INTRODUCTION TO INTERNATIONAL FINANCE

International finance
1.1.1. Meaning of International Finance
International finance is the branch of economics that studies the dynamics of exchange rates,
foreign investment, and how these affect international trade. It also studies international projects,
international investments and capital flows, and trade deficits. It includes the study of futures,
options and currency swaps. Together with international trade theory, international finance is also
a branch of international economics.
International finance is the examination of institutions, practices, and analysis of cash flows that
move from one country to another. There are several prominent distinctions between
international finance and its purely domestic counterpart, but the most important one is exchange
rate risk. Exchange rate risk refers to the uncertainty injected into any international financial
decision that results from changes in the price of one country's currency per unit of another
country's currency. Examples of other distinctions include the environment for direct foreign
investment, new risks resulting from changes in the political environment, and differential
taxation of assets and income.
1.1.2. Nature of International Finance
International finance is a distinct field of study and certain nature set it apart from other fields.
The important distinguishing nature of international finance is explained below

1) Foreign Exchange Risk: An understanding of foreign exchange risk is essential for managers

and investors in the modern day environment of unforeseen changes in foreign exchange
rates. In a domestic economy this risk is generally ignored because a single national currency
serves as the main medium of exchange within a country. When different national currencies
are exchanged for each other, there is a definite risk of volatility in foreign exchange rates.
The present International Monetary System set up is characterized by a mix of floating and
managed exchange rate policies adopted by each nation keeping in view its interests. In fact,
this variability of exchange rates is widely regarded as the most serious international financial
problem facing corporate managers and policy makers.
2) Political Risk: Another risk that firms may encounter in international finance is political risk.
Political risk ranges from the risk of loss (or gaih) from unforeseen government actions or
other events of a political character such as acts of terrorism to outright expropriation of
assets held by foreigners. MNC must assess the political risk not only in countries where it is
currently doing business but also where it expects to establish subsidiaries.
3) Expanded Opportunity Sets: When firms go global, they also tend to benefit from expanded
opportunities which are available now. They can raise funds in capital markets where cost of
capital is the lowest. In addition, firms can also gain from greater economies of scale when they
operate on a global basis
4) Market Imperfections: The final feature of international finance that distinguishes it from

domestic]

lntri

finance is that world markets today are highly imperfect. There-are profound differences
among nations] laws, tax systems, business practices and general cultural
environments. Imperfections in the world]
. financial markets tend to restrict the extent to which investors can diversify their portfolio.
Though there are | risks and costs in coping with these market imperfections, they also offer
managers of international firm ] abundant opportunities

1.1.3 Principles of International Finance

The financial manager has three major functions:
1) Financial planning and control,

2) The acquisition of
funds, and 31 the
allocation of finds.
However, each of these three functions shares most principles of global finance and their
relationships. Seven important principles of global finance are as follows
1) Risk-Return Trade-off: The maximization of stockholders wealth depends on the trade-off
between risk I and profitability. Generally', the higher the risk of a project, the higher is the
expected return from the j project. For example, if anyone is offered a chance to invest in a
project which offers an extremely high I rate of return, you should immediately suspect that
the project is very risky. The risk-return trade-off does | not apply to 100 per cent of all cases,
but in a free enterprise system, it probably comes close. Thus, the | financial manager attempt
to determine the optimal balance between risk and profitability that will | maximize.
2) Market Imperfections: Perfect competition exists when sellers of goods and services have
complete freedom of entry into and exit out of any national market. Under such conditions,
goods and services would be mobile and freely transferable. The unrestricted mobility of
goods and services creates equality in costs j and returns across countries. This cost-return
uniformity everywhere in the world would remove the incentive for foreign trade and
investment.
3) Portfolio Effect (Diversification): The portfolio effect states that as more assets are added to a
portfolio, the risk of the total portfolio decreases. This principle explains much of the
rationale for large MNCs to \ diversify their operations not only across industries but also
across countries and currencies. Some MNCs, such as Nestle of Switzerland, have operations
in countries as varied as the United States, Japan, Hong Kong. France. Russia. Mexico,
Brazil, Vietnam, Nigeria and North Korea. Because it is impossible to predict which
countries will outperform other countries in the future, these companies are hedging their
bets".
4) Comparative Advantage: Comparative advantage states that trade between the two countries
can boost living standards in both. Trade allows countries to specialize in what they do best
and to enjoy a greater variety of goods and services. At the same time, companies earn

profits from trade because most trade is carried-out by individual companies.

5) lateraatinu lrr tvou Advantage: The advantages of internationalization influence
companies -to invest direedy in foreign countries. These advantages depend on three factors:
i) 1 oration.
ii) Ownership, and
iii) Internationalizarica.
Exxon Mobil has ownership advantages, such as technology, marketing expertise, capital
and brand names. Venezuela has location advantages, such as crude oil, abundant labor
and low taxes. These internalkxijJizatian advantages allow MNCs to enjoy superior
earnings performance over domestic companies
(0 Economies of Scale: There are economies of scale in the use of many assets. Economies of
scale take place due to a synergists: effect, which is said to exist when the whole is worth
more than the mere sum of its parts. When .vanpaHes produce or sell their primary product
in new markets, they may increase their eanarngs 3 shareholder's wealth due to economies of
scale. Companies can gain from greater economiesof scale when their real capital and
monetary assets are deployed on a global basis. The expansion of a companys operations
beyond national borders allows it to acquire necessary management skills and spread existing
management skills over a larger operation.
7) Valuation: The valuation principle states that the value of an asset is equal to the present value
of its expected earnings. The value of an MNC is usually higher than the value of a domestic
company for two reasons:
i) Studies show that MNCs earn more profits than domestic companies.
ii) The earnings of larger companies are capitalized at lower rates.
The securities of MNCs have better marketability than those of domestic companies. MNCs are
also better known among investors. These factors lead to lower required rate of return and
higher price-earning ratios. When MNCs attempt to maximize their overall company value,
they also face various constraints. Those constraints that hamper an MNCs efforts to
maximize its stockholders wealth include large agency costs and environmental differences
1.1.4.

Importance of International Finance

^ The importance/benefits of international finance are as follows:

. 1) Access to capital markets across the world enables a country to borrow during tough times
and lend during good times.
12) It promotes domestic investment and growth through capital import.
3) Worldwide cash flows can exert a corrective force against bad government policies.
4) It prevents excessive domestic regulation through global financial institutions.
; 5) International finance leads to healthy competition and, hence, a more effective banking
system.
6) It provides information on the vital areas of investments and leads to effective capital
allocation.
I 7) International finance promotes the integration of economies, facilitating the easy flow of
capital. The free transfer of funds would eventually result in more equality among
countries that are a part of the global financial system.
8) International finance leads to healthy competition and, hence, a more effective banking
system.
F 9) It provides information on the vital areas of investments and leads to effective capital
allocation.
; 10) International finance promotes the integration of economies, facilitating the easy flow of
capital. The free transfer of funds would eventually result in more equality among
countries that are a part of the global financial system.
International business activities are affected by the international financial environment. For
example, a few years ago the financial crisis in the South-East Asian countries seriously
affected other financial markets in the rest of the world and international business activities
were consequently affected as well.

1) Foreign Exchange Market: The foreign exchange market is the place where money
denominated in one currency is bought and sold with money denominated in another
currency
2) Currency Convertibility: The discussion of the foreign exchange market was based on the
assumption that the currencies of various countries are freely convertible into other
currencies. This assumption is not valid. Many countries restrict the ability of residents and
non-residents to convert the local currency into foreign currency, making international
businesses more difficult.
A countrys currency is said to be freely convertible when the countrys government allows
both residents and non-residents to purchase unlimited amounts of foreign currencies with
the local currency. A currency is non-convertible when neither residents nor non-residents are
allowed to convert local currency into a foreign currency.
3) International Monetary System: Every country' needs to have its own monetary system and an
authority to maintain order in the system. Monetary system facilitates trade and investment.
India has its own monetary policy that is administered by the Reserve Bank of India.
Primarily, RBI aims at controlling inflation and money supply and maintaining an interest
rate regime that is helpful to economic growth.
4) Balance of Payments: Balance of Payments (BOP) is a statistical statement that
systematically summarizes, for a specified period of time, the monetary transactions of an
economy with the rest of the world. BOP data help measure financial transactions between
residents of the country and residents of all other countries. Transactions include exports and
imports of goods and services, income flows, capital flows, and gifts and similar one-sided
transfer payments.
International Financial System: The international financial system consists of the numerous
rules, customs, instruments, facilities, markets, and organizations that enable international
payments to be made and funds to flow across borders. In recent years, the international
financial system has experienced | tremendous growth. New financial instruments have been
created, and the volume of transactions has exploded. The dramatic metamorphosis of
international financial markets is driven by technological [ changes, the growth in world trade,
and the breakdown of barriers to financial (capital) flows

1.2. International monetary system

1.2.1.

Concept of International Monetary System (IMS)

The international monetary system establishes the rules by which countries value and
exchange their currencies. It also provides a mechanism for correcting imbalances between a
countrys international payments and its receipts. Further, the cost of converting foreign
money into firms home currency - a variable critical to the profitability of international
operations depends on the smooth functioning of the international monetary system.
An international monetary system is required to facilitate international trade, business, travel,
investment, foreign aid, etc. It is a complex system of international arrangements, rules,
institutions, policies in regard to exchange rates, international payments, capital flows. IMS
has evolved over time as international trade/flnance/business has changed, as technology has
improved, as political dynamics change, etc. For example, evolution of the European Union
and the euro currency impacts the IMS. International monetary system is an institutional
framework within which International payments are made, movements of capital an:
accommodated and ex-rates are determined.
The international monetary system has evolved over the course of centuries and defines the
overall financial environment in which multinational corporations operate. The international
monetary system consists of elements such as laws, rules, agreements, institutions, mechanisms
and procedures which affect foreig" exchange rates, balance of payments adjustments,
international trade and capital flows. This system will continue to evolve in the future as the
international business and political environment of the world economy continues to change.
The international monetary system plays a crucial role in the financial management of*
multinational business and economic and financial policies of each country
Evaluation monetary system
The history of monetary system started when in ancient time (7th century B.C.) tribes and citystates of India, Babylon, and Phoenicia used gold and silver as media of exchange in trade.
Evolution of the international monetary system can be analysed in four stages which are as

follows:

1.2.21 Gold Standard (1876-1913)

In the early days, gold was used as storage of wealth and as a medium of exchange. The gold
standard, as an international monetury system, gained acceptance in Western Europe in the
1870s and existed as a historical reality during the period 1875-1914. The majority of countries
got off gold in 1914 when World War I broke out. The classical gold standard thus lasted for
approximately 40 years. The centre of the international financial system during this period was
London reflecting its important position in international business and trade
The fundamental principle of the classical gold standard was that each country should set a par
value for its currency in terms of gold and then try to maintain this value. Thus, each country
had to establish the rate at which its currency could be converted to the weight of gold. Also,
under the gold standard, the exchange rate between any two currencies was determined by their
gold content.
1) Price-Specie-Flow Mechanism: The gold standard functioned to maintain equilibrium through
the so- called priee-specie-flow mechanism (or more appropriately the specie-flow-price
mechanism), with specie meaning gold. The mechanism was intended to restore equilibrium
automatically. When a countrys Currency inflated too fast, the currency lost
competitiveness in the world market. The deteriorating trade balance due to imports being
greater than exports led to a decline in the confidence of the currency. As the exchange rate
approached the gold export point, gold was withdrawn from reserves and shipped abroad to
pay for imports. With less gold at home, the country was forced to reduce its money supply,
a reduction accompanied by a slow-down in economic activity, high interest rates, recession,

reduced national income and increased unemployment.

The price-specie-flow mechanism also restored order in case of trade surpluses by working
in the opposite manner. As the countrys exports exceeded its imports, the demand for its
currency pushed the value toward the gold import point. By gaining gold, the country increased
its gold reserves, enabling the country to expand its money supply. The increase in money
supply forced interest rates to go lower, while heating up the economy. More employment,
increased income and subsequently, increased inflation followed. Inflation increased
consumers real income by overvaluing the currency, making it easier to pay for imports. It
should be remembered that an inflated country with the exchange rate held constant is an
advantageous place to sell products and a poor place to buy. With inflation, prices of domestic
products : would rise and become too expensive for overseas buyers. At the same time, foreign
products would become more competitive and tire balance of payments would become worse.
Next would come a loss of gold and the need to deflate and the cycle would be repeated.
Decline of the Gold Standard: There are several reasons why the gold standard could not
function well over the long-run. One problem involved the price-specie-flow mechanism. For
this mechanism to function effectively, certain rules of the game that govern the operation of
an idealized international gold standard must be adhered to. One rule is that the currencies must
be valued in terms of gold. Another rule is that the flow of gold between countries cannot be
restricted. The last rule requires the issuance of notes in some fixed relationship to a countrys
gold holdings. Such rules, however, require the nations_,willingness to place balance of
payments and foreign exchange considerations above-domestic policy goals and this
assumption is, at best, unrealistic
Because gold is a scarce commodity, gold volume could not grow fast enough to allow
adequate amounts of money to be created (printed) to finance the growth of world trade. The
problem was further aggravated bj gold being taken out of reserve for art and industrial
consumption, not to mention the desire of many people to own gold. The banning of gold
hoarding and public exporting of gold bullion by President Franldia Roosevelt was not
sufficient to remedy the problem
1.2.2.1.1.

Features of Gold Standard

Following are the features of gold standard:

1) Monetary unit is defined in terms of gold. For example, before World War 1, sovereign was
the standard coin in the U.K. Its weight was 123.17447 grains with 11/12 purity.
2) Other forms of money (e.g. token coins and paper money) are also in circulation. But they are
convertible into gold.
3) Coinage is unlimited and free of cost.
4) There is free and unlimited melting of gold coins.
5) The government buys and sells gold at fixed prices and thereby maintains parity between the
face value and intrinsic value of the standard coin.
6) There is free import and export of gold.
7) Gold is unlimited legal tender for all types of payments. All values are expressed in terms of
gold.

1.2.2.1.2.

Types of Gold Standard

Types of gold standard are as follows:

1) Gold Specie Standard: This standard existed when monetary transactions occurred with gold
coins. In other words, the gold itself was used in the transaction. Paper money was also
used, but it was tied to a specific number of gold coins. Paper bills in the United States were
actually gold certificates. A ?100 gold certificate entitled the bearer of that certificate to the
equivalent amount in gold. The gold specie standard is one of the oldest forms of a
monetary system. Gold coins were used as long ago as the Byzantine Empire. Although gold
coins are still produced, they are no longer used as currency.
2) DC Facto Gold Standard: This standard existed when a country guaranteed the value of a coin
made of s metal other than gold to be worth that amount in gold. For example, a country that
issued silver coins would tie their worth to a fixed worth of gold, regardless of what the
silver itself was worth. This gave the option of being able to pay debts without actual gold
because the value of the coin exchanging hands was guaranteed by the government to be
worth a certain amount of gold. It also meant that the country ths guaranteed the value of the
coin in gold had to have the gold reserves to back it up.
3) Gold-Bullion and Gold-Exchange Standard: In principle, a country can choose among four
kinds of international gold standards the pure coin and mixed standards, a gold-bullion

standard, and a gold- exchange standard. Under a gold-bullion standard, gold coin neither
circulates as money nor is it used commercial bank reserves, and the government does not
coin gold. The monetary authority (treasury or cant bank) stands ready to transact with
private parties, buying or selling gold bars (usable only for import or export, not us domestic
currency) for its notes, and generally a minimum size of transaction is specified.
4) Gold Points and Gold Export/Import: A fixed exchange rate (the mint parity) for two
countries oh ik gold standard is an over-simplification that is often made but is misleading.
There are costs of importing or exporting gold. These costs include freight, insurance,
handling (packing and cartage), interest on mono committed to the transaction, risk
premium (compensation for risk), normal profit, any deviation oi purchase or snle price
from the mint price, possibly mint charges, and possibly abrasion (wearing out of removal
of gold content of coin should the coin be sold abroad by weight or as bullion).
Expressing tk expelling costs as the per cent of the amount invested (or, equivalently, as per
cent of parity), the product of 1/100'1' of these costs and mint parity (the number of units of
domestic currency per unit of foreic currency) is udded to mint parity to obtain the goldexport point the exchange rate at which gold - exported. To obtain the gold-import point,
the product of 1/100,h of the importing costs and mint park) is subtracted from mint parity.
Gold-Point Spread: The difference between the gold points is called the (gold-point) spread.
The safe points and the spread may be expressed as percentages of parity. Estimates of gold
points and spread involving centre countries are provided for the classical and interwar cold

1.2.2.1.3. Advantages of Gold Standard

The advantages of gold standard are
as follows:
1) Ultimate hedge against inflation. Because of its fixed supply, gold standard creates price level
stability, eliminates abuse by central bank/ hyperinflation.
2) Automatic adjustment in balance of payments due to price-specie-flow mechanism.
3) It limits the power of governments or banks to cause price inflation by excessive issue of
paper currency, although there is evidence that even before World War I monetary authorities

did not contract the supply of money when the country incurred a gold outflow.
4) A gold standard restricts the Federal Reserve from enacting policies which significantly alter
the growth of the money supply which in turn limits the inflation rate of a country.
The extensive use of gold standards implies a system of fixed exchange rates. If all countries
are on a gold standard, there is then only one real currency, gold, from which all others derive
their value. The stability the gold standard cause in the foreign exchange market is often cited
as one of the benefits of the system

Disadvantages of Gold Standard

The disadvantages of gold standard are as follows:
1) Possible deflationary pressure. With a fixed supply of gold (fixed money supply), output
growth would lead to deflation.
2) An international gold standard has no commitment mechanism or enforcement mechanism, to
keep countries on the gold standard if they decide to abandon gold.
3) The process of adjustment for a country with a payments deficit can be long and painful
whenever an increase in unemployment or a decline in the rate of economic expansion
occurs.
A country may not be able to isolate its economy from depression or inflation in the rest of the
world

I.2.2.2.Inter War Years (1914-1944)

The gold standard as an international monetary system, worked well until World War I
interrupted trade flows and disturbed the stability of exchange rates for currencies of major
countries. There was widespread fluctuation in currencies in terms of gold during World War 1
and in the early 1920s. The role of Great Britain as the worlds major creditor nation also came to
an end after World War I. The United States began to assume the role of the leading creditor
nation.

As countries began to recover from the war and stabilize their economies, they made several
attempts to return to the gold standard. The United States returned to gold in 1919 and the United
Kingdom in 1925. Countries such as Switzerland, France and Scandinavian countries restored
the gold standard by 1928.
The key currency involved in the attempt to restore the international gold standard was the pound
sterling which returned to gold in 1925 at the old mint parity exchange rate of $4.87/. This was
a great mistake since the United Kingdom had experienced considerably more inflation than the
United States and because UK had liquidated most of its foreign investment in financing the war.
The result increased unemployment and economic stagnation in Britain.
The pounds overvaluation was not the only major problem of the restored gold standard. Other
problems included the failure of the United States to act responsibly, the undervaluation of the
French franc and a general decrease in the willingness and ability of nations to rely on the gold
standard adjustment mechanism.
In 1934, the United States returned to a modified gold standard and the US dollar was devalued
from the previous $20.67/ounce of gold to $35.00/ounce of gold. The modified gold standard
was known as the Gold Exchange Standard. Under this standard, the US traded gold only with
foreign central banks, not with private citizens. From 1934 till the end of World War II, exchange
rates w'ere theoretically determined by each currencys value in terms of gold. World War II also
resulted in many of the world's major currencies losing their convertibility. The only major
currency that continued to remain convertible was the dollar.
Thus, the inter-war period was characterized by half-hearted attempts and failure to restore the
gold standard, economic and political instabilities, .widely fluctuating exchange rates, bank
failures and financial crisis. The Great Depression in 1929 and the stock market crash also
resulted in the collapse of many banks
1.2.2.3. Bretton

Woods System (1945-1972)

The depression of the 1930s, followed by another war, had vastly diminished commercial
trade, the international exchange of currencies and cross-border lending and borrowing.
Revival of the system was necessary and the reconstruction of the post-war financial
system began with the Bretton Woods Agreement that emerged from the International
Monetary and Financial Conference of the united and associated nations in July 1944 at

Bretton Woods, New Hampshire.

There was a general agreement that restoring the gold standard was out of question, that
exchange rates should basically be stable, that governments needed access to credits in
convertible currencies if they were to stabilize exchange rates and that governments should
make major adjustments in exchange rates only after consultation ffl with other countries. On
specifics, however, opinion was divided. The British wanted a reduced role for gold, more
exchange rate flexibility than had existed with the gold standard, a large pool of lendable
resources at the $ disposal of a proposed international monetary organization and acceptance of
the principle that the burden of correcting payment disequilibrium should be shared by both,
surplus countries and deficit countries. The Americans favoured a major role for gold, highly
stable exchange rates, a small pool of lendable resources and the principle that the burden of
adjustment of payment imbalances should fall primarily on deficit countries

1.2.2.3. Bretton Woods System (1945-1972)

The depression of the 1930s, followed by another war, had vastly diminished commercial
trade, the international exchange of currencies and cross-border lending and borrowing.
Revival of the system was necessary and the reconstruction of the post-war financial system
began with the Bretton Woods Agreement that emerged from the International Monetary and
Financial Conference of the united and associated nations in July 1944 at Bretton Woods,
New Hampshire.
There was a general agreement that restoring the gold standard was out of question, that
exchange rates should basically be stable, that governments needed access to credits in
convertible currencies if they were to stabilize exchange rates and that governments should
make major adjustments in exchange rates only after consultation ffl with other countries. On
specifics, however, opinion was divided. The British wanted a reduced role for gold, more
exchange rate flexibility than had existed with the gold standard, a large pool of lendable
resources at the $ disposal of a proposed international monetary organization and acceptance of
the principle that the burden of correcting payment disequilibrium should be shared by both,
surplus countries and deficit countries. The Americans favoured a major role for gold, highly

stable exchange rates, a small pool of lendable resources and the principle that the burden of
adjustment of payment imbalances should fall primarily on deficit countries.

I.2.2.3.I. Features of Bretton Woods System

The features of bretton woods system are as
follows:
1) US Dollar-based System: The Bretton Woods system was a gold-based system
which treated all countries symmetrically, and the IMF was charged with the
responsibility to manage this system. In reality, however, it was a US-dominated
system with the US dollar playing the role of the key currency (the dollar's
dominance still continues today). The relationship between the US and other
countries was highly asymmetric. The US, as the center country, provided domestic
price stability which other countries could "import", but did not itself engage in
currency intervention (this is called benign neglect; i.e., the US did not care about
exchange rates, which was desirable). By contrast, all other countries had the
obligation to intervene in the currency market to fix their exchange rates against the
US dollar.
2) Adjustable Peg System: This means that exchange rates were normally fixed but
permitted to be adjusted infrequently under certain conditions. As a consequence,
exchange rates were supposed to move in a stepwise fashion. This was an
arrangement to combine exchange rate stability and flexibility, while avoiding
mutually destructive devaluation. Member countries were allowed to adjust
"parities" (exchange rates) when "fundamental disequilibrium" existed. However,
"fundamental disequilibrium" was not clearly defined anywhere. In reality,
exchange rate adjustments were implemented far less often than the builders of the
Bretton Woods system imagined. Germany revalued twice, the UK devalued once,
and France devalued twice. Japan and Italy did not revise their parities.
3) Capital Control: Capital control was tight. This was a big difference from the
Classical Gold Standard of 1879-1914, when there was free capital mobility.
Although the US and Germany had relatively less capital- account regulations,
other countries imposed severe exchange controls.

4) Macroeconomic Performance: Macroeconomic performance was good. In particular,

global price stability and high growth were simultaneously achieved under deepening
trade liberalization. In particular, stability' in tradable prices (wholesale prices or WPl)
from the mid 1950s to the late 1960s was almost perfect and globally common. This
macroeconomic achievement was historically unprecedented

I.2.2.3.2. Recommendations of Bretton Wood System

The negotiators at Bretton Woods made certain recommendations in 1944 which are as
follows:
-

1) Each nation should be at liberty to use macroeconomic policies for full employment.

(This tenet ruled out a

return to the gold standard.)
2) Free-floating exchange rates could not work. Their ineffectiveness had been demonstrated
during the 1920s
and 1930s. But the extremes of both permanently fixed and free-floating rates should
be avoided.
3) A monetary system was needed to recognize that exchange rates were both a national
and an international concern

1.2.2.3.3.

Breakdown of the Bretton Woods System

The Bretton Woods System worked without major changes from 1947 till 1971. During this
period, the fixed exchange rates were maintained by official intervention in the foreign exchange
markets. International trade expanded in real terms at a faster rate than world output and
currencies of many nations, particularly those of developed countries, became convertible.
The stability of exchange rates removed a great deal of uncertainty from international trade and
business transactions thus helping the countries to grow. Also, the working of the system
imposed a degree of discipline on the economic and financial policies of the participating
nations. During the 1950s and 1960s, the IMF also expanded and improved its operation to

preserve the Bretton Woods System. The system, however, suffered from a number of inherent
structural problems. In the first place, there was much imbalance in the roles and responsibilities
of the surplus and deficits nations. Countries with persistent deficits in their balance of payments
had to undergo tight and stringent economic policy measures if they wanted to take help from the
IMF and stop the drain on their reserves.
The basic problem here was the rigid approach adopted by the IMF to the balance of payments
disequilibrium situation. The controversy mainly centres on the 'conditionality issue, which
refers to a set of rules and policies that a member country is required to pursue as a prerequisite
to using the IMFs resources. These policies mainly try and ensure that the use of resources by
concerned members is appropriate and temporary. The IMF distinguishes between two levels of
conditionality, first was low conditionality where a member needs funds only for a short period
and second was high conditionality where the member country wants a large access to the IMFs
resources. This involves the formulation of a formal financial programme containing specific
measures designed to eliminate the countrys balance of payments disequilibrium.
Use of IMF resources, under these circumstances, requires IMFs willingness that the
stabilization programme is adequate for the achievement of its objectives and an understanding
by the member to implement it.

1.2.2.3.4.

Advantages of Bretton Woods System

The advantages of Bretton Woods system of exchange rate are as follows:

1) Economizes on scarce resources (gold) by allowing foreign reserves (Ss) to be used for IMS
payments. Easier to transfer dollars versus shipping gold overseas under pure gold standard.
2) By holding $ instead of gold as reserves, foreign central banks can earn interest

VERSUS

interest bearing gold.

3) Ex-rate stability reduced currency risk, provided a stable IMS and facilitated international
trade and ' investment, led to strong economic growth around the world in 50s and 60s.
1.2.23.5.Disadvantages of Bretton Woods System

non-

In long-run, Bretton Woods (gold-exchange system) was unstable. There was no way to:
1) Devalue the reserve currency ($) even when it was over-valued, or
2) Force a country to revise its ex-rate upward. A country could agree or be pressured into
devaluation, but there was no way to revalue a currency upward (appreciate through
concretionary policy).

1.2.2.4.

Exchange Rate Regimes

The exchange rate regime is the way a country manages its currency in respect to foreign
currencies and the foreign exchange market. It is closely related to monetary policy and the two
are generally dependent on many of the same factors. In other words, the concept of exchange
rate regime may be explained as the method that is employed by the governments in order to
administer their respective currencies in the context of the other major currencies of the world.
The foreign exchange market is pretty important in this case as well. Exchange rate regime has
often been likened to monetary policies and it may be concluded that both the processes are
actually dependent on a lot of similar factors.
There are two broad categories of exchange rate systems.
1) In one system, exchange rates are set purely by private market forces with no government
involvement. Values change constantly as the demand for and supply of currencies fluctuate.
2) In another system, currency values are allowed to change, but governments participate in
currency markets in an effort to influence those values.

1.2.2.5.

Different Exchange Rate Regimes

Following are the different exchange rate regimes:

Fixed Exchange Rate System

Fixed exchange rate is a type of exchange rate regime wherein a currencys
value is matched to the value of another single currency or to a basket of
other currencies, or to another measure of value, such as gold. One of the
major implications of the fixed exchange rate is that it does not let a
government create and adhere to a particular financial policy that is free
from external influences and is necessary for achieving domestic economic
stability. There are certain conditions whereby the fixed exchange rates are
preferred for the fact that they are highly stable.
in some situations, a government will devalue or reduce the value of its
currency against other currencies. In other situations, it will revalue or
increase the value of its currency against other currencies. A central banks
arsons to devalue a currency in a fixed exchange rate system are referred to
as devaluation. The term devaluation is normally used in a different context
than depreciation. Devaluation refers to a downward adjustment of the
exchange rate by the central bank. Revaluation refers to an upward
adjustment of the exchange rate by the central bank.
Advantages of Fixed Exchange Rate Systems
The advantages of fixed exchange rate are as follows
1) Risk of Uncertainty: Exchange rate is the factor by which price of one currency is
expressed in terms of the other. As a result, in international transactions, a payer is
exposed to an additional risk if he is to pay in foreign currency. Similarly, the payee is
exposed to an additional risk if the payment is not denominated in his home currency. A
fixed exchange rate protects both the payer and the payee from such a risk
2) Monetary and Fiscal Discipline: Assuming that authorities are committed to maintain a
fixed exchange rate, but without the use of exchange control, then they will have to
practice adequate self-discipline and harmonize their monetary and fiscal policies with
those of the other members of the international payments system, in case, they fail to do
so, they may face a situation of fundamental disequilibrium, that is, a situation of
continuous one-sided pressure on balance of payments.
3) Convenience: Traders and bankers favor a fixed exchange rate for its sheer convenience
and safety. There are no sudden movements to destabilize a commercial transaction.
4) Need: There may be circumstances in which it may be advisable to pursue a policy of
fixed exchange rate even if is to be maintained with an exchange control.
5) Source of Economic Benefit: If rate of exchange is chosen by taking into account the

relevant elasticitys of demand and supply of traded goods, it can be economically

beneficial.
6) Historical Relevance: A regime of fixed rates [subject to adjustment in case of a
fundamental disequilibrium was adopted by members of the IMF and this system
prevailed for over two decades.

Disadvantages of Fixed Exchange Rate Systems

The disadvantages of fixed exchange rate are as follows
1. Domestic Stability: With a fixed exchange rate, adjustment of domestic price level vis-avis that of the rest of the world has to be brought about through an inflationary or
deflationary domestic policy. This implies sacrificing domestic stability for the sake of
exchange rate stability.
2. Curbing Competitive Market Forces: I f we believe in the virtues of competitive
market, we should option for a flexible and not a fixed rate. This is because a fixed rate
regime is the one in which competitive market forces are not allow to operate freely. In
particular , a policy of exchange convertibility and free international trade imply that
fixed exchange is a baseless policy.
3. Choice of rate: There is no objective method of estimating the most appropriate fixed
rate of exchange and adopt it. Its estimation would involve a number of factors including
those prevailing in international markets and policies adopted by other countries. Where
or not the rate chosen is optimum can be judged only by adopting it and then studying its
impact on the economy.
4. Transient Nature: There is no rate which is optimum for all times to come. The very
dynamism of modern economies means that exchange rates should also be adjusted in
response to the changing situation.
5. Economic Cost of Controls: A successful policy of fixed exchange rate necessitates a
system of controls which has its own economic costs, including possibility of
misallocation of productive resources.
6. Retarding Trade and Capital Flows: Procedural hurdles restrict and retard
international! trade and capital flows, which could be ends in themselves for Exchange
Control Authorities, based on various priorities before them.

Floating Exchange Rate System

The fluctuating exchange rate regime, which is also referred to as the floating/flexible exchange
rate regime is one of several kinds or regime in which the value of a currency can fluctuate
according to movement; of she foreign exchange market. According to this system, exchange
rate fluctuates on a regular basis in response TO the changes n demand and supply forces in the
market. Some financial experts believe that the floating exchange rate regime is the more
appropriate choice to use because it docs not interfere with foreign trade, la fact, some economy
experts strongly believe that floating exchange rates are the better choice over fixed exchange
rates in most circumstances. For one thing, using the floating exchange rate regime, adjustments
are made automatically. Using floating exchange rates also makes i: possible for countries to
lessen shocks, as well as cycles for foreign business. In addition, the floating exchange rate
regime can eliminate the possibility of a country experiencing any type of crisis for balance of
payments.

Fixed versus Flexible Exchange Rates

A nations choice as to which currency regime to follow reflects national priorities about all
facets of the economy, including inflation, unemployment, interest rate levels, trade balances and
economic growth. The choice between fixed and flexible rates may change over time as priorities
change.
At the risk ol over-generalizing, the following points partly explain why countries pursue certain
exchange rate regimes. They arc based on the premise that, other things being equal, countries
would prefer fixed exchange rates.
1. Fixed rates provide stability in international prices for the conduct of trade. Stable prices
aid in the growth of international trade and lessen risks for all businesses.
2. Fixed exchange rates are inherently anti-inflationary, .requiring the country to follow
restrictive monetary and fiscal policies. This restrictiveness, however, can often be a
burden to a country wishing to pursue policies that alleviate continuing internal economic
problem^, such as high unemployment or slow economic growth.
3. Fixed exchange rate regimes necessitate" that central banks maintain large quantities of
international reserves (hard currencies and gold) for use in the" occasional defense of the
fixed rate. As international currency markets have grown rapidly In size and volume,
increasing reserve holdings has become a significant burden to many nations.
4. Fixed rates, once in place, can be maintained at rates that are inconsistent with economic

fundamentals. As the structure of a nations economy changes and its trade relationships
and balances evolve the exchange rate itself should change. Flexible exchange rates allow
this to happen gradually and efficiently, but fixed rates must be changed administratively
- usually too late, too highly publicized and at too large a one-time cost to the nations
economic health.

Types of Flexible Exchange Rate Systems

advantages of flexible exchange rate are as follows

1. Shock Absorption: A flexible rate acts as an absorber of shocks originating from other
countries. To a certain extent, it provides an automatic adjustment and insulation against
foreign disturbances.
2. Effectiveness of Monetary and Fiscal Policies: It increases effectiveness of monetary
policy for domestic stability which can be achieved with less forceful monetary and fiscal
measures.
3. BOP Adjustment: It helps in restoring balance of payments equilibrium.
4. Foreign Exchange Reserves: If the rate responds to market forces within limits, the
authorities need not intervene at all. And even if they do, they shall need comparatively
less of foreign exchange reserves to act as a buffer since such forces are usually selfregulatory.
5. No Need for International Management of Exchange Rate: Unlike fixed exchange rate
based on a metallic standard, floating exchange rates do not require an international
manager such as International Monetary Fund to look over current account imbalances.
Under the floating system, if a country has large current account deficits, its currency
depreciates.
6. No Need for Frequent Central Bank Intervention: Central banks frequently must
intervene in foreign exchange markets under the fixed exchange rate regime to protect the
gold parity, but such is not the case under the floating regime. Here there is no parity to
uphold.
7. No Need for Elaborate Capital Flow Restrictions: It is difficult to keep the parity intact
in a fixed exchange rate regime while portfolio flows are moving in and out of the
country. In a floating exchange rate regime, the macroeconomic fundamentals of
countries affect the exchange rate in international markets, which, in turn, affect portfolio
flows between countries. Therefore, floating exchange rate regimes enhance market

efficiency.
8. Greater Insulation from Other Countries Economic Problems: Under a fixed
exchange rate regime, countries export their macro economic problems to other countries.
Suppose that the inflation rate in the U.S. is rising relative to that of the Euro-zone.

Disadvantages of Flexible Exchange Rate Systems

The disadvantages of flexible exchange rate are as follow
1. Risk to the Economy: Exchange rate determined by free operation of market forces
carries several risks for the economy. If it fluctuates violently over a wide range, it can
cause severe economic disruption in the domestic economy. It also provides a wider
scope for speculative movements of funds which can trigger financial and economic
crises. There are several instances of such crises to merit caution in the matter.
2. Business Risk: In international transactions, each contract is denominated in a single
currency which is a foreign currency to at least one of the transacting parties. With a
flexible exchange rate, a party making or receiving a payment in the foreign currency is
exposed to an additional business risk if constraints of time or other causes prevent taking
out adequate forward cover. This in turn can have the effect of retarding international
transactions.
3. Money Supply: In most countries, supply of 'high-powered money (H) varies in direct
proportion to changes in foreign exchange reserves of monetary authorities; each
variation in H results in a multi fold variation in the supply of total money and credit.
Though, it can contribute the instability of prices and employment, it is not always
possible to "sterilize" the variations in foreign exchange reserves.
4. Higher Volatility: Floating exchange rates are highly volatile. Additionally,
macroeconomic fundamentals cannot explain especially short-run volatility in floating
exchange rates.
5. Use of Scarce Resources to Predict Exchange Rates: Higher volatility in exchange
rates increases the exchange rate risk that financial market participants face. Therefore,
they allocate substantial resources to predict the changes in the exchange rate, in an effort
to manage their exposure to exchange rate risk.
6. Tendency to Worsen Existing Problems: Floating exchange rates may aggravate
existing problems in the economy. If the country is already experiencing economic
problems such as higher inflation or unemployment, floating exchange rates may make

the situation worse. For example, if the country suffers from higher inflation, depreciation
of its currency may drive the inflation
rate higher because of increased demand for its goods; however, the countrys current
account may also worsen because of more expensive imports.

Managed Float:
A managed float exchange rate system is an international financial arrangement, whereby central
banks intervene only periodically, not necessarily to support a country's currency, but rather to
stabilize volatile fluctuations in foreign exchange rates. A managed float is some times called a
"dirty float" because exchange Kites are free to fluctuate, but central banks are committed to
intervene under conditions of perceived instability. The central bank steps in to offset only so
much of a change in demand or supply to bring the exchange rate back into an acceptable "band"
or range of exchange rates.
In other words, a managed currency is an exchange rate that is basically floating in the foreign
exchange markets but is subject to intervention from time to time by the monetary authorities, in
order to resist fluctuations that they consider to be undesirable.
Normally the currency floats freely in the market - the value is determined by the forces of
supply and demand for a given currency. But the government and/or central bank of a country
may decide to use intervention in the currency market as a way of manipulating its value to
achieve given macroeconomic objectives.
For example, an attempt to bring about a depreciation to:
1) Improve the balance of trade in goods and services/improve the current account position.
2) Reduce the risk of a deflationary recession - a lower currency increases export demand and
increases the domestic price level by making imports more expensive.
3) To re-balance the economy away from domestic consumption towards exports and investment.
4) Selling foreign currencies to overseas investors as a way of reducing the size of government
debt.
Or to bring about an appreciation of the currency
1) To curb demand-pull inflationary pressures; and
2) To reduce the price of imported capital and technology.

When intervening, a central bank can

1) Buy and sell domestic and -foreign currencies in the market.

2) The central bank may choose instead to change policy interest rates - e.g., raising interest
rates in a bid to attract short-term inflows of hot money into their domestic banking
system from overseas.
3) Although many currencies are officially free-floating it is not difficult to find examples of
central bank intervention.

Advantages of Managed Float

The managed float attempts to combine the advantages of both the fixed and flexible exchange
rate systems, depending on the degree of instability. The less instability, the less intervention is
necessary by central banks and they can pursue quasi-independent*domestic monetary policies
to stabilize their own economies. The greater the instability, the more intervention, is necessary
by central banks and the less free they are to pursue independent domestic monetary policies
because they are frequently required to use their money supplies to calm disturbances in the
foreign exchange markets.

Disadvantages of Managed Float

One main disadvantage is the lack of transparency in the central bank behavior as the criteria
for intervention is not disclosed in managed float. This may actually introduce more
uncertainty and at times could reduce credibility. Another shortcoming is ^at the effects of %
intervention are typically short-lived and can actually be more destabilizing. ASEAN countries
that are presently categorized to operate under the managed float regime are Singapore, Laos
and Cambodia.

I.2.2.9. Pegged Exchange Rate Regime

A pegged exchange rate system is a hybrid of fixed and floating exchange rate regimes.
Typically, a country will "peg" its currency to a major currency such as the U.S. dollar, or to a
basket of currencies. The choice of the currency (or basket of currencies) is affected by the
currencies in which s the country's external debt is denominated and the extent to which the
country's trade is concentrated with particular trading partners. The case for paging to a single
currency is mode stronger if the peg is to the currency of a principal trading partner. If much
of the country's debt is denominated in other currencies, the Choice of which currency to peg it
to
becomes more complicated.

In me pegged exchange rate regime, the value of the currency is pegged to some major
currency like U.S Dollar, Euro, or to a currency basket. The plus point of this system is that it
imposes monetary discipline a nation and checks inflation, whereas the minus point is that it
becomes very difficult Cot a smaller nation to maintain the peg if the currency comes under
speculative attack in the foreign exchange market White a pegged exchange rate regime is used
for a variety of reasons, it is most commonly associated with stabilizing currency value to the
other currency pegged to which makes investments and trades between the two countries more
predictable.
Advantages of Craw ling Pegged Exchange Rate
Following are the advantages of pegged exchange
rate:
1) The system potentially avoids the economic instability associated with the infrequent bin
discrete adjustment which characterize the fixed exchange rate, and
2) They reduce uncertainty due to volatility characterizing floating exchange rate.
Disadvantages of Crawling Pegged Exchange Rate
Sometimes it is difficult to realize in practice the above advantages if crawling pegged
exchange rate system generating substantial currency flows in anticipation of exchange rate
realignment. There flows might prompt monetary authorities to accelerate their currency
realignments, therefore creating an erratic adjustment process and exposing market operators
to unsystematic economic costs.
1.2.3.

Current Exchange Rate Arrangements

The IMF currently classifies exchange late arrangement into eight separate regimes
1) Exchange Arrangements with no Separate Legal Tender: The currency of another
country circulates as the sole legal tender or the country' belongs to a monetary or
currency union in which the same legal tender is shared by the members of the union.
Examples included Ecuador, El Salvador and panama using the U.S. dollar and the 12
euro zone member countries (like France, Germany and Italy) sharing the common
currency, the euro.
2) Currency Board Arrangements: A monetary regime based on an explicit legislative
commitment to exchange domestic currency for a specified foreign currency at a fixed

exchange rate, combined with restrictions on the issuing authority to ensure the
fulfillment of its legal obligation. Examples includes Hong Kong fixed to the U.S.
dollar and Estonia fixed to the euro.
3) Other Conventional Fixed Peg Arrangement: The country pegs its currency
(formally* or de facto)'- at a fixed rate to a major currency or a basket of currencies
where the exchange rate fluctuates within a narrow margin of less than 1 per cent, plus
or minus, around a central rate. Examples include Morocco, Saudi Arabia and Ukraine.
4) Pegged Exchange Rates within Horizontal Bands: The value of the currency is
maintained within margins of fluctuation around a formal or de facto fixed peg that are
wider than at least 1 per cent, plus or minus, around a central rate. Examples include
Denmark, Slovenia and Hungary.
5) Crawling Pegs: The currency is adjusted periodically in small amounts at a fixed, proannounced rate or in response to changes in selective quantitative indicators. Examples
are Bolivia, Costa Rica and Tunisia.
6) Exchange Rates within Crawling Bands: The currency is maintained within certain
fluctuation margins around a central rate that is adjusted periodically at a fixed proannounced rate or in response to changes in selective quantitative indicators. Examples
are Belarus and Romania.
7) Managed Floating with no Pre-announced Path for the Exchange Rate: The
monetary authority influences the movements of the exchange rate through active
intervention in the foreign exchange market without specifying, or pre-committing to, a
pre-announced path for the exchange rate. Examples include Algeria, China, P.R.,
Czech Republic, India, Russia, Singapore and Thailand.
8) Independent Floating: The exchange rate is market determined, with any foreign c,
aimed at moderating the rate to change and preventing undue fluctuations in the
exchange, establishing level for it. Example* include Australia, Brazil, Canada, Korea,
Mexico Switzerland and the United States.

1,2.4.

Currency Board

A currency board is a monetary authority that issues notes and coins convertible into a foreign
anchor at a fixed exchange rate. The anchor currency is a currency chosen for its expected
stability, and international , acceptability. For most currency boards, the U.S. dollar or L.K.

pound has been the anchor currency,

few currency boards have used gold as the anchor.

Usually, the fixed exchange rate is set by law, ma> changes to "inc exchange rate very costly
for governments. Put simply, currency boards offer the strongest f of a fixed exchange rate
that is possible short of full currency union.
The commitment to exchange domestic currency for foreign currency at a fixed exchange rate
requires that die currency board have sufficient foreign exchange to honor this commitment.
This means that its holdings of foreign exchange must at least equal 100 per cent of its notes
and coins in circulation, as set by .aw A currency board can operate in place of a central bank
or as a parallel issuer alongside an existing central bank. Usually, a currency board takes over
the role of a central bank in strengthening the currency of a developing country.
By design, a currency board has no discretionary powers. Its operations are completely
passive and automatic. The sole function of a currency board is to exchange its notes and
coins for the anchor at a fixed rate. Unlike a central bank, a currency board does not lend to
the domestic government, to domestic companies, or to domestic tanks. In a currency board
system, the government can finance its spending only by taxing or borrowing, not by printing
money, and thereby creating inflation. This results from the stipulation that the backing of tie
domestic currency must be at least 100 per cent.
According to Williamson, Currency board is a monetary institution that issues base money
solely in exchange for foreign assets, specifically the reserve currency.
Currency boards can confer considerable credibility on fixed exchange-rate regimes. The
most vital contribution a currency board can make to exchange-rate stability is by imposing
discipline on the process of money creation. This results in greater stability of domestic
prices, which, in turn, stabilizes the value of the domestic currency. In short, the major
benefits of the currency-board system are as follows:
1) Making a nations currency and exchange-rate regimes more rule-bond and predictable.
2) Placing an upper bound on the nations base money supply.
3) Arresting any tendencies in an economy toward inflation.
4) Forcing the government to restrict its borrowing, to what foreign and domestic lenders are
willing to lend it at market interest rates.

5) Engendering confidence in the soundness of the nations money', thus assuring citizens and
foreign investors that the domestic currency can always be exchanged for some other
strong currency; and
6) Creating confidence and promoting trade, investment, add economic growth.
A currency board is a monetary institution that only issues currency to the extent that it is
fully backed by foreign rescues. In other words, a currency board is an extreme form of the
fixed exchange rate regime under which local currency is fully backed by the U.S. dollar or
any other chosen currency. Its major attributes include.
1) An exchange rate that is fixed not just by policy, but by law,
2) A reserve requirement to the extent that a countrys reserves are equal to 100 per cent of its
notes and coins in circulation.
3) Money supply and thus the amount of spending as well.
4) No central bank under a currency board system.
We use a more specific definition and state that a currency board is an establishment by law,
which covers the following issues:
1. The exchange rate is pegged to the anchor currency without the existence of a certain
fluctuation hand,
2. The monetary base is covered with at least 100% of foreign reserves (of the anchor
currency).
3. 'The currency board guarantees full convertibility.

Features of Currency Boards

1) The first and foremost condition that has to be met by a national currency board is that the
reserves of foreign currency which it holds should be enough to convert all notes and coins held
by them into attest 110% to 115% of the base value.
2) The board has an absolute control over the convertibility foreign currency in coins and notes
at a fixed exchange rate in relation to the domestic rates, and there may be no restriction in
the case of current or capital account transactions.
3) The board can earn profit through interest only from foreign currency held by it.
4) The currency board does not have any discretionary power and it cannot lend any money to
the government. Likewise, the government cannot print extra money for its expenses and has
to acquire this through taxes or borrowing,

5) The board cannot lend money to commercial banks.

6) Finally, the currency board cannot manipulate interest rates by applying discounts to certain
banks. The pegging system is what controls the rates and keeps them closely aligned with the
countries concerned.

1.2.4.2.

Disadvantages of Currency Boards

Following are the disadvantages of currency boards

1) Real Appreciation: When the inflation rates after fixing the exchange rate under a currency
board do tot converge quickly and completely to the inflation rates of the anchor currency,
the country experiences a real appreciation, which induces a loss of competitiveness. This
problem occurs when the currency board U not completely credible (i.e., when the private
sector assumes that it is repealed with a certain probability) or when the tax system is
inefficient.
2) Procyclical Money Supply: A problem which is likely to appear under a currency board is
that the money supply behaves procyclical. In good times, money flows in and the interest
rate falls, this leads to more private consumption and investments and may contribute to an
overheating of the economy. In bad times, the opposite is true. Money flows-out, interest
rates rise and private demand is crowded-out, which makes a recession more severe.
3) Start-Up Problem: Another problem is the start-up problem, i.e., how to solve the question
where die foreign reserves come from to issue the own currency and fulfill the 100% reservebacking criterion.
3) Seignior age Problem: The last problem is the seignior age problem. The currency board's
100% backing- rule requires that the monetary base is completely backed by liquid reservecurrency assets. The revenues of these assets are usually lower compared to that of a
common central bank, which also holds higher interest- bearing domestic assets and
government bonds as reserves.
1.2.5.

Foreign Exchange Market Intervention

Foreign exchange market intervention is a monetary policy tool in which a central bank takes an
active participatory role in influencing the monetary fluids transfer rate of the national currency.
Central banks, especially those in developing countries, intervene in the foreign exchange market

in order to build reserves, stabilize the exchange rate, and to correct misalignments. The success
of foreign exchange intervention depends on how the central bank sterilizes the Impact of its
interventions, as well as general macroeconomic policies set by the government.
In other words, intervention in foreign exchange market can to an important tool for central
banks, particularly in developing countries. However, it can put the central bank's
credibility and scarce foreign exchange reserves at risk. Operational aspects of intervention,
including the timing* frequency, amounts, modalities of intervention, are among the most
important decisions taken by monetary authorities.
Reasons for Foreign Exchange Market Intervention
There are four broad based reasons why central banks Intervene In the foreign exchange market
1) Misalignment: Central banks intervene in the foreign exchange market to influence the level
of exchange rate. Usually* central banks believe that the market is driving the exchange rate
away from Its equilibrium* value and intervenes to break the momentum.

'.

2) Calming a Disorderly Market: Central banks intervene to calm the market and so it from
becoming disorderly. Rapid movement in the exchange rate may at times threaten the orderly
functioning of the market, leading to a widening of spreads and at times loss of liquidity. this
action serves to discourage the market from becoming one-sided.
3}Signaling/Accommodating Monetary Policy: Intervention may be used to signal future
changes to monetary policy or possibly calm expectations if monetary policy is changed
unexpectedly, which might otherwise lead to a loss in confidence and thereby induce an
unwarranted move in the exchange rate.
4) Reserve Building: Central banks intervene to maintain an inventory of net foreign currency
assets.
I.2.5.2.

Types of Foreign Exchange Market Intervention

There are two foreign exchange market interventions which are as

follows
1} Sterilized Intervention
2) Unsterilized Intervention
I.2.5.2.I. Sterilized Intervention

It is a method used by monetary authorities to equalize the effects of foreign exchange

transactions on the domestic monetary base by offsetting the purchase or sale of domestic
assets within the domestic markets. This process limits the amount of domestic currency
available for foreign exchange. In other words, sterilized intervention is a way for a country to
alter its debt composition without affecting its monetary base. It is used to counter undesirable
exchange-rate movements. For example, a decrease in the value of a countrys domestic
currency would cause a debt instrument issued in a foreign country and denominated in that
foreign countrys currency to be made more expensive.
The attempt to stabilize the value of the domestic currency by the Central Bank under the fixed
exchange rate regime results in a sale or purchase of foreign currency or domestic currency in
the foreign exchange market. Such interventions affect the monetary base and, through money
multiplier, the total money supply in the economy which leads to changes in overall price
level, inflation rate, and other economic variables. To counteract the impact of its interventions
in the foreign exchange market on the money supply, the Central Bank of the country pursues
sterilization interventions.
In the case of heavy inflow of foreign currency resulting in build-up of foreign exchange
reserves and the increase in money supply the Central Bank sterilizes the impact through
pursuing tight monetary policies.
These can take form of
1) Open market sale of government securities.
2) Increase in the policy rate, i.e., bank rate, repo/reverse repo rate; and
3) Impounding of bank reserves through increase in CRR.
On the other hand, impact of heavy outflow of-heavy currency resulting in sharp deletion in
foreign exchange reserves and consequently sharp reduction in money supply is sterilized
through pausing easy monetary policy. This can take the form of
1) Open market purchase of government securities.
2) Reduction in the policy rate, i.e., bank rate, repo/reverse repo rate; and
3) Releasing of bank reserves through reduction in CRR.
Sterilization also has its limit. Large inflow and outflow of foreign currency from the country

and consequent accumulation or depletion of foreign exchange reserves of the Central Bank
requires large holding of the government securities (as often sterilization measures are
conducted through open market sale or purchase of the government securities) by the Central
Bank. The cost of conducting sterilization may thus be substantial.

1.2.5.2.2. Unsterilized Intervention

Unsterilized intervention is an attempt by a countrys monetary authorities to influence
exchange rates and its money supply by not buying or selling domestic or foreign
currencies or assets. This is a passive approach to exchange rate fluctuations, and allows
for fluctuations in the monetary base. If the central bank purchases domestic currency by
selling foreign assets, the money supply will shrink because it has removed domestic
currency from the market; this is an example of a sterilized policy. An unsterilized policy
allows for the foreign- exchange markets to function without manipulation of the supply
of the domestic currency; therefore, the monetary base is allowed to change.
1.3. INTERNATIONAL FINANCIAL SYSTEM
1*3*1. Introduction
The international financial system consists of the numerous rules, customs, instruments,
facilities, markets, and organizations that enable international payments to be made and
funds to flow across borders. In recent years, the international financial system has
experienced tremendous growth. New financial instruments have been created, and the
volume of transactions has exploded. The dramatic metamorphosis of international
financial markets is driven by technological changes, the growth in world trade, and the
breakdown of barriers to financial (capital) flows.
From an economic standpoint, developments in the international financial system have
made financial markets more efficient because funds (financial capital) can more easily
flow around the world to wherever they will earn the highest return. Over time, as
resources are allocated more efficiently, both developed and developing countries should
experience increased economic growth. As a result, living standards around the world
should rise more than they otherwise would have.
A more globalized environment can also entail costs. A disturbance in one financial

market or in one country can have immediate effects on other countries and on the entire
international financial system. According to Alan Greenspan, These global financial
markets, engendered by the rapid proliferation of cross-border financial flows and
products, have developed a capability of transmitting mistakes at a far faster pace
throughout the financial system in ways that were unknown a generation ago.
1.3.2. Evolution of International Financial System
International financial system consists of international financial market, international financial
institutions and international financial instruments. It is divided into three sections:

Meaning of International Financial Markets

Global financial markets play a crucial role in promoting economic well
being by bringing buyers end sellers together. When a multinational
enterprise finalizes its foreign investment project, it needs to select a
particular source, or a mix of sources of funds to finance the investment
project. Here, it may be noted than a multinational enterprise positions itself
on a better footing than a domestic firm as far as the procurement of funds is concerned. A
domestic firm gets funds normally from domestic sources. It does get funds from the
international financial market too but it is not as easy as in case of a multinational enterprise. The
latter can use the parent companys funds for its foreign investment project. It can also get funds
from the host country financial market, but more importantly, it tries to get funds from the

international financial market. It selects a particular source or a mix of sources or a particular

type or types of funds that suits its corporate objectives
When one discusses the sources of funds in the global financial market, the discussion
takes into account both, the supply aspect and the demand aspect. It embraces, on one hand, the
official and non-official sources of funds and the changing profile of the international financial
market over past few decades; and on the other, the selection of the sources of funds by the
multinational firms depending on the fulfillment of the corporate objectives
1.4.1.

Functions of International Financial Market

The basic functions of international financial market are:

1. Price Setting: The value of a pounce of gold or a share of stock is no more, and no less, than
what someone is willing to pay to own it. Markets provide price discovery, a way to
determine the relative values of different items, based upon the prices at which individuals
are willing to buy and sell them.
2. Asset Valuation: Market prices offer the best way to determine the value of a firm or of the
firms assets or property. This is important not only to those buying and selling businesses,
but also to regulators. An insurer, for example, may appear strong if it values the securities it
owns at the prices it paid for them years ago, but the relevant question for judging its
solvency is what prices those securities could be sold for if it needed cash to pay claims
today.
3. Arbitrage: In countries with poorly developed financial markets, commodities and currencies
may trade at very different prices in different locations. As traders in financial markets
attempts to profit from these divergences, prices move towards a uniform level, making the

entire economy more efficient.

4. Raising Capital: Firms often require funds to build new facilities, replace machinery or
expand their business in other ways. Shares, bonds and other types of financial instruments
make this possible. Increasingly, the financial markets are also the source of capital for
individuals who wish to buy homes or cars, or even to make credit card purchased.
5. Commercial Transactions: The financial markets provide the grease that makes many
commercial transactions possible. This includes such things as arranging payment for the sale
of a product abroad, and providing working capital so that a firm can pay employees if
payments from customers run late. The stock, bond and money markets provide an
opportunity to earn a return on funds that are not needed immediately, and to accumulate
assets that will provide an income in future.
6. Risk Management: Futures, options and other derivatives contracts can provide protection
against many types of risk, such as the possibility that a foreign currency will lose value
against the domestic currency before and export payment is received. They also enable the
markets to attach a price to risk, allowing firms and individuals to trade risk until they hold
only those that they wish to retain

1.4.2. Structure of International Financial Markets

International financial markets can be classified into three parts:

1.5.1.

Meaning of Euro Currency Market

The Eurocurrency market consists of banks (called Euro banks) that accept deposits and
make loans in foreign currencies. A Eurocurrency is a freely convertible currency deposited
in a bank located in a country which a not the native county of the currency. The deposit can
be placed in a foreign bank or in the foreign branch! Of a domestic US bank.

In the Eurocurrency market, investors hold short-term claims on commercial banks which
intermediate to transform these deposits into long-term claims on final borrowers. The
Eurocurrency market is dominated US $ or the Eurodollar.
The Eurocurrency markets came into existence in late 50s when major European countries
greatly relaxed exchange control regulations and made their currencies convertible for nonresidents. Hence pound sterlingdeposits held by Banks in U.S.A. are called Euro-Sterling.
Deutsche mark held by banks in France is Euros j marks and so on. They are all Euro
currencies. Euro dollars are the main Euro currencies and are the most! 1 traded Currencies.
Hence Euro Currency market is known as Euro-dollar market.

The main difference between Euro markets and their domestic counterparts is that Euro markets
are free from! Regulations like cash reserves, deposit insurance, maximum ceiling on interest
etc., which effectively bring! H down the cost of funds. Similarly Eurobonds are free from
regulations like credit rating and disclosure normsthese differences account for Euro markets
occupying special place in the field of international finance

1.5.2.

Features of Euro Currency Market

The following are the features of the Eurocurrency market:

1. Coins and Banknotes: All euro coins have a common side and a national side chosen by the
respective national authorities. The euro is divided into 100 cents (sometimes referred to as
euro-cents, especially when distinguishing them from other currencies). In official context,
the plural forms of euro and cent are spelt without the notwithstanding normal English usage.

Otherwise, normal English plurals are recommended and used.

All circulating coins have a common side showing the denomination or value and a map in
the
Back ground
The design for the euro banknotes have common designs on both sides. The design was
created by RobertKalian. Notes are issued in 500, 200, 100, 50, 20, 10, 5. Each
banknote has its own color and is 8 dedicated to an artistic period of European architecture.
The front of the note features windows or gateways] while the back has bridges. Care has
been taken so that the architectural examples do not represent any actual existing monument,
so as not to induce jealousy or controversy in the choice of monuments. Some of thehighest
denominations such as the 500 are not issued in all countries, though they remain legal
tender throughout the Eurozone.
2) Payments Clearing, Electronic Funds Transfer: All intra-EU transfers in euro are considered
as domestic payments and bear the corresponding domestic transfer costs. This includes all
member States of the EU,] even those outside the Eurozone providing the transactions are
carried out in euro. Credit/debit card charging and ATM withdrawals within the Eurozone
are also charred as domestic, however, paper-based payment orders, like cheque, have not
been standardized so these are still domestic-based. The ECB has also set up a clearing
system, target, for large euro transactions.
3) Currency Sign:A special euro currency sign () was designed after a public survey hid
narrowed the original ten proposals down to two. The European Commission then chose the
design created by the Belgian Alain BHliet. The European Commission also specified a euro
logo with exact proportions and foreground/background color tones. While the Commission
intended the logo to be a prescribed glyph shape, font designers made it clear that they
intended to design their own variants instead. Typewriters lacking the euro sign can create it
by typing a capital , backspacing and over-striking it with the equal (=) sign. Placement of
the currency sign relative to the numeric amount varies from nation to nation andthere is no
official recommendation on the issue. Transactions in a currency take place outside the
country where the currency is a legal tender

4) Regulatory Authorities: Eurocurrencies are outside the direct control of the regulatory
authorities but still they are subject to indirect controls by authorities since all the
settlements in the currency have to take place in the country of issue.
5) Provide Free Access to New Entrants: Eurocurrency markets are highly sophisticated
and provide free access to new entrants. This resulted in competitiori of the highest
order and the players in the market Operate oh very thin margins. Margin means the
spread between the borrowing and lending interest rates.
6) Floating Interest Rate: Another interesting feature of Eurocurrencies markets is the
floating interest rate concept. Under this, the rate of interest on the borrowings and
lending are linked to a base rate called London Inter-bank Offered Rate (LIBOR). The
interest rate will be reviewed at periodical intervals, say 6 months and changed in line
with the LIBOR
1.5.3

Euro-Dollar Market

Euro-dollar market is the creation of the international bankers. It is simply a short-term

money market facilitating banks borrowings and lendings of U.S. dollars. The fetor-dollar
market is principally located in Europe and basically deals in U.S. dollars. Eurodollars are
borrowed by U.S. and foreign corporations for various purposes but especially to pay for
goods imported from the United States and to invest in U.S. security markets also. U.S.
dollars used as an international currency qr medium of exchange, and many Eurodollars
also used for this purpose. Eurodollars are usually held in Interest bearing accounts. The
interest rate paid on these deposits depends: llon the banks lending rate,
1) On rates of return available on U.S. money market instruments.
2) On rates of return available on U.S. money market instruments.
1.5.3.

Euro-Dollar Market

Euro-dollar market is the creation of the international bankers. It is simply a short-term

money market facilitating banks borrowings and lendings of U.S. dollars. The fetor-dollar
market is principally located in Europe and basically deals in U.S. dollars. Eurodollars are

borrowed by U.S. and foreign corporations for various purposes but especially to pay for
goods imported from the United States and to invest in U.S. security markets also. U.S.
dollars used as an international currency qr medium of exchange, and many Eurodollars
also used for this purpose. Eurodollars are usually held in Interest bearing accounts. The
interest rate paid on these deposits depends: llon the banks lending rate,
1.5.4.

Advantages of Euro Currency Market

Following are the benefits of euro currency market:

1) It has provided global short-term capital market, owing to a high degree of mobility of the
Euro-dollars.
2) Euro-dollars are useful for the financing of foreign trade.
3) It has enabled the financial institutions to have greater elasticity in adjusting their cash and
liquidity positions.
4) It has enabled importers and exporters to obtain credit for financing trade at cheaper
charge than otherwise ^available.
5) It has helped in plummet the profit margins between deposit rates and lending rates.
6) It has promoted international monetary cooperation.
7) It is a major source of short-term loans to finance corporate working capital needs and
foreign trade.
8) Euro-currency markets are becoming a major source of long-term investment capital for
MNCs.
1.5.5.

Disadvantages of Euro Currency Market

The Eurocurrency market has two disadvantages:

When depositors use a regulated banking system, they know that the probability of a bank failure
that would cause them to lose their deposits is very low. Regulation maintains the liquidity of the
banking system. In an unregulated system such as the Eurocurrency market, the probability of a
bank failure that would cause depositors to lose their money is greater (although in absolute
terms, still low). Thus, the lower interest rate received on home-country deposits reflects the
costs of insuring against bank failure. Some depositors are more comfortable with the security of
such a system and are willing to pay the price

International money market

1.6.1. Meaning of International Money Market

The international money market is the market that handles the international currency transactions
between the various central banks of the nations. In the international money market, the
transactions are carried-out mainly in gold or in U.S. dollar. The international money market is
governed by the international monetary transactionsbetween various nations currency. The
international money market mainly handles the currency trading between the countries. The
trading of one countrys currency for another one is also named as the foreign exchange currency
trading or forex trading.
The basic performance of the international money market involves the money borrowing or
lending by a government or some large financial institutions. Unlike share markets, the
international money market dealswith much larger fund and the players of the market are big
financial institutes. The international money market allows investing in a less risk while the
return that comes from that is also less. The best way to invest in the international money market
is by money market mutual funds or treasury bills
The international money market takes care of the exchange rates on a regular basis. Currency
band, exchangerate regime, fixed exchange rate, linked exchange rate, and floating exchange
rates are some of the other indices that govern the international money market in a huge way.

1.6.2. International Money Market Instruments

The instruments of international money market are as follows:
1. Eurocurrency: The emergence of the Eurocurrency markets was one of the most important
developments, in post-war international banking. Originally serving as a source of short-term
funds for trade financing, the markets expanded to facilitate banks foreign exchange transactions
and to provide money market trading facilities. Not long after the first transactions occurred, the
Eurocurrency market became the central mechanism for channeling international funds flows
among banks, and the London Interbank Offer Rate (LIBOR) became one of the best known and

most important international interest rates. Now most Eurocurrency transactions are priced in
terms of LIBOR plus a premium reflecting the risk of the arrangement, just as domestic loans are
priced in relation to prime
2. Euro Credits: The term Euro credit refers to loans in a currency that is not the lending banks
national currency. Euro credit loans are large and long-term, and usually only large corporations
and government agencies request them. Banks that extend these loans usually also participate in
the Eurocurrency Market, where they hold deposits in currencies other than the local currency.
The prefix euro is often used in finance to refer to funds in a foreign currency and has nothing
to do with Euro currency or European countries. A bank extends a euro credit loan when the loan
is not in the banks national currency loan ois extended in a country other bank than the one in
whose currency the loan is denominated. For example an American bank provides a loan
denomination in japan yen or Russian rubles for an company. Euro credit loans increased the
flow of capital between various countries and help governments to finance their investment
3. Euro Certificate of Deposit: Certificate of deposit is a certificate issued by a bank evidence
money and carries the banks guarantee for the repayment of principal and interest. Certificate are
negotiable instruments and are issued payable to bearer and are traded in the secondary
certificates of deposits are issued for a minimum denomination of U.S. dollar 50,000/- and for a
maxi period generally of 1 year. Certificates of deposits provide an excellent avenue to the
investors Eurocurrency market who would like to park their surplus in a high interest instrument
with Liquidity. For example, if a bank has surplus fund, which it would like to invest for a period
of say i it can buy a 4 C.D. for 3 months. If need be, the bank can sell the C. D. in the secondary
market and liquidate it
4. Euro Commercial Papers: Commercial paper is a short term unsecured promissory note that is
generally sold by large corporations on discount basis to institutional investors and other
corporates for maturities ranging from 7 to 365 days. Commercial paper is cheap and flexible
sources of fund for highly fated borrowers as it works out cheaper that bank loans. For an
investor it is an attractive short-term investment, which offers higher interest than bank deposits
5. Euro notes: Euro Notes are the notes of the euro, the currency of the euro zone. They have been
in circulation since 2002 and are issued by the European Central Bank (ECB). Each bearing the
signature of the President of the European Central Bank. Denominations of notes range from 5
to 500 and, unlike euro coins, the design is identical across the whole of the Eurozone, although

they are printed in various member states. Euro-notes encompass note-issuance facilities, those
that are underwritten, as well as those that are not underwritten
6. Floating Rate Notes: The floating-rate note is, as the name implies, an instrument whose interest
rate floats* with prevailing market rates. It pays a three or six months interest rate set above, at,
or below, LIBOR. This interest rate is reset every three or six months to a new level based on tlie
prevailing LIBOR level at the reset date. Floating Rate Notes (FRNs) are bonds that have a
variable coupon, equal to a money market reference rate, like LIBOR or federal funds rate, plus a
spread. The spread is a rate that remains constant. Almost all FRNs have quarterly coupons, i.e.,
the pay out interest every three months, though counter examples do exist At tlie beginning of
each coupon period, the coupon is calculated by taking the fixing of the reference rate for that
day and adding the spread. A typical coupon would look like 3 months USD LIBOR -0.20%
7. Bankers Acceptances: This is an instrument widely used in the US money market to finance
domestic as well as international trade. In a typical international trade transaction, the seller
(exporter) draws

time or usance draft on the buyers (importers) bank. On completing the

shipment, the exporter hands over the shipping documents and the letter of credit issued by the
importers bank to its bank. The exporter gets paid the discounted value of the draft. The
exporters bank presents the draft to the importers bank which stamps k as accepted. A
bankers acceptance is created.

INTERNATIONAL CAPITAL MARKETS:

1.7.1 Meaning of International Capital Market
The capital market deals in long-term claims to assets, such as government bonds, and corporate
shares and debentures. The demand for long-term funds in roost countries, comes from
individuals, unincorporated concerns, business corporations, public corporations and the
governments
Capital markets now exist practically in all those countries where some industrialization has
taken place. However, the major capital markets in the leading industrialized countries have
acquired-international character. From this point of mow the New York capital market now
enjoys a unique position. London was tile principal capital market in the late eighteenth and the
nineteenth centuries. Its importation the New York capital market has been less in the twentieth
century due to the decline of the UK as an economy power

Types of international capital market

Markets are classified into
International Bond Markets
The international bond market may be defined as a market for bonds, which arc sold anywhere
in the world but not in the geo-graphical territory of the country in which it is denominated.
Mostly, funds raised by the borrowers in such market consist of foreign currencies (i.e. other
than the borrowers home currency) but on some occasions, the borrower can borrow from such
international market in his home currency like a U.S. company borrowing euro dollar.
The international bond market, also known as the global bond market, is similar to the
stock market. The major difference is instead of trading stocks, investors trade what is known as
debt securities, usually in the form of bonds. The international bond market trades bonds over
electronic trading networks. There is no physical location for investors to gather, such as the
stock markets New York Stock Exchange. All transactions are conducted over the counter by
Internet or by phone. A few corporate bonds are actually listed on an exchange system
Types of International Bond Market
Following are the types of international bond market
1. Foreign Bond Market: The foreign bond market is that in which bonds are brought-out by
foreign borrowers. The foreign bonds are normally designated in the local currency. The
local market authorities look after the issuing and selling of foreign bonds
2. Eurobond Market: Euro bonds constitute a major source of borrowing in the
Eurocurrency market. A bond is a debt security issued by the borrower, which is
purchased by the investor and it involves in the process some intermediaries like
underwriters merchant bankers etc. The bonds are issued on behalf of governments, big
multinational corporations, etc
International Debt Sources
The international debt sources are as follows
1.

International Bank Loans: International bank loans have traditionally been sourced in the
Eurocurrency

Markets. Eurodollar bank loans are also called Eurodollar credits or simply 'Euro credits'
There are two components of international bank loans
I.

Euro credits: Euro credits are bank loans to MNEs, sovereign governments, international
institutions, and banks denominated in Eurocurrencies and extended by banks in

II.

countries other than the country in whose currency the loan is denominated
Syndicated Credits: The syndication of loans has enabled banks to spread the risk of very
large loans among a number of banks. Syndication is particularly important because
many large MNEs need credit in excess of a single banks loan limit. A syndicated bank
credit is arranged by a lead bank on behalf of its client

2. Euro Notes Market: The Euro note market is the collective term used to describe short to
medium-termdebt instruments sourced in the Eurocurrency markets. The euro note market has
four main components
I.

Euro Notes: Euro notes ate like promissory notes issued by companies for obtaining
short-term funds. They are denominated in any currency other than the currency of the

II.

country where they are issued. They represent low-cost funding route
Euro Note Facilities: A major development in international money markets was the
establishment of facilities for sales of short-term, negotiable, promissory notes - Euro
notes. Among the facilities for their issuance were Revolving Underwriting Facilities
(RUFs), Note Issuance Facilities (NIFs), and Standby Note Issuance Facilities (SNIFs).
These facilities were provided by international investment and commercial banks. The
Euro note was a substantially cheaper source of short-term funds than syndicated loans,
because the notes were placed directly with the investor public, and the securitized and
underwritten form allowed the ready establishment of liquid secondary markets. The

III.

banks received substantial fees initially for their underwriting and placement services
Euro Commercial Papers: It is an attractive foam to short-term debt instrument. It is a
promissory note like the short-term Euro notes although it is different from Euro notes in

IV.

some ways. It is not underwritten, while the Euro notes are underwritten
Medium-Term Euro Notes: Medium-term Euro notes are just an extension of short-term
Euro notes as they fill the gap existing in the maturity structure of international financial
market instruments. They are a compromise between short-term Euro notes and longterm. Euro bonds as their maturity ranges from one year and five to seven years

3. Euro Bonds: Following are the important kinds of bonds which are being issued to mobilize debt
internationally
1. Straight Euro Bond: These bonds have fixed maturities and carry a fixed rate of interest Straight
Eurobond are repaid by amortization or in a lump sum at the maturity date. Straight Euro-bond
are technically unsecured (debenture) bonds because almost all of them are not secured by any
specify c property of the borrower. Because of this, bondholders become general creditors in the
event of d rail It. The lenders usually look to the nature of the borrowers assets, its earning
power, and its general credit strength
2. Convertible Euro-Bond: These bonds are convertible into parent common stock and have
become increasingly popular because tile market for straight Euro-bonds has weakened.
Convertible Euro-bonds provide investors with a steady income and an opportunity to participate
in rising stock prices. International investors are inflation-conscious; they prefer convertible
Euro-bonds witch maintain the purchasing power of their money
3. Bond with Warrants: Some Euro-bonds are issued with warrants. A warrant is an option to buy a
stated number of common shares at a stated price during a prescribed period. Warrants pay no
dividends, have no voting rights, and become worthless at expiration unless the pries of the
common stock exceeds the exercise price
4. Currency Option Bonds/Multiple Currency-Bonds: Currency option bond allows the bondholder
receive the interest payment and the principle in any of the currencies specified in the bond. The
bondholder can choose the currency of their coupon and principle from among the two or more
currencies specified in the bond at the pre-determined exchange rate
5. Currency Cocktail or Currency Basket Bonds: Currency basket bonds have been developed to
stabilize the purchasing power of the coupon. This is accomplished by combining various
currencies as per some weighting process. The amount of each currency in basket generally
remain constant but the /a lux- of the basket changes, as some of the currencies depreciate or
appreciate 'relative to each other
International Equity Market
Global equity market is the worldwide markets of funds for equity financing the stock exchanges
throughout the world where investors and firm meets to buy and sell shares of stocks. The global
equity market is attributed to four reasons
1. The international trend towards privatization - i.e., the issuance of formerly state-owned
Companies representing sizable capital. The shares are offered in international markers

2. Emerging economies require relatively larger amounts of funds to support infrastructure

development and new investments; most of these funds are not available locally and thus require
issuing shares on international equity
3. Investment banks are matching, between national corporate entities in need of cash and large
international equity buyers who are located anywhere in the world. Thus, investment banks are
contributing to the growth of the international equity market
4. The development of markets with no physical trading, and thus no specific geographic
location, which are open for trade over the internet, 24 hours, seven days a week. The internetbased capital market, termed the cyber market, is dependent on a global network of high-speed
data transfers, communication satellites, sophisticated support software, and personal computers.
The cyber market requires specific electronic trading standards and practices. The growth of the
cyber market contributes to the growth in the international capital market.
The locations of the MNC's operation can influence the decision of where to place stock, as the
MNCs may desire a county where it is likely to generate enough future cash flow to cover
dividend. The stock of some U.S. based MNCs are widely traded on numerous stock exchange of
some the world. For example, the stock of Coca Cola Company is traded on six stock exchanges
in United States, the German Exchange in Frankfurt and four stock exchanges in Switzerland
. Types of International Equity/Stock Market the types of international equity/ stock markets are
as follows
1) Euro Currency Market: The term Eurocurrency describes deposits of currency, which are
owned by nonresidents of the country, whose legal tender the currency is and which are lent
by the owners. For example, a bank in Japan, whose account with a New York Bank is
credited with U.S.; dollar from an external sores, would be in possession of Euro-Dollar. The
Japanese bank would be in position to lend it anywhere in the world at a comparatively higher
rate of interest to those who would like to borrow dollars. To be used in this way, the
currencies must be freed of restriction as the use
2) Euro Credit Market: Euro credit market is the market where financial banking institutions
provide banking services denominated in foreign currencies. They may accept deposits and
provide loans. Loans provided in this market are medium-term loans, unlike loans made in the
Eurocurrency market
Euro credit market comprises banks that accept deposits and provide loans in large denominations
and in a variety of currencies. The banks that constitute this market are the same banks that
constitute the Eurocurrency market; the difference is that Euro credit loans are longer-term than

so called Eurocurrency tninc Banks participating in the S.No credit market generally also
participate in the Eurocurrency market
International Equity Sources
With the globalization and liberalization of the economy, Indian companies have started
generating funds from international markets. The international sources from where the funds can
be procured include foreign currency loans, commercial banks; financial assistance provided by
international agencies and issues of? Financial instruments like
1. American Depository Receipts (ADRs): An American Depositary Receipt (or ADR)
represents ownership in the shares of a non-U.S. company and trades in U.S. financial
markets. The stock of many non-U.S. companies trade on U.S. stock exchanges through the
use of ADRs
2. Global Depository Receipt (GDRs): Global Depository Receipt (GDR) - certificate issued by
international bank. Global Depository Receipt is a bank certificate given in more than one
county for shares in a foreign company. It is a financial instrument used by private markets to
increase capital denominated in either U.S. dollars or Euros
3. Foreign Currency Convertible Bond (FCCB): Foreign Currency Convertible Bond is just a
convertible bond that is issued in foreign currency. FCCB is a quasi-debt instrument that is
issued in a currency different than the issuers domestic currency with options to either
redeem it at maturity or convert it duo issuing companys stock; It gives two options. One is,
to get the regular interest and principal and the other is to convert the one in to equities. It is a
hybrid between bond and stock
Global/ international financial institution
A variety of agencies have been established to facilitate international trade and financial
transaction agencies often represent a group of nations. Some of the more important agencies are
as follows.

1.8.1

International monetary fund (IMF)

The international monetary fund was conceived in July 1944 during the United Nations monetary
and financial conference. The representatives of 45 governments met in the Mount Washington
hotel in the area of Bretton woods, New Hampshire, United States, with the delegates to the
conference agreeing on a frame work for international economic cooperation, the IMF was
formally organized on December 27, 1945 when the first 29 countries signed its articles of
agreement. The statutory purpose of the IMF today are the same as when they were formulated in
1943
The international monetary fund was created with a goal to stabilize exchange rates and assist the
reconstruction of the worlds international payment system. Countries contributed to a pool which
could be borrowed from, on a temporary basis by countries.
The IMF describes itself as an organization of 186 countries (as of June 29, 2009),
working to foster global monetaiy cooperation, secure financial stability, facilitate
international trade, promote high employment and sustainable economic growth,
and reduce poverty. The IMF was established to promote economic and financial cooperation among its members in order to facilitate the expansion and balanced
growth of world trade. It started functioning from March I, i94/. In June 1996, the
Fund had 182 members.

1.8.1.1

Objectives of International Monetary Fund The objectives of IMF

are as follows:

1. promote international monetary cooperation.

2. To facilitate the expansion of international trade.
3. To ensure stability to foreign exchange rates.
4. To reduce disequilibrium in the International balance of payments of member countries.
5. To promote capital investment jiu^ckward and uhder-developedxountries.
6. To assist in the establishment of a multinational systetn of payments in respect of current
2transactions between the member countries.
7. To secure multilateral convertibility (i.e., to convert the currency of any member into the
currency of any other member).
8. To provide short-term monetary help to members during emergency.
9. To achieve balanced economic growth and high level of employment in member
countries.
Functions/Role of International Monetary Fund
The functions/role of
international monetary
fund are as follow:
ij

\ the IMF offers medium-term loans to the national monetary

sbiKx of payment deficits. The IMF resources come from the oca
as fixed by the IMF in terms of SDR and members own

1.
Regulatory
Functions:
its

In

regulatory

aspect, the IMF

centres under certain conditions as set forth in the General

administera^code of good behavior in international payments. It regulates

exchange rate practices and international payments.
xmmestvi>cC on JtncsteMsshcd ^ agiesQu'wswft edrodcst?mwt
, ,TVc v*s6* pew of memfots*. IJ) IVIRC^^^N TO F<NDNSEWCCS. j|i) The?? access to these
resoscces. s&d
iv) Their share in the dlocatksi of SDRs.
IMF may borrow fh> its internal 3?$ember to Borrow
Consultative Fanctioiis: As a ccftsuMfc. tfc? IMF provides aiorum for international cooperation
and is a seweeofocyftsd&GJrchsucisssisasce ns, members

1. Board of Governors: Board of Governors is the decision-making organ of the Fund. The
Board of Governors is the highest body. It exercises powers and takes decisions. The
Board of Governors consists of one Governor and one Alternate Governor appointed by
each member country. The member country appoints its Finance Minister or the Govemo:
of its Central Bank as the Governor. The Governor has the right to vote. The Alternate
Governor penktrates in the Board Meetings, but has voting right only in the absence of
the Governor.
2. Executive Board: The 24 executive directors land 24 alternates) of the IMF are
responsible for the Funds general operations, ana for this purpose the) exercise ail the
powers delegated to them by the Board of XJOVOV:> ) nooaucuQii u. continuous session
& the bund s headquarters and meet as often as business may require, usually several
times a week.
Of the 24 executive directors, five are appointed by the countries having the largest
quotas (United States, Japan. Germany, France, and the United Kingdom), and the other
19 are elected by regional groups of the remaining members. The IMFs managing,
director also serves as chairman of the Executive Board.
3. Managing Director The managing director, who is chosen by the executive directors, is
responsible for the conduct of the ordinary business of the Fund. He is appointed for a
five-year term and may not serve concurrency as a governor or executive director of the
IMF. The managing director chairs meetings of the executive directors but may vote only
in case of a tie.
The pemuu ,ient headquarters of the IMF are at 700 19^ Street, N.W., Washington, D.C.
20431. As of 21 August 2002, the staff consisted of about 2,650 persons from 140
countries.
The IMF has a regional office for Asia and the Pacific, located in Tokyo.
4. IMF Secretariat: IMF secretariat helps managing director in carrying out the activities.
5. interim Committee: The Interim Committee of the Board of Governors on the
International Monetary System is an advisory bod> made up of 22 Fund Governors,
ministers, or others of comparable rank, representing the same constituencies as in the
Funds Executive Board. The Interim Committee normally meets tvsice a year, in April or
May, and at the time of the Annual Meetings in September or October. It advises and
reports to the Board of Governors on the latters supervision of the management and
adaptation of the International Monetary System, considering proposals by the Funds
Executive Board to ircrease quotas or amend the Articles of Agreement, and dealing with
sudden disturbances that right threaten the International Monetary System; the Interim
Committee also advises the Funds Executive Board ci these matters.
6. Development Committee: The Development Committee (the Joint Ministerial Committee
cf the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources
to Developing Countries) has 22 members - Governors of the Fund and the Bank,

ministers, or others of comparable rank - and generally meets in conjunction with the
Interim Committee. It advises and reports to the Boards of Governors of the Bank and the
Fund on all aspects of the transfer of real resources to developing countries.
1.8.1.4. Advantages of International Monetary Fund
Following are the main benefits which have occurred to the world from the functioning of the
IMF as explained "below:
1. Establishment of a Monetary Reserve Fund: Under this system, the fund is able to
accumulate a sizeable stock of the national currencies of different countries. It is out of
this stock that the fund meets the foreign exchange requirements of the member
countries.
2. Setting up a Multilateral Trade and Payments System: The establishment of the fund has
given stimulus to the setting up of a multilateral trade and payments system. No doubt,
the member countries have been allowed to impose exchange control on commercial
transactions.
3. Improvement is Short Term Disequilibrium in Balance of Payments: By lending foreign
currencies to member countries against their national currency, the fund helps them to
eliminate short term disequilibrium in their balance of payments.
4. Stability of Foreign Exchange Rates: Till recently the fund had succeeded in attaining a
certain amount of stability in foreign exchange rates. The rate of exchange under the
I.M.F. has not circulated as much as they used to be before its establishment. This
stability in foreign exchange rates had the effect of promoting the flow of international
trade among different countries.
5. Check in Competitive Currency Devaluation: Before the-establishment of the fund,
different countries of the world often resorted to competitive currency devaluation to
boost their exports which naturally produced strains in their economic and political
relationship. But after the existence of the IMF no member country has allowed to
devalue its currency without the prior consent of the fund except under certain special
circumstances.
6. No Interference in Domestic Economic Affairs: The fund does not interfere in the internal
economic affairs of member countriesnordoesf it try 'to influence their economic and
monetary policies in any way.

1.8.1.5. Disadvantages of International Monetary Fund

In its working, the fund has revealed several inadequacies iaits structure and provisions. The
shortcoming of IMF is as explained below:
1. Inability to Remove Exchange Controls: /The fund has not succeeded in persuading
member countries to eliminate exchange controls and othqrrestrictionspn foreign trade.
Even today, developed counties, like the USA and UK are continuing wftfrtheir policies
Of protection in the field of international trade.
2. No Solution of the Liquidity Problem: One of the main objectives of the fund was to
promote the international liquidity of its members by lending to them, the required
foreign currencies out of its stock. But, in actual practice, the fund found it difficult to
meet the foreign exchange requirements of its members because of its limited resources.
3. No Elimination of Multiple Exchange Rates: The elimination of these exchange rates was
cae of the main objectives of the fond. But the fond has miserably failed to achieve this
objective.
4. Fixation of Unscientific Quotas: The quotas of the various membef'e^jjntries had not
been fixed on any scientific basis. In fact, these quotas were fixed keeping in mind the
economte^nd political interests of the USA and the UK. The fund has been continuously
been dominated by these two countries since its origin.
5. No Provision for Automatic Revaluation of Currencies: A glaring defect of the fund is
that there is no provision in it for the automatic revaluation of a countrys currency when
that country continuously enjoys a favorable balance of payments as is the case with West
Germany and Japan at the present moment.
6. No Success in Securing Exchange Stability: The exchange rates of different countries
have been changing despite the existence of the fund. Several countries devalued their
currencies despite the opposition from the fund.
7. Discriminatory Treatment: Another shortcoming is that the fund discriminates in favor of
certain countries in its day-to-day functioning. It gives special concessions to western
countries while neglecting the genuine interests of the backward and under developed
countries.
1.8.1.6. IMF Financial Facilities and Policies
The Fund resources are available to the members under following policies and facilities:
1. Regular Lending Facilities: Regular facilities for IMF lending differ significantly from

concessional facilities. Interest rates, fees, and other terms associated with the
concessional facilities are significantly lower or easier to meet than the terms of regular
facilities. With in 'the regular lending facilities, the mechanisms for fast-turnaround
emergency lending differ in important ways from those for Longer-fuse lending
arrangements, in which the periods for negotiation and disbursement are more protracted
"0 Stand-By Arrangements: Stand-By Arrangements (SBAs) are designed to deal with
short-term balance of payments problems of a temporary or cyclical nature, and must be
repaid within 3 to 5 years. Drawings are normally made quarterly, with their release
conditional upon borrowers meeting quantitative performance criteria - generally in such
areas as bank credit, government or public sector borrowing, trade and payments
restrictions, and international reserve levels - and not infrequently structural performance
criteria. These criteria allow both the member and the IMF to assess progress under the
members program. Stand-By Arrangements typically over 12-18 month periods
(although they can extend for up to three years).
ii) Extended Fund Facility: Financial assistance provided through Extended Arrangements
under the Extended Fund Facility (EFF) is intended for countries with balance of
payments difficulties resulting primarily from structural problems and has a longer
repayment period, 4 to 10 years, to take account of the need to implement reforms that can
take longer to put in place and have full effect. A member requesting an Extended
Arrangement outlines its goals and policies for the period of the arrangement, which is
typically three years but can be extended for a fourth year, and presents a detailed
statements each year of the policies and measures to be pursued over the next 12 months.
The phasing of drawings and performance criteria are like those under Stand-Rv
Arrangements although phasing on a semiannual basis is possible
in) Precautionary Arrangements: Precautionary arrangements are used to assist members
interested in boosting confidence in their economic management. Under a Stand-By or an
Extended Arrangement that is treated as precautionary, the member agrees to meet the
conditions applied for such use of the IMFs resources but expresses its intention not to
draw on them. This expression of intent is not binding; consequently, as with an
arrangement under which a member is expected to draw, approval of a precautionary

arrangement signifies the IMFs endorsement of the members policies according to the
standards applicable to the particular form of arrangement
2. Special Leading Facilities and Policies: Supplemental Reserve Facility (SRF) was
introduced in 1997 to supplement resources made available under Stand-By and
Extended Arrangements in order to provide financial assistance for exceptional balance
of payments difficulties owing to a large short-term financing need resulting from a
sudden and disruptive loss of market confidence, such as occurred in the Mexican and
Asian financial crises in the 1990s. Its use requires a reasonable expectation that strong
adjustment policies and adequate financing will result in an early correction of the
members balance of payments difficulties. Access under the SRF is not subject to the
usual limits but is based on the financing needs of the member, its capacity to repay, the
strength of its program, and its record of past use of IMF resources and cooperation with
the IMF. Financing is committed for up to one year, and repayments are expected to be
made within 1 to 18 years, an4 must be made within 2 to 22 years, from the date of each
drawing. For the Erst year, the rate of change on SRF financing is subject to a surcharge
of 300 basis points above the usual
rate of charge on other IMF loans; the surcharge then increases by >0 basts iv>i,
tvwynyreadies 500 basis points.
i) Contingent Credit Lines: Contingent Credit Lmvs (U. u) "vt e*udtltd*d
Supplemental

Reserve

Facility,

the

CCL

is

designed

to

provide

sliorHotmhmmctng K overcome exceptional balance of payment problems

arising from a sudden and markets confidence. A key difference is that the
SRI is for use by member afreudvi crisis, whereas the CCL is a preventive
measure solely for member coneewetlwnl vulnerability to contagion but not
facing a crisis at the time ot the commitment i eligibility criteria confine
potential candidates for a CCL to those members impten considered unlikely
to give rise so a need to use IMF resources, whose economic ijv: progress in
adhering to relevant internationally accepted atandaids has been assessed &
IMF in the latest Article IV consultation and thereafter, and which have
constructive.
private sector creditors with a view to facilitating appropriate private sector
uoUc* umtResx^nocs committed under a CCL can be activated only if the

Board determines that the exceptional Nfiaove o payments financing needs

faced by a member have arisen owing to contagion " that iv cuvtnnstanees
largely beyond the members control stemming primarily from adverse
developments in intwnatMw capital markets consequent upon developments
in other countries. The repayment petted tv>r and rate ot charge on CCL
financing are the same os for the SRF.
ii) Compensatory Financing Facility: The

Compensatory

Financing

Facility

fCFFVtormefty the Compensatory and Contingency Financing Facility (CCFF),

provides timely finaiKing to member experiencing a temporary shortfall in
export earnings or an excess in cereal import co&Sv as a resorts ot forces
largely beyond the members control, In January 2000, the Executive Board
decided to ehmmate the contingency element of the CCFF since it had rarely
been used.

iii) Natural Disaster Financing: IMF also provides emergency assistance to a member facing
balance ef payments difficulties caused by a natural disaster. The assistance is available
through outright purchases, usually limited to 25 per cent of quota, provided that the
member is cooperating with the IMF to find a solution to its balance of payments
difficulties. In most cases, this assistance has taeu followed by an arrangement with the
IMF under one of its regular facilities. In |W^ ^ ^\dkv on emergency assistance was
expanded to include well-defined post conflict situations where a members institutional
and administrative capacity has been disrupted as a result of eentUiL but where thvxe is
still sufficient capacity for planning and policy implementation and a demonstrated
commitment on the part of the authorities; and where there is an urgent balance of
payments need and a (ok- fer the IMF in catalyzing support from official sources as part
of a concerned international eflihrt to address the flirt situation The authorities must state
their intention to move as soon as possible to a Staud4t\v Extended, or Poverty Reduction
and Growth Facility Arrangement.
iv) Emergency Financing: The Emergency.Financing Mechanism (EFM) is a set of
procedures that allow for quick Executive Board approval'of IMF financial support to a
member (being a crisis hr its external accounts that requires an immediate IMF response.
The EFM was established in September' and was used to 1997 for the Philippines;
Thailand, Indonesia, Korea, and in t8 lb* Russia.

v) Concessional Lending Facility: Concessional Lending Facility on November the

Enhanced Structural Adjustment Facility (ESAF) - th^ IMF's concessional financial
theitity to assist poor countries facing protracted balance oTpayment? problems - was
renamed the IVverty.

supported programs are expected to be based on country* designed poverty reduction strategics ami formulated in a
participator^' manner involving civil society and developmental partners The strategy, to be spelled out in a Poverty Reduction
Strategy Paper produced by ihe bortwwmg country in cooperation with tho World Bank and the IMF, should describe the
authorities goals and macroeconomic and structural policies for the three*yeur program to be supported by resources, as well as
the associated external financing needs and mtfiot sources ot financings HKw loans carry an interest rate of 0.5 per cent a year
and are repay able over Ifi y ou i s with a s year grace period on principal repayments,
Bank For International Settlement
Ssr international settlement (BIS) is an international organization fostering the cooperation of central banks
itcmational monetary policy-makers. It was established in 17 May 1930. It is the oldest international financial
Imzation. and was created to administer the transaction of money according to the Treaty of Versailles. Among
rs, its main goals are to promote information sharing and to be a key center for economic research.
Essentially, the BIS is a central bank for central banks; it does not provide financial services to individuals or corporations. The
BIS is located in Basel, Switzerland, and has representative offices in Mexico City and Hong Kong. The Bank for International
Settlements is an international organization which fosters international monetary and financial cooperation and serves as a bank
for central banks. The BIS fulfils this mandate by acting as:
1) A Forum to promote discussion and policy analysis among central banks and within the international financial community.
2) A cjcjhter for economic and monetary research.
3) A prime counterparty for central banks in their financial transactions; and
4) Agent or trustee in connection with international financial operations.
The head office is in Basel, Switzerland, and there are two representative offices - in the Hong Kong Special Administrative Region of the
Peoples Republic of China and in Mexico City.
Established on 17 May 1930, the BIS is the worlds oldest international financial organization. The objective of establishing this
international organization is to build central bank cooperation to strengthen the financial supervision so as to prevent frauds and
malpractices in the financial sector.
As its customers are central banks and international organizations, the BIS do not accept deposits from, or provide financial services to,
private individuals or corporate entities. The BIS strongly advises caution against fraudulent schemes. BIS has constituted a Committee

popularly known as Basel Committee to develop necessary guidelines for implementing effective financial supervision.

I.8.2.I.

' Constitutional Documents

The constitutional documents of the Bank consist of:

1) A Convention, signed at The Hague on 20 lh January 1930, concluded by the Government of Switzerland on the one hand and the
Governments of Germany, Belgium, France, the United Kingdom and Northern Ireland, Italy and Japan on the other.
2) A 'Constituent Charter issued by the Swiss Government on 26 th February 1930 pursuant
to the Convention: and
3) The Statutes of the Bank, which define and govern its constitution, operation and
activities and are annexed to the Constituent Charter.
The signatories to the Convention of 20th January 1930, had adopted a Plan which
contemplated the founding of the Bank by the Central Banks of Belgium, France, Germany,
Great Britain, Italy and Japan, and by "a financial institution of the United States of
America. Its Constituent Charter recites that ''the said central banks, and a banking group
including Messrs. J.P. Morgan & Company of new York, the First National Bank of New
York, and the First National Bank of Chicago, have undertaken to found the said Bank.
The Statutes provide that the Bank may not be liquidated except by a three-fourths majority
of the General Meeting, and together with the Charter, provide that certain articles of the
Statutes may not be amended except by a two-thirds majority of the Board, approved by a
majority of the General Meeting and sanctioned by a law supplementing the Charter. The
Statutes were amended in 1937, 1950, 1961 and 1969. The Convention was prolonged on
10U> June 1930 for the period of the existence of the Bank.
The Bank acts as Agent for the Organization for Economic Cooperation and Development in
connection with the European Monetary Agreement and as depositor)' of the pledge
constituted by the European Coal and Steel Community in favor of its lenders (see below
under Functions and Powers).
It also cooperates with the International Bank for Reconstruction and Development, the
International Monetary Fund and the European Investment Bank.
1.&2JL Objectives of Bunk for International Settlement
1) To act as trustee or agent in regard to international financial settlements, particularly in regard
to German reparations under the so-called Young Plan adopted at the 1930 Hague conference.

2) To promote central bank cooperation.

3) To provide additional facilities for international financial operations.
1&23. Functions and Powers of BIS
The Statutes state that the objects of the Bank are To promote the cooperation of central banks
aiid to provide additional facilities for international financial operations; and to act as trustee or
agent in regard to international financial settlements entrusted to it under agreements with the
parties concerned. The first two of these spheres of activity have become increasingly
important, particularly since the introduction of currency convcrtiblity in 195$. The Bank has
thus strengthened its ties with others international institutions such as the IMF, the IBRD and the
OECD.
The Bank may buy and sell gold coin or bullion for its own account or for the account of central
banks, hold or accept the custody of gold for central banks, make advances to or borrow from
central banks, discount, rediscount, purchase or sell short-term obligations of prime liquidity, buy
and sell exchange and negotiable securities other than shares, hold deposit accounts with and act
as agent or correspondent of any centra bank, and act as trustee or agent in connection with
international settlements. The bank may also enter into special agreements with central banks to
facilitate the settlement of international transactions between them. The Bank performs a
fourfold task, which are:
1) h is a bank whose operations are carried out 'mainly with central banks throughout the world
bjl also sometimes with commercial banks.
2) The Bank serves as a meeting place for the Governors of the eight central banks which are
represented on the Board and for representatives of other central banks or financial
institutions which are either entitled to attend General Meetings of the Bank or with whom
the business relations have been established.
3) The bank is a center for research and information on economic and monetary matters, and it
publishes a comprehensive survey each year in its Annual Report.
4) In its capacity as agent or trustee, the Bank now acts as Agent for the Organization for
Economic Cooperation and Development (OECD) under the European Monetary Agreement
and as Depositary under the Act of Pledge concluded with the^European coal and Steel
Community.

In addition, the Bank is trustee for the new bonds of the German External Loan 1924 (Dawes
Loan) and of the German Government International Loan 1930 (Young Loan), which were issued
by the Government of the Federal RepHlirnf Germany in accordance with the London
Agreement of 1953, and for the assented bonds of the Austrian Government International Loan
1930. The Bank also carries-out the functions entrusted to it n IV04 by the Ministers of the
Group of Ten of tolleding and distributing to all the participants of the Group, and to Working
Party No. 3 of the OECD, statistical data for multilateral surveillance of international liquidity
creation.
I.8.2.4.

Organizational Structures

The governance of the Bank is determined by its Statutes} which were last revised in June 2005,
following a review of the governance of the Bank by three* leading independent legal experts.
The three most important decision-making bodies within the Bank-aci^ . \ ^.
Decisions taken at each of these levels concern the running of the Bank and as such are mainly of
an administrative and financial nature^related to its linking operations, the policies governing
internal management of the BIS and the allocatibif of budgetary resources., to the different
business areas. The Banks.

administrative and budgetary rules apply to the committees hosted by the BIS.
1) General Meetings of Member Central Banks: The BIS currently has 56 member central
banks. a# of ***** are entitled w be represented, and vote in tile General Meetings.
Voting power is proportionate to the ******* oi BIS shares issued in the country of each
member represented at the meeting. At the Annual General Meeting, key decisions by
member central banks focus on distribution of the dividend and profit, appiwsl of the
annual report and the accounts of the Bank, adjustments in the allowances paid to board
members. selection of the Banks external auditors. The Annual General Meeting is held
in late JunerearkJuK
Extraordinary General Meetings must be called in order to amend the Statutes of the

Bank, change its equity capital or liquidate the Bank.

2) TBoard of Directors: The Board of Directors has at present 1$ members (January 20 U V
The Board has six
exofficio directors, comprising the Governors of the Central Banks of Belgium. France,
Germany. Italy and the United Kingdom, and the Chairman of the Board of Governors of
the U.S. Federal Reserve System. Each ex officio member may appoint another member
of the same nationality. The Statutes also provide for the election to the Board of not
more than nine Governors of other member central banks. The Governors of the Central
Banks of Canada, China, Japan, Mexico, Netherlands. Sweden and Switzerland and
president of the ECB are currently elected members of the board.
The Board of Directors elects a Chairman from among its members for a three-year term.
The Board also elects a Vice Chairman. The Board is responsible for determining the
strategic and policy direction of the BIS, supervising the management, and fulfilling the
specific tasks given to it by the Bank's Statutes. It meets atleast six times a year. Four
advisory committees, made-up of selected Board members, assist the board in its
following work.
i) The Administrative Committee reviews key areas of the Bank's administration, such as
budget and expenditures, HR policies and IT. The Committee is chaired by Philipp
Hildebrand.
ii) The Banking and Risk Management Committee addresses the financial objectives and the
business model for BIS banking operations, and the risk management framework of the
BIS. The Committee's Chairman is Stefan Ingves.
iii) The Audit Committee is the Boards contact wjth internal and external Auditors and
Compliance, and examines the implementation of the banks risk management framework
and policies. The Committee is chaired by Mark Carney.
iv) The Nomination Committee deals with the appointment of the six members of the BIS
Executive Committee, and is chaired by the Boards Chairman.
The Board has adopted a Code of Conduct for Members of the Board of Directors.
1) Management of the Bank: The General Manager is Jaime Caruana. The Deputy General
Manatee is RerveHannoun. The General Manager - the Banks Chief Executive Officer
carries-out the policy determined by the Board of Directors and is responsible to the Board
for the management of the Bank. The heads of the three main departments are Peter Dittus

(General Secretariat), Stephen Cecchetti (Monetary and Fconcstvie Department), and

GQnterPleines (Banking Department). The General Counsel is Diego Devos.
1.8.3.

World Bank

The World Bank is an international financial institution that provides loans to developing
countries tor capital programmes. The World Bank has a stated goal of reducing poverty. By law,
all of its decisions must be guided by a commitment to promote foreign investment, international
trade and facilitate capital investment.
It is not a bank in the common sense; it is made up of two unique development institutions
owned by 1ST member countries: the International Bank for Reconstruction and Development
(IHRD'I and the Intcmatkmal Development Association (IDA).
Each institution plays a different but collaborative role in advancing the vision of inclusive and
sustainable globalization. The IBRD aims to reduce poverty in middle-income and creditworthy |
HXW countries, white IDA focuses on the world's poorest countries.
Their work is complemented by that of the International Finance Corporation (IFCJk Multilateral
Investment Guarantee Agency (MIGA) and the International Centre for the Settlement
oflnvealmeut Disputes (tCSIDV
TogetherH provides low-interest loans* interest-free credits nnd^HBSuuTv? of pwpeses that
include invesintents in education* health private sector development, agriculture and
environmental and natural rcsl
Functions TWorld Bank tts main functions of World Bank are as follows:
1) Advances Loans: Main function of the Bank is to advance loans to member countries or
to pr\v. entrepreneurs on the guarantee of their vemment, for productive purposes. These
loans are advance through the medium of the central bank of the country. The Bank
collects progress reports on those projects of the member countries for which loans are
advanced to them. Between 1945 to 2000, the World Bank sanctioned loans amounting to
$33,853 crore. World Bank gives loans for short and long periods. It mainly advances
three kinds of loans.

i) Direct Loans: It either gives loans out of its own funds or it borrows in the open market
and gives the proceeds to the member countries as loan.
ii) Guarantee Loans: It gives guarantee to the loans given by private investors and thus help
them to giye loans to member countries.
iii)Joint Loans: The bank advances loans in collaboration with commercial banks operating
in different countries.
2) Provides Technical Assistance: The bank also provides technical
assistance to member-countries. It is o two kinds. One relates to
development plans and the other to the study of economies, their
analysis a.n suggesting the ways for improvements. The Bank sends its
experts to member-countries in order to provide them with technical
assistance and guidance.
3) Imparts Training: The Bank also arranges to impart training to the
officials of the member-countries in matters relating to planning,
economic development, public finance and other economic activities.
Many training programmes have been initiated by the Bank for this
purpose. In the year 1956, the Bank established Economic Development
Institute for imparting training.
4) Co-ordinates Development Assistance:-The Bank also co-ordinates
assistance given to member-countries from various agencies/countries.
First attempt in this direction was made in 1958 when Aid India Club
was founded. Now, such clubs have been founded for many countries.
5) Settlement of International Disputes: World Bank also acts as a mediator to settle
international disputes. In I960, Indo-Pakistan River Water Dispute and Suez Canal Dispute
could be settled only by the efforts of the World Bank. For solving dispute regarding
foreign investment, recently a Centre for Settlement of Investment Disputes (ICSID) has
been set up.
6) Provides Financial Assistance to World Welfare Institutions: World Bank provides
financial assistance to UNICEF, UNESCO, World Health Organization (WHO),
International Labor Organization (1LO), Food and Agriculture Organization (FAO), etc.
These world level institutions work for welfare of various sections.

7) Conducts Economic Research: World Bank has been conducting economic research since
1978. For this purpose, a separate division has been iet up and experts are hired from all
over the world for conducting this research. These research projects are''related mainly to
economic development, infrastructure development, poverty eradication, etcTWorld-Bank
als,o publishes research reports in its journals.
8) Establishing Subsidiary Institutions:' World Bank has established its subsidiary institutions
namely International Development Association jIDA), International Finance
Corporation (IFC). Multinational Investment Guarantee Agency (MIGA). These subsidiary
institutions help the World Bank in achieving its objectives.
9) Reconstruction and Development: World bank provide capita), to developing countries for
reconstruction and development of their economies.
10) Encourage Private Foreign Investment: World bank encourage private foreign investment
by providing guarantees of repayment to the investors.
11) Growth of international trade: World bank promotes growth of intenfaiojialitrade and help
maintain BOP equilibrium of the merpber countries.

1.8.4, Asian Development Bank (ADB)

The wmsnfimcniatknri development teste could not be applies! squally to (fisTssrafrepots
because of their heterogeneous identity and varying economic BeSrfe The oeeds of some of the
region* retrained target and this led to creation of die regional development banks that loon into
a.count fee economic and political identities of their regions. Asian Development Bank (ADB)
was created in this ttatntl Efforts to create ADB had started in Aiilist 19to, but they gamed
momentum only after fee USA and Japan offered to subscribe VS. $200 million each during April
1965. The formalities were completed by m id-1966 and ADB came into being from the 22"* of
August of that year. It started functioning in December 1966. Its membership was open to the
regional countries and the noe-ftjpooal developed cocaines from where resources were to be
obtained. ADB has 67 members (as of 2 February 2007).

Functions of ADB
The following. functions of ADB are as follows
1) Lending Operation: As per foe Articles, any developing member country of foe region
can borrow from I ADB for any public or private sector enterprise. Foods are channeled

Sura OCRs if foe borrowing country I possesses the necessary debt service capacity- If
not, concessional loans are provided from foe special I foods. While leading. ADB takes
use account the following consideration:
i) Gescra! economic conditions of foe borrower,
ii) Its access to other sotnoes of funds,
Its actual need for the funds and its development plans and priorities It aids only those
projects that se economically nod socially viable. Economic viability includes among
etherthings, technical feasibility, financial somdness of foe project, removal of economic
bottlenecks, and raising of producDvicy, etc. The social aspect covers poverty redactionin
general and amelioration of w'nerable groups in particular, development of human resources,
especially foe role of women, and reduction in regional disparity, etc. There are some less
developed contries that do not possess foe vyfssj'yinfrastructure for preparing effective
project reports They are provided technical assistance for this wnwStnrv l>dv I9ri foe OCR
loans are nmviderl either as dollar loan nr as mvbimnaicviresits.
2) Co-Financing: ADB lends not only on its own nrcownt, bat also partkipsiesia co-fiaantring
activities, particularly when foe project cost is large. It also ananges for foe partkipatioo
of ocher public and private finance-lending institutions so that foe borrowers get large
resources and foe leading risk of individual tenders is reduced.
3) Technical .Assistance: Technical Assistance is channded for identifying, urptemewarig
and operating of projects or for strengthening the capability for formula lag of
development strategicsia developing member countries (DMCs). Technolog) transfer is
often a part of technical It is normally provided out of TASF either as a loan or as s grant.
4) Equity Investment: Equity investment is available to private-sector enterprises aod to
financial institutions. The practice was started in I9S : Sow k is common. This way ADB
also provides risk capital.
5) Regional Cooperation: Besides the itadafoaal n>k of finaocicg projects and programmes,
ADB helps foe process of regional cooperation among DMCs. Since different member
coontriss are a different stages of development, regional cooperation benefits them alLA
phased approach is bang followed since 1992. i) In the first phase, ADB tries to create
awareness through loczsuag foe potential areas for cooperation and through quantifying
the potential benefit.

In the second phase, it identifies foe particular projects and prograres. In foe third phase, funds
are extended lor identified projects and programmes that enhance regional cooperation.
African Development Bank (AfDB)
The AfDB was created in 1964 and was for nearly two decades an African-only institution,
reflecting the desire of African governments to promote stronger unity and cooperation among
the countries of their regioi. The AfDB was created in 1964 and was for nearly two decades an
African-only institution, reflecting the desire of African governments to promote stronger unity
and cooperation among the countries of their region, in 1973, ' the AfDB created a concessional
lending window, the African Development Fund (AfDF), to which non- regional countries could
become members and contribute. The U.S. joined the AfDF in 1976. In J 982/f membership in
the AfDB non-concessional lending window was officially opened to non-regional members. The
AfDB makes loans to private sector firms through its non-concessional window and does not
have a separate fund specifically for financing private sector projects v/ith a development focus
in the region.
Functions of AfDB
The AfDBs main functions are:
1) To make loans and equity investments for the economic and social advancement of the
regional member countries (RMCs):
2) To provide technical assistance for the preparation and execution of development projects
and programs:
3) To promote investment of public and private capital for development purposes:
4) To respond to requests for assistance in co-ordinating the development policies and plans
of the RMCs:
5) To give special attention to national and multinational projects and programs that
promote regional integration.
1.8.6. European Bank for Reconstruction and Development (EBRD)
The EBRD is the youngest MDB, founded in 1991. The motivation for creating the EBRD was
to ease the transition of the former communist countries of Central and Eastern Europe (CEE)
and the former Soviet Union from planned economies to free-market economies. The EBRD

differs from the other regional banks in two fundamental ways:

1) The EBRD has an explicitly political mandate - to support democracy-building activities.
2) The EBRD docs not have a concessional loan window.
The EBRDs financial assistance is heavily targeted on the private sector, although the
EBRD does also exliia some loans to governments in CEE and thg former Soviet Union.
The EBRD is owned by 64 member countries (including 34 countries of operation), the
European Union and the European Investment Bank.
Functions of EBRD
Following are the functions of EBRD:
1) The main idea behind the creation of the JsBRD was to promote transition to market
economies in Eastern European countries.
2) The EBRDs mission indicate that they aim to promote market economies that
function well where businesses are competitive, innovation is encouraged,"
household incomes reflect rising employment and productivity, and environmental
and*social conditions reflect peoples needs.
3) To fulfill on a long-term basis its .purpose of fostering'tho'transition of Central and
Eastern European countries towards open market-oriented, economies and the
promotion of private and entrepreneurial initiative, the Bank shall assist_the
recipient member countries to implement structural and sectoral economic reforms,
including demonopolization, decentralization and privatization, to help their
economies become fully integrated into the international economy by measures
i) To promote, through private and other interested investors, the establishment,
improvement and expansion of productive, competitive and private sector activity, in
particular small and medium-sized enterprises.
ii) To mobilize domestic and foreign capital and experienced management to the end
described in (i).
iii) To foster productive investment, including in the. service and^!ha^ial sectors, and in
related infrastructure where that is necessaiy to support private and entrepreneurial
initiatives, thereby assistin# in making n competitive environment and
raising productivity, the standard of living and conditions of labour;

iv) to provide technical assistance for the preparation, financing and

implementation of relevant projects, whether individual or in the
context of specific investment programmes.
v) To stimulate and encourage the development of capital markets.
vi) To give support to sound and economically viable projects involving more than one
recipient member country.
vii) To whom it may concent promote in the fill I range of its activities environmentally
sound and sustainable development; and
viii)

To undertake such other activities and provide such other services as may further

these functions.
4) The Bank shall work in close cooperation with all its members and, in such manner
as it may deem appropriate within the terms of this Agreement, with the
International Monetary Fund, the International Bank for Reconstruction and
Development, the International Finance Corporation, the Multilateral Investment
Guarantee Agency, and the Organisation for Economic Co-operation and
Development, and shall cooperate with the United Nations and its Specialized
Agencies and other related bodies, and any entity, whether public or private,
concerned with the economic development of, and investment in, Central and
Eastern European countries.
1.8.7* Inter-American Development Bank (IDB)
The IDB was created in 1959 in response to a strong desire by Latin American countries for a
bank that would be attentive to their needs, as well as U.S. concerns about the spread of
communism in Latin America.
Consequently, the IDB has tended to focus more on social projects than large infrastructure
projects, although the IDB began lending for infrastructure projects as well in the 1970s. From
its founding, the IDB has had both non-concessional and concessional lending windows. The
IDBs concessional lending window is called the Fund for Special Operations (FSO). The IDB
Group also includes the Inter-American Investment Corporation (IIC) and the Multilateral
Investment Fund (MIF), which extend loans to private sector firms in developing countries,
much like the World Banks IFC.

Functions of IDB
Following are thee functions of IDB
1) The IDBs two main priorities are to promote poverty reduction and social equity as well
as environmentally sustainable growth the Bank focuses its work on three specific areas.
i) The first area, global competitiveness, aims to foster competitiveness through support for
policies and programs ih&tmucusi a wouuuy's potential foi development in an open
global ccouomv.
ii) The second area, modernization, has the IDB aiming to modernize borrowing states by
strengthening the efficiency and transparency of public institutions.
iii) The third area, social development, requires IDB investment in social programs that
expand opportunities for the poor.
2) The IDBs main function is to act as a multilateral lending institution.
3) IDB member states give money to the Bank, and these contributions are used to financially
assist countries in need through loans and grants. In addition to loaning money.
4) The IDB will also act as a policy advisor to help entities manage the loaned money as
efficiently as possible.
5) The IDB helps borrowing member countries in formulating development policies to help
stimulate economic growth, increase global competitiveness, enhance social equity,
modernize the state, and foster free trade and regional integration.
6) To that end, the IDB also finances technical assistance in the form of economic experts and
impartial monitors to achieve this growth.

maintain bank accounts outside their country of residence. International banking services provfc,
with confidentiality, with choice; it offers reduced complexity and a tax efficient internati
managing customers money. It is also known as Offshore Banking. International banking
service*^. ^ ' retail, commercial, corporate and trade finance services to clients around the world
through branches, representative offices, subsidiaries and affiliates.
From managing the risk, financing and paperwork associated with trade transactions to remitting
cash balance and establishing local banking services, international banks offers a comprehensive
range of services to help the company to operate around the world. Whatever the breadth and
depth of services the business needs, International banking services can make international
transactions more efficient and secure.

1.9.2.

Features of International Banking:

The features of international banking are as follows:

1) Banking Activities are Carried across Different Geographical Borders: When branches
an ^ subsidiaries are canying-out operations in different countries, then question is to
which supervisory authority will have jurisdiction over these arise. Effective
coordination can be achieved only if there is good communication between countries,
and global compliance standards are in place.
2) Risks in International Banking are both Pecuniary as well as Political: Apart from the
financial risks inherent in all business, fluctuating rates of currencies of different
countries can also pose problems giving rise to the need for hedging and other
measures. Political instability like coups or fall of governments, changing economic
and fiscal policies can all become a major cause of concern.
3) Non-Interest Income is Substantially more than Interest Income: Income from fund

based activities like commission on bills, guarantees, letters of credit, syndication fees,
loan processing, and counseling fees, etc., are more than the interest earned from
lending operations.
1.9.3. Functions of International Banking
The functions of international banking are as follows:
1) Taking deposits and making loans in domestic currency to foreign governments,
enterprises, and individuals:
2) Taking deposits and lending in foreign currencies to domestic and foreign entities:
3) Managing and acting as agents fotr syndicated loans; designing special financing
requirements for international trade and projects;
4) Foreign exchange transactions, dealing in' gold and precious metals, international money
transfers;
5) Providing documentary letters of credit, standby letters of credit, multiple currency
credit lines, bank acceptances, Euro note issuance facilities;
6) Trading in currency futures and options, financial future and options, interest rate and asset
swaps; writing interest rate caps;
7) Underwriting and placement of Eurobond issues, distribution of Euro commercial paper,
assisting cross- border mergers, acquisitions and sale financial advisory and
investment services.
1.9.4. Factors Leading to the Growth of International Banks
The following are the reasons for the growth of international banking:
1) Low Marginal Costs: Managerial and marketing knowledge developed at home can be
used abroad with low marginal costs.
2) Knowledge Advantage: The foreign bank subsidiaiy can draw on the contacts and credit
investigations for use in that foreign market I Nation Information Services
3) Local firms in jfmation on trade and financial markets in the (tunable from foreign
domestic banks.
4) restige: Very large multinational banks have high perceived prestige, liquidity, and
deposit safety that can be used to attract clients abroad.
5) Regulation Advantage: Multinational banks are often not subject to the same regulations
as domestic banks. There may be reduced need to publish adequate financial information,

lack of required deposit insurance and reserve requirements on foreign currency deposits,
and the absence of territorial restrictions (that is, U.S. banks may not be restricted to state
of origin).
6) Wholesale Defensive Strategy: Banks follow their multinational customer abroad to
prevent the erosion of their clientele to foreign banks seeking to service the
.multinational's foreign subsidiaries.
7) Retail Defensive Strategy: Multinational banks prevent erosion by foreign banks of
the travelers check, tourist, and foreign business market.
8) Transaction Costs: By maintaining foreign branches and foreign currency balances,
banks may reduce transaction costs and foreign exchange risk on currency
conversion if government controls can be circumvented.
9) Growth: Growth prospects in a home nation may be limited by a market largely
saturated with the services offered by domestic banks.
10) Risk Reduction: Greater stability of earnings is possible with international
diversification. Offsetting business and monetary policy cycles across nations
reduces the country specific risk of any one nation.
1.9..Forms of International Banking
There are different types of international banking offices ranging from correspondent bank*
relationships, through which minimal service can be provided to banks-customers, to branch
offices, and subsidiaries

1) Correspondent Bank: A correspondent bank is a bank located elsewhere that

provides a service on behalf of another bank, besides its normal business. The
correspondent banking system enables a banks foreign client to conduct business
worldwide through his local bank or its contacts.
2) Representative Offices: A representative office is a small service facility staffed by

the parent bank personnel that is designed to assist the foreign clients of the parent
bank in dealings with the banks correspondents and to provide the clients with a
level of service greater than that provided through merely a correspondent
relationship.
3) Foreign Branches: Foreign branches, which may provide full services, may be
established when the volume of business is sufficiently large and when the law of
the land permits it. Foreign branches facilitate better service to the clients and help
the growth of business.
4) Subsidiaries and Affiliates: A subsidiary bank is a locally incorporated bank that is
either wholly or largely owned by a foreign parent and an affiliate bank is one that
is only partially owned but not controlled by its foreign parent. Subsidiaries and
affiliates are normally meant to handle substantial volume of business. Their
autonomy, compared to branches, is more operational and has strategic management
leverage.
5) Offshore Financial Centers: A major contributor to the growth of international
banking is the offshore banking centres. An offshore banking center is a country
whose banking system is organized to permit external accounts beyond the normal
economic activity of the country. The principal features that make acountry
attractive for establishing an offshore banking operation are virtually total freedom
from host- country government banking regulations, e.g., low reserve requirements
and no deposit insurance, low taxes, a favorable time zone that facilitates
international banking transactions, and to a minor extent, strict banking secrecy
laws.
Offshore banks operate as branches or subsidiaries of the parent bank. Offshore financial
centers have one or more of the following characteristics;
i) Large foreign-currency (Eurocurrency) market for deposits and loans (that in
London, e.g.).
Market that is a large net supplier of funds to the world financial markets (that in
Switzerland, e.g.).
iv) Market that is an intermediary or pass-through for international loan funds (those in
the Bahamas and the Cayman Islands, e.g.).

v) Economic and political stability.

vi) Efficient and experienced financial community.
vii) Good communications and supportive services.
viii)

Official regulatory climate favorable to the financial industry, in the sense that it

protects investors without unduly restricting financial institutions.

1.9.3.

Euro Bank

A Euro Bank is defined as a financial intermediary that simultaneously bids for time deposits
and makes loans in a currency or currencies, other than that of the country in which it is
located. It accepts Euro currency deposits and gives Euro currency loans. A Euro Bank's
balance sheet consists of deposits and loans in other currencies. A Bank in Singapore,
accepting deposits of Euros by a British Company is called a Euro Bank. Thus, Euro Bank
refers to a function rather than an institution.
Euro Banks are international banks with the minimum of host government interference any
dealing in any convertible currency other than currency of the host country.

These Banks deal with both the residents and the non-residents but dealings are essentially in any
currency other than the currency of the host country:
Among the non-official funding agencies, international banks occupy the top position. If one
looks at their development since the 1950s,.distinct structural changes are evident. In the first
half of the twentieth century and till the late 1950s, international banks were primarily domestic
banks performing the functions of international banks. This , means that they operated in foreign
countries accepting deposits from, and making loans to, the residents of the host countries. They
dealt in the currency of the host countries, and at the same time, dealt in foreign currency while
making finance available for foreign trade transactions.
However, in the late 1950s and especially*in the early 1960s, banks with purely international
character emerged on the global financial scene. This new variety of banks came to be known as
Euro banks. The Euro banks emerged on a footing quite different from the traditionally known
international banks.
The Euro banks deal with both the residentsapd the .non-residents, but they deal essentially in
any currency other than the currency ofthe host couotjqr. For example, if-Euro bank is located in
London, it will deal in any currency other than the British Pound. The deposits and loans of the
Euro bank are remunerated at the interest rate set by the market forces operating in the Eurocurrency market and not by the interest rate prevailing among the domestic banks in the
host^ountry. Again, |p other difference between the traditional international bank and the Euro
bank is that the former Is'subjected to rules and jegulations of the host country, but the Euro
banks are free from those rules and regulations.
The rationale behind the deregulation is that the activities of the Euro banks do not touch the
domestic economy because they are concerned normally with the placement of the funds (foreign
currency) from one foreign market to another foreign market and so they are neutral from the
viewpoint of any direct impact on the balance of payments of the host country .
1.9.7. International Banking Services

The competitive global marketplace requires banks to expand internationally. International

banking represents the wide range of banking and Financial services provided to domestic and
international operations of targe local corporates and local operations of multinationals
corporations. International banking services include access to commercial banking products,
including working capital facilities such as domestic and international trade operations and
funding, channel financing, and overdrafts, as well as domestic and international payments. INR
term loans (including external commercial borrowings in foreign currency), letters of guarantee,
etc
These are some forms of international banking services
1) Import and Export Services: Import and export services support and simplify the
international commercial goods purchases and sales. Range of international banking
services can streamline document exchange, reduce payment or collection risks, and
facilitate financial transactions almost anywhere in the world.
2) Global Cash Management Services: If clients have international receivables and
payables, International banking service has powerful tools that can improve cashflow
between accounts. With $55 billion of transfer activity eveiyday and over 3.8 million
wire transfers take place in a year.
3) International Bank Account Number (IBAN): If clients organization conducts business
with corporations located in the European Union (EU), he/she may has been asked to
remit payment for goods and services to their banking provider using an IBAN
(International Bank Account Number) to direct the payment to his/her counterparty.
4) Trade Finance: Trade finance expertise can help customers* to export business, even in
tough market conditions. Using public and private insurance programs, international
banking services can put together the financing package client need to complete his/her
sale.
5) Foreign Currency and Exchange Services: When clients business strategies need to
stretch beyond borders, turn to international banking services. As a market-maker in all
major and most emerging market currencies, international banking services can handle
transactions upto certain limit.
6) International Correspondent Banking: With a network of correspondent banks

worldwide, international banking services can help to manage overseas banking needs.
International banks always work for strengthening relationships with a wide range of
international financial institutions.
7) SWIFT: SWIFT enables its users to exchange automated, standardized financial
information securely and reliably, thereby lowering costs, reducing operational risk, and
eliminating operational inefficiencies. Whether clients are considering the use of
SWIFT file Act to fulfill the companys file transmission connections or simply need
prior and/or current day account reporting via SWIFT statements, as an active member
of SWIFT, international banks can provide those services.
8) Online Services: Conducting business overseas is never simple. Whether client is an
importer cc an exporter, he/she expend a great deal of time and resources on document
and transaction management That is why international banks have developed a set of
online resources to help customer to manage these processes more efficiently.
9) Strategic Sources: When dealing with buyers or suppliers in other countries, the rules
and regulations involved can often seem like a confusing maze of information and
requirements. -International banking services help client to navigate that maze by
introducing strategic sources - companies and agencies that can provide a foil range of
services to assist with his non-bank, trade services needs
10) Remittances: Remittance is a facility by which the bank makes funds available from a
customer at one place to him or anyone authorized by him, at another place within India
and abroad. International remittances can be inward or outward. International inward
remittances ensure quick and safe delivery of funds from exchange houses and banks to
beneficiaries in India. When any person, firm, organization or resident in India desires
to transfer funds to any place outside India, it gives rise to foreign outward remittances.
Funds are raised from the international financial market through the sale of securities,
such as international equities or Euro-equities, Euro bonds, medium-term and short-term
Euro notes and Euro commerctat papers. Presently, the use of securities is quite
extensive.

Funds are raised from the international financial market through the sale of securities,

ch

SU

equities or Euro-equities, international bonds like Euro bonds, medium-term and short-term.
Euro commercial papers. Presently, the use of securities is quite extensive.
Following are the various types of international financial instruments:
1.10.1.
Euro Commercial Paper (ECP)
It is a promissory note like the short-term Euro notes although it is different from Euro notes in
some ways. It is not underwritten, while the Euro notes are underwritten. The reason is that ECP
is issued only by those companies that possess a high degree of rating. Again, the ECP route for
raising funds is normally investor- driven, while the Euro note is said to be borrower-driven.
ECP came up on the pattern of domestic market commercial papers that had a beginning in the
USA and then in Canada as back as in 1950s. The prefix Euro means that the ECP is issued
outside the country in the currency in which it is denominated. Most of the ECPs are
denominated in U.S. dollars, but they are different from the U.S. commercial papers in the sense
that the ECPs have longer maturity going upto one year. Moreover, ECPs are structured on the
basis of all-in-cos^ whereas in U.S. commercial papers, various charges, such as front- end fee
and commission are collected separately.
ECPs face minimal documentation. Over and above, they are not underwritten. That is why their
use has been ilarge since their very inception. However, since 2000, there has been a marked
decline in the volume in favor of long-term bonds.
1.10.1.1. Features of Euro Commercial
Papers Following are the features of euro papery:
1) Euro commercial papers,are unsecured as they are backed only by the general credit
standing of the issuing companies and by the lines of credjt that they might be'in a
position to obtain from banks.
2) Euro commercial papers are negotiable by endorsement and delivery.
3) Euro commercial papers are regarded-as'highly safe&ndliqpiti instruments.
4) Euro commercial papers are also known To be a simple and flexible instrument in

respect of documentation needed and the spread of maturitie available.

5) Euro commercial papers are normally issued in a bearer form on discount to face value
basis.
6) Euro commercial papers are primarily issued by public utilities, bank holding companies,
insurance companies, transportation companies and finance companies

Advantages of Euro Commercial Papers Euro commercial "papers provide the following
advantage

lie maturity,
{reification of short tenn funding through market that is found attractive by wide variety of
investors, Mobility in limits determined by the issuers cash flow requirements at any point of
time, successful Euro CP program will enhance the reputation of the issuer world wide among
the investing community.
In recent years, the growth in number of new issues and volume has showed down in Euro
Commercial Paper markets. As a result of some defaults, investors concern about credit
worthiness has increased dramatically.
1.10.2. Euro Bonds
Eurobonds constitute a major source of borrowing in the Eurocurrency market. A bond is a debt
security issued by the borrower, which is purchased by the investor and it involves in the process
some intermediaries like underwriters merchant bankers etc. Eurobonds are bonds of
international borrowers sold in different markets simultaneously by a group of international
banks. The bonds are issued on behalf of governments, big multinational corporations, etc.

Eurobonds are unsecured securities and hence normally issued by Governments, Governmental
Corporations, and Local Bodies which are generally guaranteed by the governments of the
countries concerned and big multinational borrowers of good credit rating.
The bonds are sold by a group of international banks, which form a syndicate. The lead banks in
the syndicate advises the issuer of the bond on the size of the issue, terms and conditions, timing
of the issue etc. and take up the responsibility of coordinating the issue. Lead managers take the
assistance of co-managing banks. Each issue is underwritten by a group of underwriters and then
is sold.
1.10.2.1. Features of Euro Bonds
Following are the features of euro bonds
1) Euro bond issues are not subject to the costly and time-consuming registration procedure.
Disclosure requirements are also less stringent than those which apply to domestic issues.
This feature appeals to many MNCs, which often do not wish to disclose detailed and highly
sensitive information.
2) Euro bonds are issued in bearer form, which facilitates their negotiation in the secondary
market This feature also means that the county of the ultimate owner of the bond is not a
matter of public record.
3) Euro bonds offer investors, exemption from tax-withholding provisions applicable to domestic
and foreign bonds. Hus feature allows US MNCs to reduce their borrowing cost by having
their offshore financing subsidiaries issue Eurodollar bonds, with payment of interest and
principal guaranteed by the parent company.
4) Euro bonds are commonly denominated in a number of currencies.
5) Euro bonds carry a convertibility clause allowing them to be converted into a specified
number of shares of common stock.
6) In euro bonds coupon payments are made yearly.
1.10.3. Foreign Bonds
Foreign bond is a bond that is issued in a -domestic market by a foreign entity, in the domestic

markets currency. Foreign bonds are regulated by the domestic market authorities and are
usually given nicknames that refer to the domestic market in which they are being offered. Since
investors in foreign bonds are usually the residents of the domestic country, investors find them
attractive because they can add foreign content to their portfolios without the added exchange
rate exposure. In other words, foreign bonds are debt instruments issued by foreign corporations
or foreign governments. Such bonds are exposed to default risk, especially the corporate bonds.
These bonds are denominated in the currency of the country where they are issued, however, in
case these bonds are issued in a currency other than the investors home currency, they are
exposed to exchange rate risks. An example of a foreign bond - A British firm placing dollar
denominated bdnds in U.S.A.
Features of Foreign Bonds
A foreign bond has following characteristics:
1) The bond is issued by a foreign entity (such as a government, municipality or corporation).
2) The bond is traded on a foreign financial market.
3) The bond is denominated in a foreign currency.
4) Issuers of foreign bonds include national governments and their sub-divisions, corporations,
and supranational (an entity that is formed by two or more central governments through
international treaties).
5) They can be publicly issued or privately placed.
Difference between Foreign Bonds and Euro Bonds
International bonds are classified as foreign bonds and Euro bonds. There is a difference between
the two, primarily on four counts:
1) In the case of foreign bond, the issuer selects a foreign financial market where the bonds are
issued in the currency of that very country. If an Indian company issues bond in New York
and the bond is denominated in U.S. dollar, it will be called a foreign bond. On the contrary,
in the case of Euro bonds, they are denominated in a currency other than the currency of the
country where the bonds are issued. If the Indian company's bond is denominated in U.S.
dollar, the bonds will be issued in any country other than the USA. Then only it will be
called Euro bond.

2) Foreign bonds are underwritten normally by the underwriters of the country where they are
issued. But the Euro bonds are underwritten by the underwriters of multi-nationality.
3) The maturity of a foreign bond is determined keeping in mind the investors of a particular
country where it is issued. On the other hand, the Euro bonds are tailored to the needs of the
multinational investors. In the beginning, the Euro bond market was dominated by
individuals who had generally a choice for shorter maturity, but now the institutional
investors dominate the scene who do not seek Euro bond maturity necessarily to match their
liabilities. The result is that the maturity of Euro bonds is diverse. In England, Euro bonds
with maturity between eight and twelve years are known as intermediate Euro bonds.
4) Foreign bonds are normally subjected to governmental regulations in the country where they
are issued. For example, in the case of Yankee bonds (the bonds issued in the USA), the
regulatory thrust lies on disclosures. In some of the European countries, the thrust lies on the
resource allocation and on monetary control. Samurai bonds (bonds issued in Japan)
involved minimum credit-rating requirements prior to 1996. But the Euro bonds are free
from the rules and regulations of the country where they are issued. The reason is that the
currency of denomination is not the currency of that country and so it does not have a direct
impact on the balance of payments.
Global Bonds
It is the World Bank which issued the global bonds for the first time in 1989 and 1990. Since
1992, such bonds are being issued also by companies. Presently, there are seven currencies in
which such boids are denominated, namely, the Australian dollar, Canadian dollar, Japanese yen,
Swedish krona and Euro. Global bonds are debt instruments that are issued simultaneously in
several

countries.

These

bonds

are

usually

issued

by

large

multinational

organizations^aiW'^overeigneqtitiesrboth of which regularly carry-out large fundraising

exercises. By issuing global bon3$4.jm issuing entity is able to attract funds from a vast set of
investors and reduce its cost of borrowing. These bonds are specifically designed to be traded in
any financial market.
4.10.4.1. Features of Global Bonds The special features of the global bonds are:
1. liiey carry high ratings.
2. They are normally large in size.
3. They are offered for simultaneous placement in different countries.

4. They are traded on "home market basis in different regions.

1.10*4.2. Working of Global Bonds

..

.*

Trading in global bonds is similar to that of regular bonds. However, unlike regular bonds, they
can be issued in die domestic as well as in international currencies. The returns on global bonds
could be impacted by fluctuations in the foreign currency market.
Thus, when investing in global bonds, an investor must select a bond that is:
1) Issued in a stable currency, like the U.S. dollar or the Euro, or opt for bonds in the
domestic currency.
2) Issued from a country that has a stable government. Although bonds from countries with
less stable government may offer higher yields, there is a higher risk of default.
1.10.4.3. Benefits of Global Bonds
Following are the benefits of global bond:
1) Global Bonds Help in Diversifying an Investment Portfolio: Investment in global bonds
helps reduce exposure to economic or political instability in a specific country and
improves a portfolio's risk profile. For example, returns to a U.S. investor who has
invested in Japanese and European bonds will not be impacted by fluctuations in the
U.S. interest rates.
2) Global Bonds Improve the Rate of Return: Returns from global bonds are typically
higher than returns offered by traditional government bonds and securities.
1.10.4.4. Risk Associated with Global Bonds
The risks associated with global bond investing are:
1) Capital gains can erode when an investors domestic currency appreciates visits the
currency in which the bond is issued.
2) The risk of the issuer defaulting on interest and principal payments is high due to the lack
of government data on these bonds.
3) High taxes are levied on profits generated through these bonds. These taxes, at times;
make global bonds unattractive.
1.10.5. Euro Equity
International equities or the Euro-equities do not represent debt, nor do they represent foreign

direct investment. They are comparatively a new instrument representing foreign portfolio
equity investment. In this case, the investor gets the dividend and not the interest as in case of
debt instruments. On the other hand, it does not have the same pattern of voting right that it
does have in the case of foreign direct investment. In foci. international equities are a
compromise between the debt and the foreign direct investment.
1.10.5.1.

Benefits of Euro Equity

The issuers issue international equities under certain conditions and with certain objectives
1) When the domestic capital market is already flooded with its shares, the issuing
company does not like to add further stress to the domestic stock of shares since such
additions will cause a foil in the share prices. In order to maintain the share prices, the
company issues international equities.
2) The presence of restrictions on the issue of shares in the domestic market facilitates
the issue of equities.
3) The company issues international equities also for the sake of gaining international
recognition among the public.
4) International equities bring in foreign exchange which is vital for a firm in a developing
country.
5) International capital is available at lower cost through the Euro equities Funds raised
through such an instrument do not add to the foreign exchange exposure.
From the viewpoint of the investors, international equities bring in diversification benefits and
ruse tennnjvritu a given risk or lower the risk with a given return. If investment is made m
international equates along wnh international bonds, diversification benefits are still greater.

Advantages of ADRs
1. Recti 'x investor enjoy rights which are comparable to those of holders of the

underlying securities

cihcocitcfus convenience and efficiency of trading in the

US securities markets merits to the Issuing Company: For issuers, there are several
reasons for launching and managing an VDR programme.
2. An ADR programme can stimulate investor interest, enhance a companys visibility,
broaden its stakeholder base* and increase liquidity ilBy enabling a company to tap US
equity markets, the ADR offers a new avenue for raising capital, often at highly
competitive costs. For companies with a desire to build a stronger presence in the
United States* an ADR programme can help finance US initiatives or facilitate US

iiit

acquisitions.
3. ADRs can provide enhanced communications with shareholders in the United States.
ADRs can provide enhanced communications with shareholders in the United States.
4. ADRs provide an easy way for US employees of non-US companies to invest in their
companies7 employee stock purchase plans
5. Features such as dividend reinvestment programmes can help ensure a continual stream
of investment into an issuers programme
6. ADR ratios can be adjusted to help in ensuring that an issuers ADRs trade is in a
comparable range with those of its peers in the US market.
7. May increase focal prices as a result of global demand / trading through a more
broadened and a more diversified investor exposure Benefits to the Investors:
Increasingly investors aim to diversify their portfolios internationally. Obstacles*
however, such as undependable settlements, costly currency conversions, unreliable
custodial services, poor information flow, unfamiliar market practices, confusing tax
conventions and internal investment policy may discourage institutions and private
investors from venturing outside their local market. As negotiable securities* ADRs are
quoted in US dollars and pay dividend of jnterest in US dollars. They overcome the
obstacles that mutual funds, pension funds, and other institutions may have in
purchasing and holding securities outside the focal market Enumerated below are the
principal advantages to the investors: i) Depositor) Receipts are US Securities:

Depository receipts are registered with the US Securities and Exchange Commission
and trade like any other US security in file over-the-counter market or on a national
exchange. Depository receipt investors enjoy rights which are comparable to those of
holders of the underlying securities, plus they have the benefits, convenience and
efficiency of trading in the US securities markets.
8. Depository Receipts are easy to Buy and Sell: Investors purchase and
sell depository receipts through their US brokers in exactly the same
way as they purchase or sell securities of US companies. Many
regt.;sal

NASD

brokers/dealers,

and

virtually

all

New

York

brokers/dealers, make markets in and know iinuttW'OM. uc^AAitui) receipts.

9. Depository Receipts are Liquid: Depositoiy receipts are as liquid as
their underlying securities because they are interchangeable. For
example, if a US broker/dealer cannot purchase or sell a depository
receipt in the. US, it can always create a depositoiy receipt by
purchasing the underlying non-US securities for deposit with the
depository, which will then issue depository receipts for the
securities.
10. Depository Receipts are Global: Investors can choose, from more than
1500 different equity depository receipts and several debt depository
receipts from 50 countriefl^cluding Australia, Brazil, United Kingdom,
France, Germany, Hong Kong, Italy, Japan, Mexico, Singapore, Spain,
Sweden and Thailand. Most of the companies are researched by US
analysts, while others have a local following.
Depository Receipts are Convenient to Own
a. Depository receipt trades clear and settle through standardized US
clearance

systems

within

three

business

days;

while

direct

investments in non-US shares are subject to complicated and varied

standards for international trades.
b. Depositoiy receipts are negotiable US securities. They are quoted in
dollars, pay dividends or interest in dollars, and trade exactly like any
other US security.
c. Unlike many non-US securities, which are issued in bearer form,

depositoiy receipts are issued in registered form, thus protecting the

holder in the event the certificates are lost.
d. Depository receipts overcome the obstacles that many mutual funds,
pensions and other institutions may have in purchasing and holding
securities abroad.
ix) Depository' Receipts are Cost-Effective
a) Global custodian safe keeping charges are eliminated, saving depository receipt
investors up to 30 basis points annually.
b) Dividends and other cash distributions are converted into dollars at competitive
foreign exchange rates.
c) The standard three-day settlement for depository receipts significantly lowers the fail
rate on trades and consequently the costs associated with financing failed trades.
d) Investors enjoy both market liquidity and arbitrage opportunities. Depository receipts
may to bought and sold in the US or the depository receipts can be cancelled and the
underlying securities released into their home market
Holding depository receipts may facilitate the process of reclaiming excess' withholding on
dividends and reduce transfer.
1.10.6.4.

Disadvantages of ADRs

ADR have some important limitations and drawbacks

1) Limited Selection: Not all foreign companies are available as ADR. For example,
Japan's Toyota Motor has an ADR, but Germanys BMW does no.t
2) Liquidity: Plenty of companies have ADR programs available, but some may be very thinly
traded.
3) Exchange Rate Risk: While ADRs are priced in dollars, for sake of convenience, the
investment is still exposed to fluctuations in the value of foreign 'currencies. Because ADRs are
like stocks, it needs to buy enough of them to ensure adequate diversification. So if one dont
have enough investment capital to spread around, say 25 to 30 ADRs (or more), it would not be
able to create a truly diversified portfolio on its own.
1.10.7. Global Depositary Receipts (GDRs)
It is a global finance vehicle that allows an issuer to raise capital

simultaneously in two or more markets through a global offering. GDRs may

be used in either the public or private markets inside or outside the US.
They are marketed internationally, mainly to financial institutions.
Global Depository Receipt- certificate issued by international bank, which
can be subject of worldwide circulation on capital markets. GDRs are
emitted by banks, which purchase shares of foreign companies and deposit
it on the accounts. Global Depository Receipt facilitates trading of shares,
especially those from emerging markets. Prices of GDRs are often close to
values of related shares.
For example, a European investor wanting an exposure in Indian securities could do so via.two
routes
1) Enter the Indian stock market and buy the companys stock on one of the Indian
markets. But this would also expose the investor to exchange risks and statutory rules
and regulations governing purchase and sale of securities in the Indian markets
2) Through GDRs which would give the investor ownership of the Indian company's
stock without being subject to Indian stock market regulations to a great extent
GDRs have become synonymous witfTseHing equity ii>the^guremaikets
This is so because fresh shares are issued by the company which is raising moneyfrom the
markets, and transferred to a depositor)' which, in turn, issues a receipt which is quoted and
traded at any stock exchange where it is listed.

1.10.1.7.

Features of GDR The characteristics of GDR are as follows:

1. GDRs can hoisted oft any American and European Stock Exchange.
2. One GDR can represent more than one share, e.g., one GDR = two
3.
4.
5.
6.
7.

shares.
The bearer or holder of the GDRs can get them converted into shares.
The holder of the GDRs has not right to vote in the company.
However ,tJjg share holders to have this right.
The dividend on these GDRs is quite like the dividend on shares.
GDRs are in U.S. dollar denomination.

Vfoantxmomy places its equity shares in the custody of a domestic (Indian) bank which is the
Domestic Qmta Bank (DCS) - The Company authorizes an Overseas Depository Bank (ODB)
to issue GDRs (book b&afe$ adopted for price discover}') against issue of the companys
equity shares or Foreign Currency Ownffrihle Bonds. The ODB can be any bank in the country
where the Indian company plans to make the issue -O foe company's orders, the DCB
instructs the ODB to issue the GDRs to investors. GDRs are issued at a cofRua predetermined
ratio to the companys shares or bonds. A GDR is evidence of a Global Depository Share. TV
holder of one GDS will in reality be holding one or two or even ten equity Shares or bonds of
the Indian company.

Advantages of GDRs
TV -dbfef advantages cf issuing GDR are the following:
3) Getting Fwe^i Capital: The Indian companies can get foreign capital through the
medium of GDR. It nates sufficient finance available to them. It thus increases the
foreign exchange reserve in the country. Beat these factors help in the economic
development
T More Liquidity: There is more liquidity in the GDRs as compared to the shares because
they are issued by the financially sound companies. In other words, they can be sold
easily

II Increase InGoodwill of Company: A company that issues the GDR gains reputation in the
market This 3SgsaafiioB directly affects the sales of the company
Floating Costs: A company has to bear less expense in issuing GDR as compared to the
issuing of shares
5) Better Share Price: A company earns morq price by issuing GDR instead of issuing shares
in the domestic mazlaeti because foe GDR is an indicator of foe good financial position of
foe company
c Scattered Shareholders: The issue of the GDR makes it possible for the shareholders to cross
the domestic boundaries and spread for and wide. This ends foe financial problem of foe
company and it comes to be recognized an global basis
IJiTA Disadvantages of GDRs
TV disadvantages of GDRs are as follows:
GDR (Global Depository Receipt) is raised through public issues and, hence, is more expensive
in terms of adnasigretive expenses
GDRs do, however, have foreign exchange risk if foe currency of foe issuer is different from foe
currency of foe GDR, which is usually USD
hurodacticn to International financial Syste
Basis of

ADRs
GDRT^^
Difference
l) Centre The NYSE is the largest stock The LSE is not as large as theKY$^
exchange in the world by both value but is the global centre for
2) No legal or technical difference Unlike the NYSE, the LSE
Instniment between an ADR arid a GDR. The makeT^..demandsrequiring
US has three disclosure
levels ofrequired
ADR Detailed
companiesinformation
to give holds*
the righton
3) Comprehensive
required
Disclosure for F-l, the US prospective which fee \ company, but less onerous for
4) GAAP Foreign companies listing in the US LSE satisfied with a statement olpe
must reconcile their accounts to US difference between the UK and
5) Cost US listing could be expensive. Total GDR listing on the LSE

is

initial costs likely to be in the range comparatively inexpensive. Initial

6) RetaQ A public offering in the US allows Over 5,000 US QlBs accessed, but
an issuer to access the US retail ordinary

investors

cannot

7) Liability Legal liability of both, a company Legal liability of a company and its
and

its

individual

directors directors is less than in the case of

increased by a full US listing.

an ADR.