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Chapter Ten

International lending

Learning objectives

1. Describe the structure of the international financial system

2. Explain the principles that underpin international lending and describe country risk analysis and illustrate how it is carried out.

3. Describe the products commonly used in international lending

4. Explain the special types of credits such as red clause credits used in international lending.

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Introduction

• Development of international business post WW II

• Rise of international financial system• International financial institutions

• International financial markets

• International financial instruments

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Structure of international financial system

• The main international financial markets consist of the foreign exchange market, international money market, international credit market, international bond markets and international equity markets.

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• The foreign exchange market is the market where foreign currencies are traded.

• Spot market

• Forward market

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• International money markets serve the need for short-term funds.

• International money markets could be broadly divided into two segments: the European money market and the Asian money market

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• The international credit market serves the need for medium term funds (more than one year but upto five years).

• Such medium-term loans extended by banks to MNCs are called Eurocredits or Eurocredit loans.

• The reference or base rate used for the purpose is called the London Interbank Offer Rate (LIBOR).

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• The international bond market comprises of three types of bonds, that is, domestic bonds, Eurobonds and foreign bonds.

• International investors typically face four types of risk when they invest in international bonds.

• To raise long-term funding, MNCs typically issue stocks in the international market.

• Depository receipts used to raise equity. There are two types global depository receipts (GDRs) and American depository receipts (ADRs).

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International lending

• Like all other lending, international lending is also underpinned by three basic principles of lending that you learnt in Chapter 1.

• International lending poses additional risks to lenders such as country risk and foreign exchange risk which are not encountered in domestic lending.

• Country risk is a broader concept than sovereign risk

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Assessing country risk

• According to Madura (2012) the techniques include

• Checklist approach

• Delphi technique

• Quantitative analysis

• Inspection visits

• Combination of techniques

• S&P’s country risk assessment involves Economic Risk and Industry Risk.

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Products in international lending

These can be grouped into three categories:

• transactions/ payments related

• Short-term financing,

• long-term financing

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Payment related products:• Prepayment

• Letters of credit• Foreign documentary bills of exchange

• Bill of Lading

• Consignment

• Open account

• Forward exchange contracts12

• Short-term financing needs arise mainly because of the time lag involved in various stages of the operating cycle.

• The operating cycle is also called the cash-to-cash cycle.

• Short-term products include

• Factoring

• Banker's Acceptance

• Working capital finance

• Medium-term financing

• Pre-shipment finance 13

• Post-shipment finance

• Long-term post shipment finance• Supplier credit

• Buyer credit

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Special facilities

• Special types of credit facilities• Red clause credit

• Transferable documentary credits

• Back-to-back credits

• Stand-by Letter of credit

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Uniform customs and practice for documentary credits

• In order to bring uniformity in practices followed in documentary credits, the International Chamber of Commerce issued Uniform Customs and Practice (UCP) for documentary credits way back in 1933.

• The latest of the UCP called UCP 600 was issued in July 2007.

• Banks across the world follow these standards.

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Summary

• International financial system• International financial institutions

• International financial markets

• International financial instruments

• International lending poses additional risks to lenders such as country risk and foreign exchange risk which are not encountered in domestic lending.

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Products in international lending could be grouped into three categories: • transactions/ payments related

• Short-term financing,

• long-term financing

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• Special types of credit facilities• Red clause credit

• Transferable documentary credits

• Back-to-back credits

• Stand-by Letter of credit

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