Risk Management Manual of Examination Policies - FDIC

INTERNATIONAL BANKING Section 11.1
and Regulations through Part 347. As with the domestic
investment portfolio, the purchase of foreign debt
securities with speculative characteristics merely to
generate higher short-term income is an unsuitable
investment practice.
While policy considerations with respect to managing risk
are very similar to those contained within the Securities
section of this Manual, the foreign aspect of Eurobonds,
notes, and debentures requires greater diligence,
consideration, and monitoring than would otherwise be
expected of a plain vanilla domestic bond portfolio. As
with international loans or other credit products, foreign
debt securities should be purchased under a boardapproved
country exposure line. Moreover, policy
guidelines should prescribe permissible investments,
minimum credit quality standards, and maximum duration.
All investment selection activities should be consistent
with the bank’s broader strategic plan, including its risk
appetite regarding transfer, credit, interest rate, liquidity,
and price risks.
Before purchasing a foreign security, the institution should
analyze the following factors relative to the investment:
legal implications, credit soundness, marketability,
exchange rate risk, and country risk. Credit soundness
considerations for foreign debt instruments also include all
the qualitative and quantitative considerations for domestic
debt instruments (including, for example, credit measures
that isolate the extent of leverage and cash flow of the
debtor). For non-rated foreign debt issues, it is especially
important to adopt conservative minimum thresholds for
credit evaluation criteria (i.e. earnings coverage of debt
service requirements). Particularly important is a bank
assessment of the reasonableness of the risk-reward
tradeoff, using, for example, an analysis of the credit
spread between the issue and comparable U.S. Treasury
instrument as a benchmark.
Regarding pre-purchase analyses of foreign debt securities
in countries with a low sovereign rating ceiling (endemic
within many emerging market instruments), enhanced
diligence is necessary to preclude the introduction of
higher risk securities into the portfolio. Examiners may
wish to note that nationally recognized statistical rating
organizations (NRSRO) have historically not rated certain
debentures above the foreign currency rating for the
sovereign (sovereign ceiling). However, a company’s
credit metrics (ability to repay) in an emerging market may
have been better represented by a credit grade that was
higher than its host government for a variety of factors,
including:
• Foreign company’s overall importance to the
sovereign economy.
• Extent to which company has direct or indirect access
to foreign exchange and/or ability to export
product/services and realize U.S. currency within its
operations.
• Company’s access to the international capital markets.
• Extent of foreign ownership and implied support.
Supporting documentation of the pre-purchase analysis
should be retained in the institution’s files for examiner
review. To ensure adherence to written policies and
procedures, the international portfolio should be reviewed
at least annually by the bank’s board of directors and more
frequently by its investment or asset/liability management
committee. To properly determine overall country
exposure, the instruments should also be incorporated
within the bank’s country exposure report under the
appropriate country of risk.
Placements
Banks may maintain interest-bearing time deposits with
foreign banks and overseas branches of U.S. banks.
Referred to by various terms such as placements, interbank
placements or redeposits, maturities of these instruments
may range from overnight to several months or even years.
Deposit placements are usually connected with foreign
exchange markets and international money centers such as
New York, London, Frankfurt, Singapore, and Nassau and
carried in the account “Due From Foreign Banks-Time.”
They involve both foreign banks and overseas branches of
U.S. banks and are made under a pre-approved placement
line that, in essence, is a line of credit.
The bulk of due from time deposits consists of Eurodollar
placements, with smaller amounts in other Eurocurrencies.
Eurodollars and Eurocurrencies are simply dollars or
foreign currencies domiciled outside the respective country
of denomination. The Eurodollar market has grown
significantly since 1960 with increased interbank activity
stemming from the desire to put idle Eurodollar balances to
work or to fund Eurodollar loan requests. Although treated
as deposits in the Reports of Condition, due from bank
time deposits contain the same credit and country risks as
any extension of credit to a bank in a foreign country.
Consequently, a prudently managed bank should place
deposits only with sound and well-managed banks after a
thorough investigation of their creditworthiness.
Placement activity should be governed by a formal bank
policy similar to that used for Federal funds transactions.
The policy should define terms, designate acceptable levels
of concentration in relation to credit and country risks, and
identify those banks acceptable for placement activity.
Lists of acceptable depositories with prescribed limits
should be provided to the traders or placement officers and
DSC Risk Management Manual of Examination Policies 11.1-13 International Banking (12-04)
Federal Deposit Insurance Corporation