Changes in US banks’ country exposure over the last decade

Some observations

At a time when anti-globalization sentiment is on the rise in many parts of the world, what choices do US banks face in their international operations? How much influence will the burgeoning geopolitical forces have on banks’ country risk assessment, and, ultimately, their proclivity to do business with customers and counterparties in other countries?

May 10, 2017

A blog post by Val Srinivas, Banking & Securities research leader, Deloitte Services LP

But before I get into the details, please indulge me in a brief history of country risk analysis in banking. Up until the 1980s or so, this field was not well-established at all, with neither banks nor regulators having sufficient expertise to assess and manage country risk.1 Of course, since then, this discipline has come quite far, with almost every major bank having dedicated teams of specialists and formal risk governance mechanisms in place.2

An impetus for this transformation was perhaps the Latin America debt crisis in the 1980s. In being true to the aphorism, “don’t let a crisis go to waste,” US bank regulators responded to this development with force. While not as severe as the most recent economic crisis, swift action was nevertheless needed to ensure that the situation didn’t get out control. The US acted as the “lender of the last resort,” with the Federal Reserve leading a globally coordinated effort involving other central banks, the International Monetary Fund, and the commercial banks.

In addition, domestically, there were several actions that US authorities took to manage the events, including permitting banks to delay the full recognition of loan losses in their portfolios and lend more to these countries so they could continue meeting their debt obligations.3 But a longer-lasting development was the passage of the International Lending Supervision Act of 1983, meant to further bolster federal banking regulators’ efforts to closely supervise the international lending activities of US banks. Fortunately, by this time, US regulators were already increasing their monitoring of cross-border activities of US banks through the Interagency Country Exposure Review Committee, which was established in 1979 by the Federal Reserve, the OCC, and the FDIC, as a response to the OPEC price shock in the 1970s. The main intent here was to ensure that banks were treating foreign currency risk in their cross-border exposures in a more methodical manner.

One way bank regulators began to closely monitor foreign exposure was by requiring US banks to report their foreign exposures for each country in a consistent and periodic manner through the FFIEC (Federal Financial Institutions Examination Council) 009 Country Exposure Report. This report is expected from every bank in the United States that has foreign claims over $30 million. Currently, 68 US banking organizations report these data. Eight “large financial institutions” with significant exposure are also expected to file an additional form—FFIEC 009a—with more details. These data are also an input into the consolidated banking statistics compiled by the Bank for International Settlements. The FFIEC releases these aggregate data 90 days after the report date in the form of the Country Exposure Lending Survey.

What does the data tell us about how banks are doing business globally?

Frankly, until recently, I was not even aware of this report. As you may expect, it contains, even at the aggregate level, some very revealing data about how banks are doing business globally.

For instance, the total number of foreign claims by US banks on an ultimate-risk basis as of December 31, 2016 (the latest reporting period) stood at $3.6 trillion, in contrast to $1.68 trillion on December 31, 2006. But, as a proportion of total assets held by these institutions, it is only a modest increase—from 18.4 percent in 2006 to 21.9 percent in 2016. Similarly, as a proportion of tier 1 capital, there has only been a slight decrease from 2006, when foreign claims were three times the tier 1 capital, compared with 2.8 times in 2016. These data clearly suggest that US banks’ exposure to foreign countries in 2016 is not meaningfully different from their exposure in 2006, although there may have been some significant fluctuations in the intervening years.

As might be expected, the bulk of the current claims—85 percent—are held by the eight largest financial institutions (LFIs), a drop from 2006, when the LFIs made up nearly 91 percent of total foreign claims.

Claims on the banking sector are about 22 percent of the total, while the public sector and the nonfinancial sector account for just over a quarter and 31 percent, respectively.

In terms of geographic concentration, the G-10 countries owe the US banks over $2 trillion (56 percent of total claims), the most of any country group (figure 1). And the two largest obligor countries are the United Kingdom and Japan (figure 2).

Source: FFIEC Country Exposure Lending Survey, December 2016

It is also quite revealing to me that the top rankings of countries by value of claims have shifted quite a bit over the last decade, except for the United Kingdom, which retains the top spot. This latter fact alone is fascinating because now I cannot wait to see how Brexit may affect the United Kingdom as the top obligor in the future.

Revelations from the FFIEC Country Exposure Lending Survey

Another interesting data point relates to banking centers, such as the Cayman Islands, which was not in the top 10 obligors in 2006, but is now in the third spot in 2016. Also, the obligations of the residents of Cayman Islands to the US banks grew the most, on a proportionate basis—over 10 times—from about $33 billion to by over $340 billion between 2006 and 2016.

And Korea, the Netherlands, and Italy have been replaced by the Cayman Islands, Switzerland, and Brazil. Meanwhile, the claims on China, a major trading partner with the United States, are only about $83 billion, although this number has increased by nearly $60 billion from 2006.

Source: FFIEC Country Exposure Lending Survey, December 2016

Source: FFIEC Country Exposure Lending Survey, December 2006

Obviously, there is more to country exposure analysis than what I have highlighted here. Even at the aggregate level of banks’ exposure, there are several observations one could draw from my analysis. As I indicated earlier, I was surprised to see that although the gross number of foreign claims of US banks has gone up by more than two times, as a proportion of total assets or tier 1 capital, the increases have been quite modest. Also, the proportion of claims by the largest financial institutions has remained in a similar range. However, there has been a noticeable shift in the top countries from 2006 and 2016, with the most notable change being the growth of Cayman Islands.

While individual bank exposure is not public knowledge, these initial findings raise a number of questions, some which may not be easy to answer. But any estimation of how country exposure of US banks will change has to begin with an understanding what it is today, and what it has been in the past.

What do you think?

My own view is that despite the anti-globalization forces, the global financial interconnections are so strong and so deeply embedded that we will not likely see any significant decrease in foreign claims of US banks, although the individual country exposure might evolve as a result of a multitude of factors. What are your thoughts on any of the points I have raised here?

1 Cynthia C. Lichtenstein, “The U.S. Response to the International Debt Crisis: The International Lending Supervision Act of 1983,” Virginal Journal of International Law, Vol 25:2, January 1985
2 Office of the Comptroller of the Currency, “Common Practices for Country Risk Management in U.S. Banks,” Interagency Country Exposure Review Committee Country Risk Management Sub-Group, November 1998
3 Cynthia C. Lichtenstein, “The U.S. Response to the International Debt Crisis: The International Lending Supervision Act of 1983,” Virginal Journal of International Law, Vol 25:2, January 1985

QuickLook is a weekly blog from the Deloitte Center for Financial Services about technology, innovation, growth, regulation, and other challenges facing the industry. The opinions expressed in QuickLook are those of the authors and do not necessarily reflect the views of Deloitte.

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