What are the three risks that should be considered for inter

What are the three risks that should be considered for international banking? Explain each.

Solution

Country Risk

The factors usually associated with this type of risk are the political and economic stability of a country, exchange controls, if any, and the country\'s penchant for protectionism of domestic industry at short notice. All these factors will determine whether the country can and will honor their payment commitments-in time. For example, from many a first world country point of view, Sri Lanka is seen as a reasonable short term risk, (i.e., an export exposure up to two years is considered in order, provided the Sri Lankan importer can produce a documentary credit, preferably confirmed by a \"first class\" bank.) This is because Sri Lanka has liberalized exchange control, has no history of default on foreign debt commitments and has a reasonably robust economy. What holds the country back from being seen as a \"more comfortable\" level of risk is the political problems caused by the separatist issue.

Most banks have specialized units dealing with country risk and they control the level of exposure that bank will assume for each country. This system of policing is vital where balancing the stability of the institution against the greater profitability of transactions with higher risk areas. However, there is often a lot of friction between commercial bankers and these units where the former feels that the latter is too strict at times and business considerations are overlooked.

Foreign Exchange Risk

Payments and receipts in foreign currency are an everyday occurrence in international trade and the trader is always at the mercy of exchange rate fluctuations due to various economic, politicaland even purely speculative reasons. The astronomical volume of the global foreign exchange market leaves the importer/exporter with no control and an adverse movement in the transaction currency vis-a-vis the local currency can wipe out the entire profit and more of the deal.

It is vital that traders forge links with foreign exchange trading rooms in banks as then they will be able to stay abreast of the dynamic market and, more importantly, enter into forward foreign exchange ontracts to protect their profit margin. Surprisingly, many lending officers in banks consider the dealing room of a bank as a place of mystery and leave their customer to discuss any exchange rate issues with the dealer. This should not be the case and lenders must make efforts to gain at least a basic understanding of the workings and trends in the market.

Bank Risk

We do not need a rocket scientist to tell us that the world is full of banks of varying degrees of stability and strength and indeed the business pages of major magazines and newspapers are filled with articles on bank performance and bank collapse. When financing an importer or exporter, a bank often looks to the security of a backing document issued by another bank, be it a guarantee or a documentary credit. It is important to realize that the documentary credit issued by Bank A may not be as secure as that issued by Bank B, due to Bank A.

Dealing with bank risk is quite complicated and can be a sesitive issue most of the time, even more than country risk. Again, many banks leave this problem to a specialized unit and seek their guidance from time to time. In fact, many international banks produce and distribute instructions for their branches, setting limits for the various institutions they traditionally deal with. Anything outside such parameters has to be referred to this specialized unit for clearance.

A contribution to the business decision is also required from the management of the branch and if they feel that the branch can maintain recourse to a valued customer, then there is some flexibility to deal with the higher risk bank