Essay: Global Financing Strategy
1 If Germany imposes interest rate ceilings on German bank deposits, what is the likely effect of this regulation on the euro interest rate?
While Germany does not have any statutory laws governing the ceilings on interest rates, the morality of a credit contract is required to be analyzed by a court, as per the Federal Court of Justice. The contract is said to be excessive when the interest being charged amounts to twice the average market interest rate for a specified duration .
Germany uses subjective controls to limit extortionate credit practices. However, should it choose to impose an interest ceiling on Bank deposits, the following rippling effects may take place:
Large credit providing firms profit more during such ceilings than smaller competitors while new entrants would find it difficult to provide better options to consumers. Hence, the number of providers becomes limited.
Interest rate ceiling with affect the business strategies of lending institutions directly.
Specialized credit providers are adversely affected in correlation with the fall in total new production and outstandings.
Borrowers would face greater risk as credit providers would adapt rates in accordance to borrowers’ risk of default.
Those most in need of credit may not be able to avail it.
Based on the above rippling effects of a ceiling being imposed on bank deposit rates, it can be said that the those holding German Euromarks would be forced to move their investments to the more stable Eurodollars to be able to earn a better rate of interest. As the supply of Euromarks would correlate to the demand of Eurodollars, the interest rate for marks would decline while that of Eurodollars would increase.
2 What is the major difference in the role of commercial banks in corporate governance between the USA and Japan?
Legal scholars have compared the corporate governance of the USA with Japan, calling it grossly inferior . They have argued that American banks are limited by their scope and geographical range to monitor and control the activities of its corporate borrowers. While the American banking system has its flaws, it is based more on a principle of equity dominance where corporate governance is concerned. Hence, the USA would be in a better position to revise its corporate governance and banking regulations rather than converting to a completely new system like Japan’s.
Japanese’s banks as investors in companies, are first considered creditors and the shareholders. They are fixed claimants while other shareholders are residual claimants. However, banks, as institutions, are prone to promote investments that are low on risk so long as they earn a steady return. They may forgo the opportunity to make bigger profits if the risk is deemed to be high. Hence, they are not in an unbiased position where they can consider the profitability of the company and its growth.
Japanese Banks form the center of the Keiretsu, a network of intercompany equity holdings. The keiretsu had been formed to provide better stability to the companies that are its members. However, banks have been known to use their dominance to promote their own interests rather than that of the other shareholders. Never the less, Japanese banks have a firsthand influence on corporate management and are hence better placed to manage governance.
American banks, on the other hand, have too little control over corporate governance. As a result, firms are free to take up projects that are both, high on profits as well as risk. In addition several American regulations such as doctrines limiting the implementation of contractual agreements leave the lending institutions at risk of moral hazards undertaken by the borrower. Finally, the American legislation itself often seems too willing to give companies a market free of corporate governance, placing banks and lending institutions at greater risk .
3 What is country risk? How can we assess country risk?
With the fast paced globalization of business during the last two decades, organizations have had to increasingly face the risk of investing large amount of resources in offshore facilities and operations. As such, it has become imperative to analyse and forecast the financial, economic and political environment of a country before organizations make the decision on foreign investments. Country Risk is a term which is used, simply put, to describe the level of risk involved when investing in that particular nation. It includes analysis of creditworthiness and the country’s aptitude and readiness to meet international financial commitments. In a globalized business environment, several players are to be considered as part of country risk such as private entities, ministries and market operators.
However, it is not easy to assess country risk as it can have adverse impact on foreign relations and international trade for both, investors as well as countries soliciting FDI. In order to standardize the concept of country risk, a rating system has been developed to gauge the reliability of countries on an even scale. There are several rating agencies like Standard & Poor’s, Moody’s, International Country Risk Guide and Fitch IBCA. These agencies compile a ranking list in which ratings are assigned to nations based on the level of risk they pose to investors. Being high ranked in such lists is especially vital for developing countries aiming to reach capital markets. The ratings analyse country risk based on three major variables, namely: a) Economic variables – GDP, Real Annual GDP growth, Yearly Inflation Rate, Budget Balance as % GDP and Current Account balance as % GDP, b) Financial Variables – Foreign debt as % GDP, Foreign Debt Service as % Export Goods/Services, Current Account as % Export Goods/Services, Net Liquidity/ Import Cover and Stability of the Exchange Rate, and c) Political Risk Variables – Stable government, internal/ external conflicts, social-economic problems, corruption, religious/ ethnic/ civil tensions and so on.
4 What are bankers' acceptances? What are the advantages of bankers' acceptances as an export-financing instrument?
A “bankers’ acceptance” or BA is a time draft, that is, an order to pay a specified amount of money to the holder of the acceptance on a specified date . It is a form of guarantee of payments between two companies. The bank accepts or agrees to pay a certain amount on a certain date to a company should the company who has drawn the Banker’s Acceptance fails to honour the payment. Using banks for such financing lowers counterparty risk arising from the inability of companies to precisely gauge the risk involved in conducting a particular business deal. Through a Banker’s Acceptance, a bank can replace its own credit instead of a borrower’s and hence creates a negotiable financial instrument that can be freely traded.
Since a bank is involved in the business transaction, the importer and exporter can trust the fulfilment of the contract with more ease. Whatever risk arises out of acceptance financing is borne by the bank and so conducting business is relatively safer for the exporter. A Banker’s Acceptance is a low risk instrument which is why they are able to trade at rates around the same as CDS. Simply put, an exporter can put a banker’s acceptance up for sale for a comparatively small discount. Just how small a discount is given is directly correlated to the rate of interest being charged. For offering all these benefits to both, exporters as well as importers, banks charge a reasonable fee or commission for taking the risk of payment in case of default. In case a Letter of Credit or LC is to be raised, then a further fee becomes applicable.
Bibliography
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