capacity,
and personnel resources. Maximum credit lines should be
established for each individual borrower, and maximum
aggregate lines established for each political entity where
credit is advanced, based on country risk analysis. Banks
may also consider assigning limits based on the potential
for contagion issues, meaning adverse events in one
country may lead to similar adverse events in another.
This may occur, for example, in the case of two or more
countries with close trading ties, such as in the case of
Mercosur countries in South America. Banks should also
consider establishing country and credit sub-limits by
transaction type (loans versus investments) and tenor
(short-term versus long-term).
Detailed in a preceding paragraph is the notion of currency
risk. This refers to the potential loss on loans made in
foreign currencies that may decline relative to the U.S.
dollar or to the impact of foreign currency devaluations.
Aggregate country loan limits should include a currency
sub-limit in order to control currency loss exposure.
Investments
In addition to international loans and deposit placements,
U.S. banks may periodically allocate capital and risk to
investments in foreign debt securities and/or debentures.
The debentures may be issued by a foreign bank,
corporation, or sovereign government for their respective
capital needs. Banks with foreign offices might hold
securities of foreign governmental entities to meet various
local laws or reserve requirements, reduce tax liability, or
as an expression of goodwill. As with domestic bond
issues, duration and maturity of the instruments will vary
and, in the case of debentures, represent an unsecured
obligation of the issuer.
Foreign debt securities held by U.S. banks, typically U.S.
dollar-denominated in the form of Eurobonds, Medium
Term Notes (MTNs), or Yankee Bonds provide some
liquidity in the secondary markets (during normal market
conditions) and, depending on the country and
circumstances of the issuer, may offer much higher yields
than what would otherwise be feasible in the highly
competitive trade finance market. Higher yields over
comparable U.S. Treasury instruments are driven by a
confluence of factors including credit quality, country risk
(including transfer risk), as well as foreign currency
fluctuations.
Examination Guidance
International investments may be internally reported within
a bank’s domestic bond portfolio, even though they are
slotted differently for call report purposes. Banks with
foreign branches are permitted a broader scope of
investment activities, including investment services and
underwriting of debt and equity securities. Limitation of
international investments and definition of permissible
activities are governed by the Federal Reserve Board's
Regulation K which is incorporated into the FDIC Rules
International Banking (12-04) 11.1-12 DSC Risk Management Manual of Examination Policies
Federal Deposit Insurance Corporation