Oxford Press- Global banking

GLOBAL BANKING

GLOBAL BANKING

Second Edition

Roy C. Smith

Ingo Walter

1

2003

1

Oxford New York

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Copyright
2003 by Oxford University Press, Inc.

Published by Oxford University Press, Inc.

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Library of Congress Cataloging-in-Publication Data

Smith, Roy C., 1938–

Global banking / Roy C. Smith, Ingo Walter.—2nd ed.

p. cm.

Includes bibliographical references and index.

ISBN 0-19-513436-2

1. Banks and banking, International. 2. Capital market.

3. Competition, International. I. Walter, Ingo. II. Title.

HG3881 .S5434 2002

332.1'5—dc21 2002003692

987654321

Printed in the United States of America

on acid-free paper

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Preface

Few sectors of the global economy have experienced the dynamic and struc￾tural change that has occurred over the past 20 years in banking and fi￾nancial services. Regulatory and technological changes have been among

the main catalysts, making entrenched competitive structures obsolete and

mandating the development of new products, new processes, new strategies,

and new public policies toward the industry. This rapid evolution in one

of the most important yet least understood international industries gave

rise to the first version of this book, published in 1990, followed by a

second published by Oxford University Press in 1997.

Since that time developments have accelerated. Financial centers, in vig￾orous competition with each other, have undergone further regulatory

change in efforts to capture greater shares of international trade in financial

services. Also, common efforts at the regional and global level have tried to

support safety and soundness and a reasonably level competitive playing

field. Accordingly, banks, insurance companies, asset managers, and securi￾ties firms have had to devise and implement new strategies—sometimes lead￾ing events or (perhaps more often) responding to them—and the financial

services industry has seen an unprecedented wave of consolidation in all

parts of the world. The dominant strategic cliche´ of the 1990s was “universal

banking,” and most banks believed that to be better they had to be bigger.

Meanwhile, the environment for global banking services experienced a

20-year period of growth and expansion unknown to its history. During

this time, stock price and volume data for the United States and Europe

indicated a rate of growth twice that of the real economy. But with this

transactional intensity came an onslaught of competition for which the

staid banking institutions of the past were unprepared. Client relationships

were now fiercely contested. Clients expected banks to be more innovative

and to provide better-priced services. Technology constantly changed what

was possible and what was on offer from competitors.

vi Preface

The transaction volumes made markets volatile and sometimes difficult

to read. Several banking firms failed or had to be rescued by takeovers. A

banking crisis and prolonged economic stagnation battered the industry in

Japan. A vigorous bull market and continuing restructuring needs induced

a boom in mergers and acquisitions (M&A) and initial public offering

(IPO) activity in the United States and Europe, forcing banks to staff up

quickly to keep up with them, only to be sharply reversed early in the new

millennium. Financial crises rocked the emerging markets again, but this

time the accumulated amount of debt and equity securities outstanding in

these countries drove the crises into the capital markets. Financial services

were separating into two distinct halves, wholesale and retail, and the

wholesale part was almost entirely dominated by capital market activity.

Much of the conventional wisdom of the late 1980s and 1990s (such

as the expected dominance of Japanese banks in the global financial system)

proved to be wrong just as, no doubt, much of today’s conventional wis￾dom will lose meaning in an industry whose reconfiguration has some way

to go. In short, the pace of change soon made it necessary for us to think

about another edition of our 1997 book.

Here we attempt to reassess this continuing transformation process—

its causes, its course, and its consequences. We begin with an overview of

recent developments. We then consider in some detail the major dimensions

of international commercial and investment banking, including money and

foreign exchange markets, debt capital markets, international bank lending,

derivatives, asset-based and project financing, and equity capital markets.

We next consider the various advisory businesses—mergers and acquisi￾tions, privatization, institutional asset management, and private banking.

In each area we make an effort to identify the factors that appear to dis￾tinguish the winners from the losers. This is brought together in the final

section of the book, which deals with problems of strategic positioning and

execution, as well as with some of the critical regulatory issues.

The book is intended for two more or less distinct audiences. The first

is made up of banking and finance professionals and executives in nonfi￾nancial firms who would like a “helicopter” view of developments in this

industry that affect their vital interests either because they are in it or be￾cause they want to understand patterns of competition among suppliers of

financial services. The second is made up of university students in courses,

either at the advanced undergraduate or graduate level and in executive

development programs on international banking and financial markets.

Participants in such courses usually find it very helpful to understand both

the structure and the dynamics of the global banking and securities industry

as they prepare for or develop their professional careers.

We are grateful to colleagues at New York University who have pro￾vided valuable feedback on the earlier editions, as well as various drafts of

the manuscript for this book. An equal measure of thanks go to colleagues

at other institutions who used the earlier editions as a textbook in courses

on global banking. Our own students, several hundred per year, have pro-

Preface vii

vided sometimes merciless critiques and will no doubt be pleased by this

much shorter, heavily reworked, and streamlined text. The subject is com￾plex and requires some slogging. This is certainly no novel that’s impossible

to put down. But we think the reader will be well rewarded for the effort

required to work through the discussion.

Finally, we are especially grateful to Gayle DeLong of the Baruch

School, City University of New York, and Ann Rusolo of New York Uni￾versity, both of whom helped immeasurably in preparing the manuscript

for publication.

New York Roy C. Smith

November 2002 Ingo Walter

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Contents

1. The World of Global Banking, 3

Part I Competing in Global Debt and Equity Markets

2. International Money and Foreign Exchange Markets, 19

3. Global Bond Markets, 48

4. Swaps and Derivative Securities Markets, 74

5. International Bank Lending, 99

6. Asset-Related and Project Financing, 118

7. Global Equity Markets, 147

Part II Competing in Global Advisory and Asset Management Services

8. Global Mergers, Acquisitions, and Advisory Services, 185

9. Privatization, 224

10. Institutional Asset Management and Insurance, 244

11. Private Banking, 271

x Contents

Part III Competitive Strategies

12. Assessing and Managing Cross-Border Risks, 293

13. Global Banking Regulation, 335

14. Strategic Positioning and Competitive Performance, 356

15. Competitive Implementation, Organization, and

Management, 396

Index, 413

GLOBAL BANKING

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3

1

The World of Global Banking

Financial people know in their bones that their profession goes back a long

way. Its frequent association with “the world’s oldest profession” may sim￾ply be because it is almost as old. After all, the technology of finance is

very basic, requiring little more than simple arithmetic and minimal literacy,

and the environment in which it applies is universal—that is, any situation

that involves money, property, or credit, all of which are commodities that

have been in demand since humankind’s earliest days.

These financial commodities have been put to use to facilitate trade,

commerce, and business investment and to accommodate the accumulation,

preservation, and distribution of wealth by states, corporations, and indi￾viduals. Financial transactions can occur in an almost infinite variety, yet

they always require the services of banks (whether acting as principal or

as agent) and financial markets in which they can operate.

Banks, too, therefore have a long history: a history rich in product

diversity, international scope, and, above all, continuous change and ad￾aptation. Generally, change has been required to adjust to shifting economic

and regulatory conditions, which have on many occasions been drastic. On

such occasions banks have collapsed, only to be replaced by others eager

to try their hand in this traditionally dangerous but profitable business.

New competitors have continually appeared on the scene, especially during

periods of rapid economic growth, opportunity, and comparatively light

governmental interference. Competitive changes have forced adaptations,

too, and in general have improved the level and efficiency of services offered

to clients, thereby increasing transactional volume. The one constant in the

long history of banking is, perhaps, the sight of new stars rising and old

ones setting. Some of the older ones have been able to transform themselves

into players capable of competing with the newly powerful houses, but

many have not. Thus the banking industry has much natural similarity to

economic restructuring in general.

4 Global Banking

It is doubtful, however, that there has ever been a time in the long

history of banking that the pace of restructuring has been greater than

today’s. Banking and securities markets during the 1980s and 1990s in

particular have been affected by a convergence of several exceptionally

powerful forces—deregulation and reregulation, rapidly increasing com￾petition and disintermediation, product innovation and technology—all of

which have occurred in a spiraling expansion of demand for financial ser￾vices across the globe. Bankers today live in interesting, if exhausting and

hazardous, times.

Before examining these issues in detail in this book, a brief look at

where we have come from should be useful in orienting ourselves to the

present.

The Legacies of Global Banking

History has revealed that both bankers and credit were plentiful and active

in the ancient world. The recorded legal history of several great civilizations

started with elaborate regulation of credit, such as the Code of Hammurabi,

ca. 1800 b.c., where the famous Babylonian set forth, among other laws,

the maximum rate of interest for loans of grain (331⁄3%) and of silver

(20%).

In the Ancient World

Maritime trade abounded in the Mediterranean and was already highly

developed by the Greeks and the Phoenicians in 1000 b.c. Such trade in￾volved long-distance shipment of commodities that were not locally avail￾able. Wherever trade occurred, there had to be a means of payment ac￾ceptable to both sides, often obtained only through the good offices of a

bank represented in both countries acting as a foreign exchange or bill

broker.

Banks also helped the merchants, shipowners, and, later, public officials

manage their money—sometimes by accepting it on deposit; sometimes by

investing it for them in precious metals, precious stones, or the financial

assets of the day. One could make money on money long before Alexander

the Great.

By the time of the second century a.d., the Romans, then at their peak,

had reorganized everything. Their power in the Mediterranean was abso￾lute, peace reigned along its shores, piracy had been eliminated, trade flour￾ished, and coinage was available throughout the Roman Empire. Bankers

and financiers prospered. Will Durant described them as follows:

One of the streets adjoining the forum became a banker’s row, crowded

with the shops of the moneylenders and moneychangers. Money could be

The World of Global Banking 5

borrowed on land, crops, securities, or government contracts, and for fi￾nancing commercial enterprises or voyages. Cooperative lending took the

place of [commercial] insurance; instead of one banker completely under￾writing a venture, several joined in providing the funds. Joint-stock com￾panies existed chiefly for the performance of government contracts....

They raised their capital by selling their stocks or bonds to the public in

the form of partes or particulae, i.e. “little parts,” or “shares” [or “part￾nerships” or “participations”].1

Under other circumstances, this financial and commercial infrastructure

might have grown to produce large international banking and trading com￾panies of the kind that exist today. It didn’t happen in the Roman period,

largely because it seemed that the state, focused as it was on conquest and

strict control of its empire through efficient administration, reserved for

itself the principal financial powers in the society. As the state was the

principal holder of capital, it became the principal dispenser of it, too,

lending out large sums to the public, no doubt accompanied by some degree

of corruption. Perhaps to preserve this convenient arrangement, the Roman

senate did not permit limited liability companies to be formed, thus keeping

the private wealth of the empire where it could be best controlled: among

individuals.

In any case, large banks and commercial houses never emerged in the

Roman days, although banking transactions themselves were plentiful on

a small scale. This may have proved to be a contributing cause to the

decline of the empire, which, along with political deterioration, suffered

acute economic decay. In the third century, much economic difficulty was

experienced, including the “great crash” of a.d. 259, after the Emperor

Valerian had been taken captive when markets collapsed and there were

runs on banks in various parts of the empire.

During the following century, Rome’s economic decline was irrevers￾ible. Coinage and gold bullion was leaving the empire in a great payment

drain (it ended up mostly in the Near East and in India). The population

was declining, and barbarians had to be brought in to replenish the dwin￾dling supply of workers. Wealth had become highly concentrated at the

top, and the nouveau riche had been suppressed. Society’s savings were

dissipated in consumption; military conquests were no longer being under￾taken to resupply the state with plunder and slaves; and the empire itself

was breaking into two parts, with most of the action taking place in the

eastern capital, Constantinople. What was left of the smart money moved

there.

After the Romans

The rest, sadly, we know—although one eminent historian of the period,

Harold Mattingly, a distinguished Cambridge University scholar and expert

on Roman finance, makes a curious observation: