Outlook
 

SUMMER 2005 

In Focus This Quarter: 

U.S. Banking in a Global Economy 

Global economic integration continues to reshape the U.S. economy and banking industry. While international trade and financial flows make the world richer over the long run, in the short run they introduce both opportunities and risks to the U.S. economy and individual sectors—including FDIC-insured depository institutions. Many of the perceived risks associated with 

globalization relate to the large imbalances in trade and finance that have arisen between the United States and its major trading 

partners. The implications these imbalances might have for the U.S. economy and banking industry are among the issues addressed 

in this issue of FDIC Outlook. 

Unraveling the U.S. Current Account Deficit 

The current account measures the net flow of current transactions 

between countries, including payments for goods, services, and interest. 

As the U.S. current account deficit has reached record levels in recent 

years, analysts have continued to debate both its causes and implications. This article explores the key concepts underlying this debate by 

discussing what makes up the current account, how the U.S. current 

account deficit has grown so large, how it is being financed, and 

whether the situation is sustainable over the long run. See page 3. 

In Person: Two Perspectives on Global Financial Imbalances 

FDIC Chief Economist Richard A. Brown recently spoke with two 

prominent experts on international finance and asked them to discuss 

the future implications of a U.S. current account deficit that reached a 

record $666 billion in 2004. Stuart S. Brown discusses the “benign” 

scenario for resolving this imbalance, while Roger M. Kubarych 

addresses the “adverse” scenario. The resulting transcript shows that 

either position can be argued persuasively, and that the present situation 

represents a unique challenge for global policymakers. See page 13. 

The Globalization of the U.S. Banking Industry 

FDIC-insured U.S. banks have steadily grown their international operations, while foreign banks have expanded their profile in 

the U.S. marketplace. At the same time, consolidation in the U.S. banking industry is having a profound effect on the structure of 

its international operations, as the vast majority of the foreign assets of U.S. banks are held now by just a few large institutions. 

This article discusses the structure and strategies of U.S. banks with international activities and compares their financial performance to that of banks with primarily domestic operations. See page 25. 

Opportunities and Risks Facing Community Lenders That Support International Trade 

Although smaller firms (those with fewer than 500 employees) accounted for almost one-third of U.S. exports in 2001, many of 

them face considerable challenges in financing the production and sale of export goods. This circumstance presents opportunities 

for community banks that are looking for ways to increase small business fee income and strengthen loan demand. This article 

examines those opportunities as well as the risks facing community lenders in supporting small and mid-sized enterprises engaged 

in international trade. See page 34. 

U.S. Current Account Balance as a Percent of GDP 

The U.S. Current Account Deficit Reached a Record 

5.7 Percent of GDP in 2004 

Note: GDP = gross domestic product. 

Source: U.S. Department of Commerce, Bureau of Economic Analysis. 

1980 1985 1990 1995 2000 2004

–7 

–6 

–5 

–4 

–3 

–2 

–1 

0 

1 

2 

FEDERAL DEPOSIT INSURANCE CORPORATION 
The FDIC Outlook is published quarterly by the Division of Insurance and Research of the Federal Deposit 

Insurance Corporation as an information source on banking and economic issues for insured financial 

institutions and financial institution regulators. 

The FDIC Outlook provides an overview of economic and banking risks and discusses how these risks relate 

to insured institutions nationally and in each FDIC region. 

Single copy subscriptions of the FDIC Outlook can be obtained by sending the subscription form found on 

the back cover to the FDIC Public Information Center. 

The FDIC Outlook is available online by visiting the FDIC’s Web site at www.fdic.gov. For more information 

or to provide comments or suggestions about FDIC Outlook, please call Barbara A. Ryan at 202-898-3841 or 

send an e-mail to baryan@fdic.gov. 

The views expressed in the FDIC Outlook are those of the authors and do not necessarily reflect official 

positions of the Federal Deposit Insurance Corporation. Some of the information used in the preparation 

of this publication was obtained from publicly available sources that are considered reliable. However, the 

use of this information does not constitute an endorsement of its accuracy by the Federal Deposit Insurance 

Corporation. 

Chairman Donald E. Powell 

Director, Division of Insurance 

and Research 

Arthur J. Murton 

Executive Editor Maureen E. Sweeney 

Managing Editor Mary Ledwin Bean 

Editors Richard A. Brown 

Barbara A. Ryan 

Ronald L. Spieker 

Norman Williams 

Publications Managers Elena Johnson 

Geri Bonebrake 

Contact information for the FDIC’s six geographic regions: 

Atlanta Region (AL, FL, GA, NC, SC, VA, WV) 

Jack M. Phelps, Regional Manager, 678-916-2295 

Chicago Region (IL, IN, KY, MI, OH, WI) 

David Van Vickle, Regional Manager, 312-382-7551 

Dallas Region 

Midsouth (AR, LA, MS, TN): Gary Beasley, Regional Manager, 901-821-5234 

Southwest (CO, NM, OK, TX): Alan Bush, Regional Manager, 972-761-2072 

Kansas City Region (IA, KS, MN, MO, ND, NE, SD) 

John Anderlik, Regional Manager, 816-234-8198 

New York Region 

Mid-Atlantic (DC, DE, MD, NJ, NY, PA, PR, VI): Kathy Kalser, Regional Manager, 917-320-2650 

New England (CT, MA, ME, NH, RI, VT): Paul Driscoll, Regional Manager, 781-794-5502 

San Francisco Region (AK, AS, AZ, CA, FM, GU, HI, ID, MT, NV, OR, UT, WA, WY) 

Catherine Phillips-Olsen, Regional Manager, 415-808-8158 

FDIC OUTLOOK 2 SUMMER 2005 
Unraveling the U.S. Current Account Deficit
 

Much has been said and written in recent months 

about the growth of the U.S. current account deficit, 

which reached a record $666 billion in 2004 (see 

Chart 1). But to many, the concept remains abstract 

and hard to understand. This article is intended to 

explain the current account to non-economists and 

help assess the implications of the large global financial imbalances that have arisen in recent years 

between the United States and its major trading 

partners. It outlines the factors that underlie the 

recent growth in the U.S. current account deficit 

and describes how this deficit is being financed. Ultimately, the concerns over the current account deficit 

relate to its long-term sustainability and whether it 

could lead to a sudden adjustment that would create 

problems for the U.S. economy. 

Defining the Current Account 

The current account is an accounting concept that 

measures the net flow of current transactions between 

countries, including payments for goods, services, and 

interest. It represents one of many measures of a country’s trade with the rest of the world and includes 

imports of goods, such as cars and clothing, as well as 

services, such as the sale of insurance, real estate, and 

shipping. For the United States, it also includes income 

and unilateral transfers into and out of the country, but 

these factors play a minor role. 

On a net basis, an increase in exports pushes the current 

account toward a surplus, while an increase in imports 

Chart 1 

pulls it toward a deficit. A current account deficit 

occurs when the total value of goods and services a 

country imports is more than the total value it exports. 

(For more information regarding U.S. international 

transactions, see “U.S. International Accounting 

Basics” on page 11.) 

Although the U.S. current account deficit has been 

the subject of heightened discussion in recent months, 

shifts in exports and imports have been behind the 

growing U.S. deficit since 1991. At that time, when the 

United States last had a current account surplus, the 

economy was recovering from a recession, and weakened 

domestic consumption limited the appetite for imports 

(see Chart 1). From 1994 to 1997, the deficit was relatively stable at around 1.6 percent of gross domestic 

product (GDP). After 1997, however, the U.S. current 

account went into a sustained decline, and by 2004 

the deficit had reached 5.7 percent of GDP. 

Factors Contributing to the U.S. Current Account 

Deficit 

Although the United States has run current account 

deficits in the past, the persistent deterioration in 

the U.S. net trade position since the early 1990s is 

unprecedented. Today, not only is the current account 

deficit nearly twice as large as the 1980s deficit relative 

to the size of the U.S. economy, it has shown few signs 

of changing direction and contracting. One reason for 

this situation is that net imports of consumer goods 

have been the largest single contributor to the widenU.S. Current Account Balance 

as a Percent of GDP 

The U.S. Current Account Deficit Reached a Record 5.7 Percent of GDP in 2004 

Note: GDP = gross domestic product. 

Source: U.S. Department of Commerce, Bureau of Economic Analysis. 

1960 1965 1970 1975 1980 1985 1990 1995 2000 2004

–7 

–6 

–5 

–4 

–3 

–2 

–1 

0 

1 

2 

FDIC OUTLOOK 3 SUMMER 2005 
In Focus This Quarter: U.S. Banking in a Global Economy 

Chart 2 sions—which have grown almost 10 percent per year 

Cumulative Contributions to the 

U.S. Current Account Balance, 1994 to 2004 

on average. Overall, larger net imports of consumer 

goods have expanded the U.S. current account deficit 

by 1.1 percentage points of GDP over the last decade 

TotalConsumer GoodsEnergyCapital andIndustrial GoodsServicesAutosFoods, Feeds,and BeveragesOther GoodsUniversalTransfersIncome 

(see Chart 2). 

Energy demand also has contributed to the growing 

deficit. The United States has long been a net 

importer of oil and other energy products, and it has 

had to continue importing energy products even as 

the price of energy commodities and nominal oil 

prices have risen during the past decade. As a result, 

0 

Percent of Gross

Domestic Product –1 

–2 

–3 

–4 

–5 

the cost of U.S. net energy imports has contributed 

Note: Current account components are on a net basis. Capital and Industrial Goods 

excludes energy and autos.
 

Source: U.S. Department of Commerce, Bureau of Economic Analysis.
 

almost a full percentage point of GDP to the widening 

current account deficit since 1994 (see Chart 2). 

ing current account deficit, and alternatives for many 

imported products are neither readily available in the 

United States nor produced domestically in sufficient 

quantities to accommodate American demand. Consequently, much of the U.S. deficit is expected to remain. 

From 1994 to 2004, the current account deficit grew 

by about 4 percentage points, from approximately 1.7 

to 5.7 percent of GDP. This increase can be broken 

down mainly in terms of consumer goods imports, 

energy, and exports. The largest component of the 

increase has been imports of non-automobile consumer 

goods—particularly furniture, appliances, and televiChart 3 

The deterioration in the deficit has not been solely 

due to the United States’ increased appetite for 

imports—a reduction in sales of certain U.S. exports 

has also contributed. Historically, the United States 

has been a net exporter of capital goods, food, and 

services, but in recent years, net exports of foods and 

services slipped relative to the size of the U.S. economy (see Chart 3). In 2002 the United States became 

a net importer of capital goods (excluding automobiles 

and energy products) for the first time since 1986. 

Taken together, the relative contraction of the three 

net export items of capital goods, food, and services 

added 1.3 percentage points to the current account 

deficit during the past decade. 

Imported Consumer Goods and Energy Account for 

Much of the Increase in the U.S. Current Account Deficit 

Note: Current account components are on a net basis. 

Source: U.S. Department of Commerce, Bureau of Economic Analysis. Percent of Gross Domestic Product 

–7 

–6 

–5 

–4 

–3 

–2 

–1 

0 

1 

2 

3 

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Foods, Feeds, and Beverages Energy 

Capital and Industrial Goods (ex-energy, ex-autos) 

Services 

Income, Unilateral Transfers, and Misc. Goods Current Account Balance 

Automobiles 

Consumer Goods 

FDIC OUTLOOK 4 SUMMER 2005 
Unraveling the U.S. Current Account Deficit 

Chart 4 Percent of Gross Domestic Product 

Note: Positive (negative) figures represent net capital inflows (outflows) to (from) the United States. 

Source: U.S. Department of Commerce, Bureau of Economic Analysis. 

Although Foreign Official Reserves Have Increased, 

Foreign Private Holdings Have Financed the Bulk of the U.S. Current Account Deficit 

(financial account inflows and outflows) 

–8 

–6 

–4 

–2 

0 

2 

4 

6 

8 

10 

12 

14 

16 

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Foreign Private Holdings of U.S. Securities 

Foreign Direct Investment in United States U.S. Total Investment Abroad 

Foreign Official Reserves of U.S. Securities Capital Account Balance 

Financing the Current Account Deficit 

If individuals spend more than they earn, they have to 

find a way to make up the difference. Similarly, when 

a country runs a current account deficit, it has to 

finance the deficit by borrowing from abroad. In international accounting, the financial transactions offsetting the current account are collectively known as the 

financial account (previously known as the capital 

account; see “U.S. International Accounting Basics”). 

Historically, most of the support for the U.S. current account deficit has come from foreign private 

investors purchasing U.S. securities rather than 

official investments or foreign direct investment 

in U.S. companies. In 2004, total inflows of financing capital reached a record 12.2 percent of GDP, 

compared with 4.3 percent ten years ago (see 

Chart 4). And foreign private investment inflows 

amounted to more than 8 percent of GDP—far 

more than the 3 percent originating from foreign official 

investment—despite the widely publicized risk of additional dollar depreciation and very low U.S. interest 

rates.1 (For more on dollar depreciation, see the box 

entitled “Dollar Depreciation Alone Will Not Balance 

1 The Economist Group. “USA: Currency Forecast,” Economist Intelligence Unit ViewsWire, January 16, 2004. 

the Current Account.”) Foreign official investment 

has also expanded considerably from near zero in 2001 

to 3 percent of GDP in 2004 (see Chart 4). 

Partially offsetting these foreign inflows have 

been outflows by U.S. entities, predominately 

investments by private individuals and companies 

overseas. These international cross-flows of capital 

represent international portfolio diversification 

activities, as U.S. investors are able to realize a 

better mix of return and risk by investing a portion 

of their capital in foreign countries, and foreign 

investors do the same by investing in the United 

States. The recent growth of U.S. capital outflows 

also reflects the global growth of financial markets 

and the active participation of U.S. investors in 

those markets. Similarly, the breadth, legal protections, stability, and overall liquidity offered by 

U.S. asset markets continue to support foreign 

investment interest in the United States. 

Foreign Sources of Capital 

According to data collected by the U.S. Treasury, a 

notable shift in foreign investment occurred in 2004, 

when Asia overtook Europe for the first time as the 

largest net purchaser of long-term U.S. securities.6 OverFDIC OUTLOOK 5 SUMMER 2005 
In Focus This Quarter: U.S. Banking in a Global Economy 

Dollar Depreciation Alone Will Not Balance the Current Account
 

According to economic theory, if not conventional 

wisdom, the current account deficit will correct itself 

after the dollar declines sufficiently. The basic theory 

is straightforward: a decline in the dollar leads to a 

decline in the price of exports and an increase in 

the price of imports. As a result of these price shifts, 

U.S. exports increase while imports decline, leading 

in time to a balanced current account. As Chart 5 

shows, over long periods, this generally has been the 

case. Since 1980, the dollar’s foreign exchange value 

index has risen roughly threefold, while the current 

account has deteriorated from a position of balance 

to today’s record deficit. 

Unfortunately, over shorter periods, the real world 

is not so simple. For example, the current account 

deficit continued to widen, though at a slower pace, 

during a period of dollar weakness between 1985 

and 1987. Moreover, the current account balance 

improved sharply, even posting a small surplus, 

as the U.S. economy entered a recession in the 

early 1990s, despite the fact that the dollar was 

strengthening. Although theory would suggest that 

this dollar strength should have led to a deteriorating 

trade position, instead the current account deficit 

was improving. In contrast, since 2002 the dollar 

has declined roughly 10 percent in value, yet the 

deficit has continued to widen. Although the 

recent decline in the dollar is comparable to the 

decline of the mid-1980s, if adjusted for inflation, 

the recent decline has only been half as large as it 

was then. Even so, the large deterioration of the 

deficit in 2004 in the face of a weaker dollar does 

not seem to reflect theory. 

As one source notes, most empirical and theoretical 

models indicate that even large movements in 

exchange rates by themselves will have only a modest 

effect on narrowing a current account deficit as 

large as that generated by the United States.2 This 

2 Maurice Obstfeld and Kenneth Rogoff, “The Unsustainable 

U.S. Current Account Position Revisited,” National Bureau of 

Economic Research (working paper, no. 10869, October 2004), 

http://www.nber.org/papers/w10869. 

Chart 5 

During the Past 30 Years, the Dollar’s Foreign 

Exchange Value Generally Rose as the 

U.S. Current Account Deficit Widened 

Trade-Weighted Value of the Dollar U.S. Current Account Deficit 

(index: January 1997 = 100) (percent of gross domestic product) 

2 

1 

140 

120 

0 

100 –1 Trade-Weighted 80 –2 

the Dollar 

Value of 

–3 60 

–4

40 Current Account –5 

20 Deficit –6 

0 –7 

1974 1980 1985 1990 1995 2000 2004 

Sources: Federal Reserve Board and U.S. Department of Commerce, Bureau of Economic

Analysis. 

circumstance has been attributed to three primary 

factors: (1) the role of foreign pricing decisions, 

(2) the effects of transactions between parent 

companies and their foreign affiliates (also called 

intra-firm transactions), and (3) the relative 

economic strength of U.S. trading partners. 

On the first point, foreign firms, especially the 

Europeans and Japanese, have not raised their 

U.S. prices at the same pace that the dollar has 

weakened in recent years.3 Between 2002 and 2004, 

the dollar depreciated 30 percent against the euro, 

but the price in dollars of manufactured goods 

exported to the United States from the European 

Union rose only 9 percent.4 This hesitancy to raise 

prices may have reflected a desire to maintain 

U.S. market share as well as the presence of dollar 

hedges. Although many exporters had dollar 

hedges in place as the dollar began to drop, most 

of these contracts have now expired, which has 

only delayed the pressure to raise U.S. prices. 

3 Import prices usually rise following currency depreciation, because 

if prices do not adjust, foreign firms receive a lower relative price 

in their own currency. 

4 Alan Greenspan, “Capital Account” (speech at Advancing Enterprise 2005 Conference, London, England, February 4, 2005), Federal 

Reserve Board, http://www.federalreserve.gov/boarddocs/speeches/ 

2005/20050204/default.htm. 

FDIC OUTLOOK 6 SUMMER 2005 
Unraveling the U.S. Current Account Deficit 

Second, intra-firm transactions are an important part Chart 6 

U.S. Imports and Exports 

(dollars in billions on a

year-2000 dollar basis) 

Trade-Weighted Value of the Dollar

(index: January 1997 = 100) 

Sources: Federal Reserve Board and U.S. Department of Commerce, Bureau of Economic 

Analysis. 

Relative Economic Growth May Be Driving 

International Trade More Than the Weakening 

U.S. Dollar 

Imports Exports 

Trade-Weighted Value 

of the Dollar 

-

200 

400 

600 

800 

1,000 

1,200 

1,400 

1,600 

1,800 

60 

70 

80 

90 

100 

110 

120 

130 

1989 1991 1993 1995 1997 1999 2001 2003 

of U.S. trade, and these transactions can sometimes 

cancel out the price effects of changing currency 

values. In 2003, intra-firm trade averaged 42 percent 

of total U.S. goods trade, with 47 percent in imports 

and 32 percent in exports. In some cases of intrafirm trade, currency effects can be muted, because a 

multinational corporation may simultaneously benefit and be harmed by changes in foreign exchange 

rates, depending on where its operations are located. 

Intra-firm trade is a key issue with respect to imports 

from those nations against whose currencies the dollar 

has depreciated the most in recent years. For example, 

the dollar fell 32 percent against the euro from April 

2002 to April 2005, but only 23 percent overall; however, 59 percent of U.S. imports from the European 

Union occur as intra-firm trade versus 47 percent lowered the price of U.S. exports in these countries, 

overall. And almost 80 percent of imports from Japan the relatively weak economic growth of the U.S. 

are intra-firm transactions.5 While a European multi- major trading partners limited their appetite for all 

national corporation’s exports to the United States goods and services, including those purchased from 

might have been harmed by the euro’s rise against the United States. As a result, the real value of 

the dollar in recent years, if that corporation also U.S. exports has remained relatively stable during 

had a U.S. subsidiary, the firm would have benefited the past several years. 

from the depreciating dollar as it sold goods abroad. 

Only a few factors have been mentioned that could 

Finally, the relative economic strength of the United limit the declining dollar’s ability to reduce the U.S. 

States and its trading partners has a major effect on current account deficit. Another factor may be the 

the current account balance by affecting the volume lack of domestically produced substitute goods for 

of U.S. imports and exports. Chart 6 highlights those the United States currently imports, such as 

recent trends in inflation-adjusted U.S. imports and many consumer electronics. Something as simple as 

exports. Between 2002 and 2004, the U.S. economy consumer tastes can also influence trade patterns— 

has experienced fairly robust growth, with real gross a preference by some Americans for French wines, 

domestic product (GDP) rising at a 3.7 percent aver- for example. Given all of these considerations, 

age annual rate. This strong economic growth has changes in the foreign exchange value of the dollar, 

kindled growth in the real value of U.S. imports, especially over the short run, are likely to have only 

despite the weaker dollar. Likewise, since the dollar limited effects on U.S. international trade patterns. 

began its slide in 2002, average economic growth Over a longer period, history suggests that U.S. 

has been modest in the major export destinations import activity should come under pressure from a 

for U.S. goods and services. Real GDP growth has falling dollar while our export growth improves. In 

averaged less than 3 percent in Canada, less than the interim, though, other factors may trump the 

2 percent in Japan, and just over 1 percent in the declining dollar’s ability to mitigate the expanding 

euro zone. Although the weaker dollar may have current account deficit. 

5 Purba Mukerji, “Is Intra-Firm Trade Limiting the Impact of the 

Weaker Dollar?” Dismal Scientist/Economy.com, April 5, 2005. 

FDIC OUTLOOK 7 SUMMER 2005 
In Focus This Quarter: U.S. Banking in a Global Economy 

Chart 7 

Percent of Gross Domestic Product 

Note: Positive (negative) figures represent net capital inflows (outflows) to (from) the United States. 

Source: U.S. Treasury. 

Japan and the Rest of Asia Provided the Majority of Financing for the U.S. Current Account Deficit during 2004 

-2 

0 

2 

4 

6 

8 

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 

Other 

Latin America and Caribbean 

United Kingdom 

Asia (excluding Japan) 

Japan 

Europe (excluding United Kingdom) 

all, Asia accounted for slightly less than half of all net 

foreign purchases, compared with slightly less than 

a third for Europe. Japanese purchases of U.S. Treasury 

securities, agency securities, corporate bonds, and equities expanded for the third year in a row and accounted 

for roughly 28 percent of all net purchases (see Chart 7). 

During the same period, investment from the United 

Kingdom, historically one of the largest purchasers of 

long-term U.S. securities, tapered off slightly. 

In addition to Asia’s growing role in funding the U.S. 

current account deficit, the makeup of other foreign 

investment has shifted since 2001. Typically, foreign 

governments and central banks have preferred to hold 

their reserves in U.S. Treasury debt, with less use of 

agency securities, corporate bonds, or stocks. Since 

the United States has been running current account 

deficits for more than ten years, a number of countries 

that export to the United States have accumulated 

significant holdings of dollar-denominated assets in 

their official reserves. Given that official investors 

prefer to hold U.S. Treasuries, the recent run-up in 

foreign official investment since 2001 has resulted in 

6 Data on the geographic origin of foreign capital flows produced by 

the Treasury International Capital (TIC) reporting system of the U.S. 

Treasury are not perfect. Within the TIC system, capital flows are 

assigned to the country of the foreign counterparty and not the country of the ultimate owner. For a thorough discussion of this and other 

TIC data issues, see: Francis E. Warnock and Chad Cleaver, “Financial 

Centers and the Geography of Capital Flows,” Board of Governors of 

the Federal Reserve System (International Finance Discussion Papers, 

no. 2002-722, April 2002), http://www.federalreserve.gov/pubs/ifdp/ 

2002/722/default.htm. 

a marked increase in net foreign purchases of U.S. 

Treasury securities (see Chart 8). 

Over time, these net purchases have resulted in an 

estimated 60 percent of U.S. Treasury securities now 

being held as official reserves of other countries. 

However, it is difficult to estimate the holdings of U.S. 

Treasury securities by particular foreign governments 

and central banks; for example, the Bank of Japan held 

roughly $700 billion in securities at the end of 2004 

but did not disclose the types of securities. 

Long-Term Consequences 

Economists are divided about the consequences of a 

long-term current account deficit. Some believe that 

a country that runs a persistent current account deficit 

is consuming more than it produces and living beyond 

its means. Others view this situation as neither good 

nor bad, but rather the result of a country realizing 

the economic benefits that accrue when other countries produce certain goods or services more cheaply. 

Although a country running a deficit may not generate as many new jobs, its citizens may benefit from 

lower prices. 

Historically, large current account deficits have tended 

to unwind with varying degrees of speed and disruption 

to the macroeconomy. In the debate about how the 

current account deficit may unwind, two basic questions 

FDIC OUTLOOK 8 SUMMER 2005 
Unraveling the U.S. Current Account Deficit 

Chart 8 

Percent of Gross Domestic Product 

U.S. Treasury and Corporate Securities Remain the Preferred Investment for Foreign Investors 

Note: Positive (negative) figures represent net capital inflows (outflows) to (from) the United States. 

Source: U.S. Treasury. 

–3 

0 

3 

6 

9 

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 

Treasury Securities 

Agency Securities 

Corporate Securities 

Equities 

Foreign Corporate Securities and

Equities Owned by U.S. Residents 

emerge: how soon might an adjustment occur, and how 

disruptive could that adjustment be? 

How Soon Might an Adjustment Occur? 

Some analysts suggest that the United States should be 

able to continue running a current account deficit for 

some time. These analysts believe that some of the 

inflows of foreign capital supporting the U.S. deficit 

are the result of conscious government and central 

bank strategies. As one analysis put it, “An array of 

central banks and finance ministries has emerged to 

resist, for their own local reasons, the adjustment [in 

the U.S. current account deficit] that the cyclical 

fundamentals seem to require.”7 This view puts most 

of the responsibility for the current account deficit on 

the export-led economic growth strategies of Asian 

countries, which rely on managed exchange rates 

and support the U.S. current account deficit with 

purchases of dollar-denominated assets. 

Others disagree with this argument and note that little 

cooperation now exists among Asian countries on trade 

and exchange-rate issues. One Asian country could try 

to benefit at the expense of its neighbors by being the 

first to stop managing its currency against the dollar and 

sell its dollar reserves. The removal of capital controls 

7 Michael P. Dooley, David Folkerts-Landau, and Peter Garber, “The 

Revived Bretton Woods System: The Effects of Periphery Intervention 

and Reserve Management on Interest Rates and Exchange Rates in 

Center Countries,” National Bureau of Economic Research (working 

paper, no. 10332, August 2004), http://www.nber.org/papers/ 

w10332.pdf. 

in these nations during recent decades has compounded 

the problem by allowing private investors to move 

quickly from one currency into another. Large sales of 

dollar-denominated assets by private investors would 

raise the costs of maintaining a managed exchange rate, 

making it more tempting for Asian central banks to sell 

their reserves. These developments could accelerate the 

timing of a current account adjustment. 

Risks of a Disorderly Adjustment 

In contrast to the relatively mild adjustments experienced by industrialized countries in the past, some 

analysts have suggested that a U.S. current account 

adjustment is likely to be “disorderly,” possibly involving a flight from dollar-denominated assets, a spike in 

U.S. interest rates and inflation, and a global recession.8 

These analysts believe that global imbalances— 

pronounced differences between countries’ growth rates 

and current accounts—represent a source of economic 

fragility. It follows that the longer the U.S. current 

account deficit and other global imbalances continue 

to grow, the greater the odds of having a disorderly 

adjustment. Under this scenario, the enactment of 

protectionist trade legislation or a negative reaction 

8 Stephen Roach, “The Danger Zone of Global Rebalancing,” paper 

presented at Morgan Stanley Global Economic Forum, April 11, 2005, 

http://www.morganstanley.com/GEFdata/digests/20050411-mon.html; 

Roach, “Close Your Eyes,” paper presented at Morgan Stanley Global 

Economic Forum, February 14, 2005, http://www.morganstanley.com/ 

GEFdata/digests/20050214-mon.html; and Roach, “An Unprepared 

World,” paper presented at Morgan Stanley Global Economic Forum, 

January 31, 2005, http://www.morganstanley.com/GEFdata/digests/ 

20050131-mon.html. 

FDIC OUTLOOK 9 SUMMER 2005 
In Focus This Quarter: U.S. Banking in a Global Economy 

to tighter Federal Reserve monetary policy could 

trigger a sudden and disruptive adjustment. Other 

analysts, however, see many of the same imbalances 

but suggest that a more imminent adjustment in the 

current account deficit is likely. 

Historical experience can help evaluate these differing 

perspectives and shed light on the current situation. 

A recent Federal Reserve Board study looked at more 

than 20 historical episodes in which an industrialized 

country unwound a significant current account deficit 

either in part or completely.9 Overall, the results of the 

study suggest that current account adjustments tend 

to occur quickly. A deficit can substantially deepen 

within a year or two, and then significantly unwind 

in the same amount of time. In the historical episodes, 

most nations started with a modest current account 

deficit of about 2 percent of GDP. The deficit then 

expanded and peaked around 4 percent. In some cases, 

deficits grew to more than 6 percent of GDP before 

reversing direction. However, once current account 

deficits began to contract, they typically took about 

two years to shrink to between 1 and 2 percent of 

GDP. In another two years, many, but not all, of these 

countries moved into balance or surplus. 

According to the Federal Reserve Board study, although 

current account deficits may unwind fairly quickly, the 

effects on economic activity typically have been mild 

for industrialized countries. During the episodes 

reviewed, median real GDP growth slowed by only 

about 3 percentage points. Increases in inflation and 

short-term interest rates were associated with current 

account adjustments, but the changes were not dramatic. 

After removing the effects of inflation, real exchangerate depreciation also tended to be limited at around 

8 percent. While all these adjustments occurred with 

only mild effects, there is no assurance that this must 

always be the case. 

9 Hilary Croke, Steven B. Kamin, and Sylvain Leduc, “Financial 

Market Developments and Economic Activity during Current Account 

Adjustments in Industrialized Economies,” Board of Governors of the 

Federal Reserve System (International Finance Discussion Papers, 

no. 827, February 2005), http://www.federalreserve.gov/pubs/ 

ifdp/2005/827/default.htm. 

The results of this study also show that the magnitude of the effects of an adjustment hinges on how 

fast the economy is growing as it heads into the 

adjustment. Rapidly growing economies appear to 

slow more significantly and exhibit a greater tendency 

to enter recession. The jump in inflation and the 

decline in real exchange rates tend to be considerable 

in economies that are expanding rapidly before the 

adjustment. These results suggest that many rapidly 

growing economies may have been overheating 

before the current account adjustment and that their 

large current account deficits may have been part of 

a larger macroeconomic problem. 

Conclusion 

The U.S. current account deficit has been widening 

for more than a decade. Until now, net inflows of 

foreign savings have been adequate to fund the current 

account gap while offsetting the financing outflows 

resulting from U.S. residents and businesses investing 

abroad. However, at more than 6 percent of GDP, the 

U.S. current account deficit has entered uncharted 

territory. In past cases involving other industrialized 

countries, large current account deficits have eventually 

resolved themselves, usually with modest economic and 

financial market consequences. But the U.S. current 

account deficit is not typical, given the predominant 

global role played by the U.S. economy, its financial 

markets, and the dollar. The uncertainty posed by this 

situation, along with its far-reaching implications for 

economic performance, makes it worthy of ongoing 

attention and study. 

J. Aislinn Bohren, Economic Research Assistant 

Brian Lamm, Senior Financial Analyst 

FDIC OUTLOOK 10 SUMMER 2005 
U.S. International Accounting Basics
 

The United States is both an importer and exporter exports, and as a result it must pay for these net 

of goods and services. But it is also an exporter and imports of goods by also being a net importer of 

importer of investments, as U.S. investors seek to foreign savings. Because these foreign savings inflows 

place their savings abroad while foreign savers seek are credited to the financial account, they offset the 

to invest in U.S. assets, such as stocks, bonds, and U.S. net negative trade position (see Table). 

real estate. These trading relationships are reflected The table also shows that the U.S. net trade deficit in two international transaction accounts, the in goods dominates its current account deficit. Simi­ current account and the financial account, summa­ larly, the biggest source of foreign savings supporting rized below. In open economies—those without the net import position in 2004 came from private significant capital or trade controls—these two foreign investors. accounts must balance. In the case of the United 

States, it consumes more in imports than it sells in J. Aislinn Bohren, Economic Research Assistant 

U.S. International Transactions 

as of 2004 (dollars in billions) 

Table 

Current Account Financial Account 

Financial Financial 

Component: Exports Imports Net Component: Outflows Inflows Net 

Trade in Goods Official Reserve 

and Services $ 1,147 $ –1,764 $ –617 Assetsd $ 3 $ 355 $ 358 

Goods 808 –1,473 –665 Private Securities 

and Claims –572 962 390 

Consumer goods 

and autos 191 –601 –410 Direct Investmente –249 116 –133 

Capital goods and 

industrial supplies 

and materialsa 510 –546 –35 Capital Accountf — — –1 

Energy 24 –210 –186 Statistical Discrepancyg — — 52 

Other goods 82 –116 –34 

Services 340 –291 48 

Interest Incomeb 369 –345 24 

Unilateral Transfersc — — –73 

Balance on Current Account $ –666 Balance on Financial Account $ 666 

Notes: 

a The industrial supplies and materials component excludes autos and energy. 

b Interest income is domestic investors’ interest receipts on foreign investments (export column) and interest payments to foreign investors (import column). 

c Unilateral transfers include gifts, foreign aid, nonmilitary economic development grants, government pensions, and private remittances. 

d Official reserve assets are foreign currency assets held by a central bank. 

e Direct investment is investment made by a foreign individual or company (source) to acquire or construct physical capital in the host country. 

f In 1999, what was previously known as the capital account was renamed the financial account in the U.S. balance of payments. The capital account was redefined as a component 

of the financial account, which includes non-produced, non-financial assets such as debt forgiveness. 

g Although the balance on the current and financial accounts sum to zero in theory, in practice differences invariably arise due to measurement and estimation errors. The statistical 

discrepancy represents these differences. 

Source: Bureau of Economic Analysis Balance of Payments. (See the Bureau of Economic Analysis U.S. International Transactions Accounts Data tables (http://www.bea.gov/bea/ 

international/bp_web/list.cfm?anon=71®istered=0) for more information.) 

FDIC OUTLOOK 11 SUMMER 2005 
In Focus This Quarter: U.S. Banking in a Global Economy 

U.S. Trade Demographics in 2004 

Goods and Services by Country 

Chart 1 Chart 2 

Exports of Goods and Services by Country Imports of Goods and Services by Country 

Dollars in billions (percent of U.S. exports) Dollars in billions (percent of U.S. imports) 

Japan, $87 (8%) Australia, $11 (1%) Australia, $21 (2%) Japan, $151 (9%) 

Mexico, $129 (11%) Other Countries in 

Asia and Africa, 

$259 (23%) Latin America and
 

Other Western
 

Hemisphere,


excluding


Mexico, International

Organizations $102 (9%) and Unallocated, 

$7 (1%) 

Canada, $220 (19%) 

European Union,

$283 (24%) Non-European Union Europe,


$40 (3%)
 

Source: U.S. Department of Commerce, Bureau of Economic Analysis 

Balance of Payments. 

U.S. Trade Demographics in 2004 

Goods and Services by Industry 

Chart 3 

Exports of Goods and Services by Industry 

Dollars in billions (percent of U.S. exports) 

Autos, $88 (8%) Consumer Goods, 

$103 (9%) 

Other, $26 (2%)
 Capital Goods,
 

$331 (29%)
 Foods, Feeds, and
 

Beverages,
 

$56 (5%)
 

Travel and
 

Transportation


Services,
 

$131 (11%)
 

Direct Defense
 

Industrial Supplies Services, $14 (1%)
 and Materials,
 

$179 (16%)
 Other Services, Energy, $195 (17%) $24 (2%) 

Source: U.S. Department of Commerce, Bureau of Economic Analysis 

Balance of Payments. 

Mexico, $170 (10%) Other Countries in 

Asia and Africa, 

$559 (31%) Latin America
 

and Other
 

Western
 

Hemisphere,
 

excluding


Mexico,
 

$141 (8%)
 International 

Organizations

Canada, $279 (16%) and Unallocated, 

$5 (0.3%) 

Non-European Union Europe, European Union,
 $60 (3%) $388 (22%)
 

Source: U.S. Department of Commerce, Bureau of Economic Analysis 

Balance of Payments. 

Chart 4 

Imports of Goods and Services by Industry 

Dollars in billions (percent of U.S. imports) 

Consumer Goods, 

Autos, $228 (13%) $373 (21%) 

Other, $54 (3%) 

Foods, Feeds, 

Capital Goods, and Beverages, 

$344 (19%) $62 (4%) 

Travel and
 

Transportation
 

Services,
 

$142 (8%)
 

Direct Defense Industrial Supplies Services, $28 (2%) and Materials,
 

$202 (11%) Energy, Other Services,
 

$210 (12%) $121 (7%)
 

Source: U.S. Department of Commerce, Bureau of Economic Analysis 

Balance of Payments. 

FDIC OUTLOOK 12 SUMMER 2005 
In Person: Two Perspectives on Global Financial 

Imbalances 

The far-reaching changes being driven by globalization naturally lead to questions about where the 

process is leading us. At a personal level, job security 

surely ranks first as a concern in the minds of most. 

But individuals also face uncertainty about the new 

types of financial risks they face and what investment 

strategies make the most sense in a changing world. 

At a policy level, it is generally appreciated that 

globalization is making the world richer, but that 

there are winners and losers in the short run. In 

addition, the emergence of unprecedented global 

financial imbalances—perhaps best exemplified by 

the large and growing U.S. current account deficit— 

have led many to express worries about the future 

of the world’s largest economy. 

During the week of May 2, 2005, FDIC Chief Economist Richard A. Brown conducted a pair of interviews 

with prominent experts on international financial 

trends. He asked these experts to look into America’s 

economic future and discuss the implications of a 

U.S. current account deficit that reached $666 billion 

in 2004. Brown posed a specific set of questions to 

each expert regarding either the “adverse” scenario or 

the “benign” scenario for resolving this large financial 

imbalance. Edited transcripts of both interviews 

appear below. 

Outlining the benign scenario is Stuart S. Brown, 

Professor of Economics and International Relations 

at the Maxwell School of Citizenship and Public 

Affairs and Senior Research Associate at the Moynihan 

Institute of Global Affairs at Syracuse University. 

Addressing questions about the adverse scenario is 

Roger M. Kubarych, Senior Economic Adviser for 

HVB Group, Henry Kaufman Adjunct Senior Fellow 

in International Economics and Finance at the Council on Foreign Relations, and former Chief Economist 

of the New York Stock Exchange.1 (See “Other Opinions on the Current Account Deficit” after this article 

for views besides those of Dr. Brown and Mr. Kubarych.) 

We begin with Professor Brown. 

Stuart Brown: “This is a global economic problem, and we all 

have to do our part.” 

MR. RICHARD BROWN: Good afternoon, Stuart. 

We’re going to ask you to outline what a benign 

scenario might look like with regard to the current 

account deficit. What are some of the developments 

that need to come into play to reduce these imbalances 

in a way that does not damage the performance of 

the U.S. economy? 

DR. STUART BROWN: First of all, when we talk 

about an adjustment to the current account imbalance, 

we’re not talking about going back to a surplus or even 

a zero balance. I think many would agree that if the 

United States eventually achieved annual current 

account deficits of something like 2.5 to 3 percent of 

gross domestic product (GDP), that would probably 

constitute a reasonable, medium-term equilibrium. 

This reflects the fact that the U.S. economy is dynamic 

and fast growing owing largely to superior productivity 

growth, with a labor force being boosted by immigration 

that is more rapid than in, 

let’s say, Europe. 

That gives you a sense of 

the type of adjustment—an 

admittedly large one—that 

would be needed over time 

to reach a new equilibrium, 

although in the case of 

financial markets there is a 

tendency to overshoot 

during the adjustment 

process. But we’re certainly 

not going to see the current account deficit fall from 

6 percent of GDP to zero. So that’s number one. 

1 HVB Group is the parent organization of Hypo Vereinsbank, 

Germany’s second-largest bank, and Bank Austria-Creditanstallt. 

Stuart S. Brown 

FDIC OUTLOOK 13 SUMMER 2005 
In Focus This Quarter: U.S. Banking in a Global Economy 

“I think many would agree that 

if the United States eventually 

achieved annual current account 

deficits of something like 2.5 to 

3 percent of GDP, that would 

probably constitute a reasonable, 

medium-term equilibrium.” 

Stuart Brown 

Second, one needs to recognize that part of that solution involves actions that are the responsibility of a 

variety of actors in the world, not just the United 

States. With respect to Asia, I think it is reasonable 

to think that a revaluation of currencies is at some 

point going to be likely. And this is going to 

contribute to an overall solution to the problem of 

global imbalances. 

But it’s not just about China revaluing its currency. It is 

also about the indirect impact that a Chinese revaluation would have on other Asian countries, which would 

be less reticent about allowing their currencies to appreciate against the dollar if the Chinese move first. That is 

to say, Asia must gradually move to greater reliance on 

domestic demand-led growth. Such developments aren’t 

going to completely eliminate the U.S. deficit, but they 

might reduce it by $75 billion to $100 billion of the 

$660 billion current account deficit we have now. So 

it’s that order of magnitude. 

Third—and this is hugely important—Europe and 

Japan have to grow. And that is going to require all of 

the systemic changes to their economies that economists have been talking about for a very, very long 

time. Ultimately, the current account deficit in the 

United States is a reflection more than anything else 

of a more rapidly growing U.S. economy compared to 

the other major economies of the world, obviously 

excluding China, which is also playing a significant 

role in stimulating global demand. 

Although a decline in the value of the U.S. dollar is 

part of the solution as well, you can’t expect the entire 

burden to be taken on by the dollar, and it won’t be. 

There are other elements required for a gradual adjustment, some of which I’ve described. 

Also, I should add that as far as the United States is 

concerned, more serious attention needs to be paid to 

the federal budget deficit both over the next few years 

and—more importantly—in terms of the critical, 

longer-term challenge of maintaining the solvency of 

entitlements, notably Medicare, Medicaid, and Social 

Security. On that issue, however, my problem with the 

pessimists is that they tend to think that a budget deficit 

reduction in the United States by itself is going to have 

a dramatic effect on the current account deficit, and I 

think the evidence does not bear that out. In fact, I 

would cite an authoritative Federal Reserve study 

published earlier this year that concludes that for every 

dollar in fiscal deficit reduction, we can expect to get 20 

cents of improvement on the current account balance.2 

So, the benign scenario I am outlining depends in part 

on everybody realizing that this is a global economic 

problem, and we all have to do our part. Ultimately, 

the major countries, indeed the entire world, have a 

vested interest in promoting policies that contribute 

to reducing global trade imbalances. As I said, this 

includes the United States, which has ample reason— 

in addition to the current account deficit—to address 

its fiscal challenges. 

The benign scenario also involves a gradual rise in 

interest rates in the United States, which would be 

what one would expect in any event given where we 

are in the business cycle, along with a gradual decline 

in a still-overvalued dollar. In addition, a benign 

scenario presupposes a fairly stable long-term dependency between Asia and the United States. In particular, 

the Asian countries are extremely interested in maintaining market openness with the United States, the 

largest consumer of their products. 

In my view, proponents of the “hard-landing” scenario 

overemphasize the concern that the Asian central 

banks harbor over the potential for so-called capital 

losses on their dollar holdings. The concern is that if 

the dollar declines—and, even worse, if it declines 

rapidly—that would cause the Asian central banks to 

suffer increasingly stiff capital losses on their foreign 

exchange reserves. Furthermore, as the story goes, the 

fear of a rapidly declining dollar will lead those central 

2 Christopher J. Erceg, Luca Guerrieri, and Christopher Gust, “Expansionary Fiscal Shocks and the Trade Deficit,” Federal Reserve Board 

(International Finance Discussion Papers, no. 2005-825, January 

2005), http://www.federalreserve.gov/pubs/ifdp/2005/825/default.htm. 

FDIC OUTLOOK 14 SUMMER 2005 
In Person: Two Perspectives on Global Financial Imbalances 

banks to cut back on their purchases of U.S. assets, 

which, of course, finance the current account deficit. 

“It’s not just about China 

revaluing its currency. It is also 

about the indirect impact that 

a Chinese revaluation would 

have on other Asian countries, 

which would be less reticent 

about allowing their currencies 

to appreciate against the dollar 

if the Chinese move first.” 

Stuart Brown 

I think this reflects a misunderstanding of how central 

banks view foreign exchange reserves, particularly in 

Asia. We’re still not that far removed from the Asian 

financial crisis of the late 1990s, where insufficient 

foreign exchange reserves contributed to the crisis. 

Central bankers in China, Taiwan, Thailand, Malaysia, 

and elsewhere are very cognizant of the need to build 

up foreign exchange reserves—even to levels that one 

might typically regard as “excessive”—as a buffer to 

defend themselves against potential future speculative 

attacks. Furthermore, these reserves do not represent 

claims against domestic output—that is, the reserves 

are not used to buy domestic goods and services. So to 

compare this notional capital loss on foreign exchange 

reserves (arising from a decline in the value of the 

dollar) to GDP in these Asian economies, as the adherents of the hard-landing view tend to do, makes little 

economic sense to me. The only exception to this 

view—that Asian central banks should be less worried 

about a medium-term decline in the U.S. dollar— 

would involve a scenario in which the U.S. economy 

and the dollar were headed for a longer-term systemic 

crisis, and I just don’t see a realistic basis for attaching 

any significant weight to such a scenario. 

I think that the overriding concern of Asian governments is to be able to continue with their fundamental 

export-led growth strategy. By exporting manufacturing 

goods to the United States, these economies can 

employ the sizeable surplus labor force coming from the 

agricultural sector to the cities. They need a reasonably 

competitive exchange rate to do that. If they have to 

accumulate foreign exchange reserves as part of that 

process, that’s a secondary issue, as is the changing 

value of those reserves. 

The actual fiscal cost for China of buying all these 

foreign exchange reserves and maintaining the peg 

between the renminbi and the dollar is that the Bank 

of China has fewer resources to transfer to the budget. 

And that is a trivial matter in my view relative to 

employing hundreds of millions of peasantry from 

the countryside and exporting as much as they can. 

But having said all that, I think that the Chinese 

recognize that protectionist pressure in the U.S. 

Congress is picking up steam. In light of that, a realistic 

way to stave off that all-out assault on Chinese imports 

to the United States is for the Chinese to allow some 

strengthening of their currency. And I think that is 

exactly what they will end up doing. 

MR. RICHARD BROWN: In the sense that this 

situation has thus far remained “benign,” and that it 

appears plausible that the benign scenario could 

continue going forward, let me ask you where things 

could go wrong. What are some of the factors that 

could derail an orderly resolution of the current 

imbalances? 

DR. STUART BROWN: First, I would not want to 

suggest that an adverse scenario is impossible. I would 

simply say that in a probabilistic sense, the benign 

scenario is much more likely. The idea that there will 

be a sudden re-evaluation of U.S. assets leading foreign 

investors and central banks to dramatically curtail their 

purchases of Treasuries and the myriad of other official 

and private U.S. assets runs counter to the basic reality 

that underlying U.S. economic fundamentals are sound. 

I find that the more pessimistic assessments of the situation tend to exaggerate the vulnerabilities of the U.S. 

economy and underestimate its strengths. 

If you look objectively at the United States, you see the 

deepest, most liquid, most sophisticated financial 

markets in the world. Above all, it’s a politically stable 

country with unparalleled protection for property rights 

and, therefore, a great, safe place to put your money. 

Second, you have more rapid economic growth in the 

United States than the rest of the industrialized world, 

grounded in much more rapid productivity growth led 

by increasingly inventive applications of information 

FDIC OUTLOOK 15 SUMMER 2005 
In Focus This Quarter: U.S. Banking in a Global Economy 

and computing technology. So the notion that there is 

going to be a sudden, precipitous reversal of the net 

capital currently flowing into the United States does 

not appear credible. The one possible exception to this 

benign scenario I’m outlining would be a perception on 

the part of investors that the U.S. political process was 

ultimately too paralyzed to address the country’s longerterm fiscal challenge. Perhaps there is a basis for such a 

perception, but I would still argue that it is premature. 

“As far as the United States is 

concerned, more serious attention 

needs to be paid to the federal 

budget deficit both over the next 

few years and—more importantly—in terms of the critical, 

longer-term challenge of maintaining the solvency of entitlements, notably Medicare, 

Medicaid, and Social Security.” 

Stuart Brown 

I understand that we’ve already seen private investors 

scale back on dollar holdings over the past few years. 

There is nothing confusing about that, as private 

investors operate strictly on the basis of expected real 

(currency-adjusted) returns. I would only add that as 

the dollar declines—and I would expect it to decline 

somewhat more over the next few years—there is a 

natural brake on the speed with which that adjustment 

happens. Private investors, who still think of the 

United States as a very dynamic, healthy economy, will 

continue to buy on dollar weakness. 

I also think that central banks, particularly in Asia, will 

continue to buy dollar-denominated assets, including 

U.S. Treasuries, to limit the extent to which their 

currencies appreciate. So I don’t identify with this basic 

fear of a massive slowdown in combined official and 

private capital inflow to the United States, which would 

force a precipitous, painful reduction in the U.S. current 

account deficit. That scenario just does not comport 

with the basic underlying strength of the U.S. economy 

and Asia’s long-term dependence on our market. 

MR. RICHARD BROWN: Does the presence of 

these global financial imbalances reflect, in your 

opinion, a fundamentally deflationary global economy, with oversupply in a number of manufacturing 

sectors? Is that one of the elements of the imbalances 

that we see right now? 

DR. STUART BROWN: I essentially subscribe to the 

view that there is an oversupply of global savings. You 

can call it a global savings glut or you can call it a lack 

of investment opportunities relative to the existing 

supply of global savings. But I think that this is a big 

reason why there has been such a massive flow of money 

in the last few years to the United States, where there 

are opportunities to invest your money productively or 

safely. Part of the reason for the inflow has been the 

Asian financial crisis and its aftermath. I also think it’s 

because of the relative lack of growth in places like 

Japan and Europe. I’m not saying that lack of growth is 

going to last forever, but I think that this is part of the 

reason why the United States attracts foreign capital. 

“Central bankers in China, 

Taiwan, Thailand, Malaysia, and 

elsewhere are very cognizant of 

the need to build up foreign 

exchange reserves—even to levels 

that one might typically regard as 

“excessive”—as a buffer to defend 

themselves against potential 

future speculative attacks.” 

Stuart Brown 

The other side of that net inflow of capital is, of course, 

our current account deficit. I see the current account 

deficit not completely, but largely, as an endogenous 

result of stronger U.S. economic growth and the desire 

of a variety of institutions and investors around the 

world to put their money in a safe, reasonably highreturn place. As long as that continues at the same 

rate, it’s difficult to see how the current account deficit 

can turn around decisively. 

MR. RICHARD BROWN: Is it a “flight to quality” 

by international investors? 

FDIC OUTLOOK 16 SUMMER 2005 
In Person: Two Perspectives on Global Financial Imbalances 

DR. STUART BROWN: I think it’s fundamentally 

a flight to quality not just in terms of the safety of 

U.S. government paper, but in terms of the underlying 

productivity of the U.S. economy and the lack of 

sufficient investment alternatives in other places. 

MR. RICHARD BROWN: In terms of risk management on the part of FDIC-insured institutions, you 

mentioned the likelihood of a transition toward higher 

interest rates and perhaps a weaker dollar. What sorts 

of things should financial institutions do to prepare for 

the adjustments that need to take place? 

DR. STUART BROWN: I’m not an expert on 

financial institutions, but I would suspect that they’re 

doing exactly what they should be doing. Chairman 

Greenspan and the Federal Reserve have long been 

signaling that we’re at the point of the business cycle 

where the expansionary monetary policy of the last 

few years has to reverse—irrespective of the current 

account deficit—and that interest rates are going up 

to contain inflationary pressures. The Fed’s strategy 

has been to avoid surprising the markets; they have 

not tried to camouflage this. They’ve signaled very 

transparently that rates in the United States are 

going to rise relative to rates in other major countries. 

I don’t think that the speed with which rates will rise 

is going to be accelerated markedly by the presence of 

a large current account deficit. In fact, what is extraordinary is that with all these rumors about central banks 

diversifying their foreign exchange reserves and running 

from the United States, why have long-term U.S. real 

interest rates been so low? They’ve been lower than 

you would think at this stage of the business cycle, and 

lower than last year and the year before that. So I don’t 

see much evidence to suggest that the current account 

deficit is going to complicate the interest rate picture 

to any considerable degree. 

I would imagine that bank earnings are going to suffer 

as rates rise, because it becomes tougher to raise loan 

rates commensurately with deposit rates, which will 

narrow spreads. That’s a totally understandable issue. 

I would also think that equities could weaken due to 

rising interest rate expectations. But I don’t see a basis 

for serious concern about some systemic financial challenge on the back of this. 

MR. RICHARD BROWN: I just have one more 

question for you, Stuart. You mentioned the revaluation of the Chinese currency. Is there an issue there 

with regard to the convertibility of capital and the 

health of the Chinese banking system? There are 

some who say that the high level of problem loans 

at some Chinese banks is one of the impediments to 

creating a convertible currency and allowing that 

exchange rate to rise. 

DR. STUART BROWN: Revaluation should not be 

confused with full convertibility of the currency, particularly on the capital account side of the balance of 

payments. There is no reason that a revaluation of 

the renminbi has to be accompanied by a very rapid 

reduction of capital controls in China. In fact, I think 

that that would be a mistake. 

“The idea that there will be 

a sudden re-evaluation of U.S. 

assets...runs counter to the 

basic reality that underlying 

U.S. economic fundamentals 

are sound.” 

Stuart Brown 

So the fact that China revalues its currency and then 

pegs it at a different rate, and even if they go, by the 

way, to a managed floating-exchange-rate system where 

they allow some greater flexibility in their exchange rate 

and thereby acquire greater control over their monetary 

policy, that doesn’t mean that they have to remove all 

capital controls. One would expect very serious problems in China’s financial sector if capital controls were 

completely removed before the huge problem of nonperforming loans in Chinese banks was addressed first. 

MR. RICHARD BROWN: Thank you, Stuart, for 

sharing your insights on these issues with the readers 

of FDIC Outlook. 

Stuart S. Brown is co-author, with David H. Levey, 

of “The Overstretch Myth: Can the Indispensable Nation 

Be a Debtor Nation?” in the March/April 2005 edition 

of Foreign Affairs (http://www.foreignaffairs.org/2005/ 

2.html). Brown and Levey will again be featured in the 

Review and Response section of the July/August issue of 

Foreign Affairs discussing their views on the U.S. current 

account deficit. 

FDIC OUTLOOK 17 SUMMER 2005 
 

In Focus This Quarter: U.S. Banking in a Global Economy 

Roger Kubarych: “What if foreign countries and 

central banks decide to change their minds?” 

MR. BROWN: Good morning, Roger. What we 

would ask you to do today is to describe for us an 

adverse scenario for resolving the U.S. current 

account deficit. That is, what does an adverse 

scenario look like, and what are some of the things 

that could bring it about? 

MR. KUBARYCH: Looking back at past financial 

incidents—and there have been some nasty ones, like 

the stock market crash of 1987, the banking crisis 

and thrift crisis of the late 1980s and early 1990s, and 

the collapse of the high-tech bubble—the financial 

and the economic consequences get bigger if there 

is a kind of a feedback mechanism going through 

the international side. That certainly was the case 

in 1987 when much of the tension in the financial 

markets had to do with a series of confrontations 

between the United States and other countries, 

including Japan and Germany. 

Certainly, the world is a little broader today, and there 

are more countries that are involved. But clearly I 

would think that an adverse scenario that could result 

from the current U.S. dependence on foreign savings 

would be a development that suddenly, dramatically, 

and in a lasting way stopped those savings from flowing 

into the United States. One way this could happen 

would be to block these flows, as occurred in the case 

of certain takeover bids by foreign companies back in 

the 1980s, or by a policy decision by foreign governments to discontinue the purchase of U.S. assets. 

So how could this scenario develop? If you look through 

the various precedents, some sort of protectionist measures by the United States could provide the trigger. 

Let me step back and say that it’s a matter of logic more 

than anything else that in order to run a current 

account deficit of $700 billion, which is well over 

6 percent of gross domestic product, it has to be 

financed. If you can’t finance it, you can’t run it. So the 

adverse scenario is one that forces the United States to 

have a smaller current account deficit, because it can’t 

finance a bigger one. And the main risk scenario that I 

can see is that something interferes with the kind of 

Roger M. Kubarych 

flows of capital from abroad 

that we’ve become accustomed to. 

MR. BROWN: If foreign 

investors move away from 

dollar-denominated assets, 

what sorts of assets would 

they move into? And what 

are some of the implications that that might have for 

U.S. long-term interest rates and equity prices? 

MR. KUBARYCH: Well, first of all, there are basically 

two types of foreign investors that have been financing 

the U.S. current account deficit. 

One type is foreign official institutions: central banks, 

government agencies, and private-sector agencies and 

financial institutions that are actually influenced or 

directed by the governments of their countries. These 

kinds of institutions are particularly common in Asia, 

and up to 75 to 80 percent of the U.S. current 

account deficit in the last two or three years has been 

financed by the combination of foreign central banks, 

government investment corporations, and others 

directly or indirectly controlled by foreign governments, mostly in Asia. 

The second type of foreign investor is private 

investors, and they take two forms: portfolio investors 

that buy stocks, bonds, and other types of financial 

instruments; and direct investors, meaning corporations that make investments in existing companies 

through takeovers or stock purchases or create new 

greenfield investments in the United States.3 

The direct investment activities of foreign private 

companies have diminished dramatically since 2000. 

They peaked in the late 1990s when the transplant 

factories were being established by the Japanese auto 

3 The World Bank Local Economic Development glossary (see 

www.worldbank.org) defines a greenfield investment as factories and 

offices being built on land that previously has not been developed. 

Greenfield investments also imply that facilities are designed and built 

for investors, rather than the investor buying a facility already built. 

FDIC OUTLOOK 18 SUMMER 2005 
In Person: Two Perspectives on Global Financial Imbalances 

companies. In the last few years, those investments 

have diminished a lot and no longer represent a major 

part of the financing. 

“The main risk scenario that 

I can see is that something 

interferes with the kind of flows 

of capital from abroad that 

we’ve become accustomed to.” 

Roger Kubarych 

There appears to be much less interest on the part of 

foreign companies in being here in the United States 

right now. If they are here already, they’re probably 

making money. But there’s no real enthusiasm. Those 

same companies are now more interested in Brazil, 

Mexico, China, and Eastern Europe. 

So the real question is this: What are those foreign 

central banks, government institutions, and other 

financial institutions going to do with their money? 

And the answer is that they’re going to diversify it. 

They’re going to move out of U.S. government securities at the margin either by selling securities they 

already have or, more likely, taking the bulk of their 

new acquisitions of dollars and selling them for euro, 

sterling, yen, or what you might call commodityrelated currencies like the Australian dollar and 

Canadian dollar. There are plenty of other currencies 

and plenty of other bonds and stock markets for 

foreign investors to go into. Actually, they’ve become 

disproportionately invested in the dollar relative to 

their trade patterns. 

MR. BROWN: What implications would that have for 

U.S. inflation and interest rates? Could we see another 

episode of stagflation similar to the late 1970s? 

MR. KUBARYCH: There’s no doubt that the ability 

to import cheap—that is, inexpensive—products from 

around the world has kept down U.S. inflation. The 

Chinese all by themselves are bringing down the U.S. 

inflation rate by several tenths of a percent. Import 

prices from China and some of the other Asian developing countries are actually lower today than they were 

a year ago. Japanese import prices from the perspective 

of the United States are up less than 1 percent from last 

year. It’s only when you look at manufactured goods and 

import prices from Europe that you see a significant 

increase in price. 

What’s happened is that whatever exchange rate 

changes there have been in the last few years, the 

foreign producers are essentially bearing that burden 

themselves rather than passing it on in higher prices. 

And that’s one reason why American consumers and 

businesses are buying foreign products, because their 

prices haven’t gone up. In order to have a change in 

incentives that would reduce the current account and 

trade deficits, those import prices are going to have to 

go up. And those price increases, in turn, would be 

matched by domestic corporations that are competing 

with imported goods. Raising prices is always the easiest route to more profits. 

So this big current account adjustment, the unfriendly 

one, would be inflationary. That rise in inflation will 

set off an increase in inflationary expectations that 

will lead to big sales in the bond market by traders and 

investors, so long-term interest rates will also go up. 

But how much? That depends on how sudden the 

shock is and, of course, on the political climate in 

which it is made. But there will be upward pressure on 

U.S. interest rates, and that will feed through into a 

reduced demand for housing, so the housing boom will 

cool off and housing prices will stop going up. Average 

housing prices in this country are up 11 and a half 

percent from a year ago. That rate of appreciation will 

slow quite a bit—and in a hurry—which will lead to 

lower consumer spending. The capital gains—both 

realized and unrealized—on housing in the last few 

years have spurred greater levels of consumption, leading to higher domestic economic activity and a higher 

level of imports as well. 

“Looking back at past financial 

incidents...the financial and the 

economic consequences get bigger 

if there is a feedback mechanism 

going through the international 

side.” 

Roger Kubarych 

FDIC OUTLOOK 19 SUMMER 2005 
In Focus This Quarter: U.S. Banking in a Global Economy 

“What are those foreign central 

banks, government institutions, 

and other financial institutions 

going to do with their money? 

The answer is that they’re going 

to diversify it.” 

Roger Kubarych 

So there will be a reversal of the process that we’ve 

benefited from in the last few years, which is low interest rates, facilitated by low inflation, which has been 

kept down by a high level of imports. Low inflation 

has led to the big housing boom, where prices on average have been going up far faster than incomes. And 

people have been drawing on that elevated level of 

housing wealth to consume more. As a result, the U.S. 

savings rate has been very low, in some quarters barely 

above zero. And the United States has enjoyed a high 

rate of economic growth compared to any other industrial country. 

MR. BROWN: If there were one or two policy initiatives that the United States could undertake to mitigate 

the possibility of these adverse consequences, what 

might they be? 

MR. KUBARYCH: Well, the United States is out 

there right now trying to get the exchange-rate adjustment mechanism to work better, but government officials are doing so in a “kind and gentle” way. They’re 

trying to get exchange-rate flexibility into the Asian 

system so that there will be a gradual increase in these 

currencies rather than a sudden, disruptive one. And 

they would naturally welcome some increase in import 

prices that would provide an incentive for Americans 

to switch out of imports and into domestically produced 

products. That would be part of the process of adjusting 

the trade deficit. 

You don’t want to adjust the trade deficit by running a 

recession. For one thing, nobody benefits from a recession, and it’s not a sustainable policy. You can’t run a 

sustained recession just to hold down the trade deficit. 

The only countries that have done that have been 

countries that were facing a loss of access to the capital 

markets. For example, Argentina went through a terrible recession in the late 1990s. But that’s not something that’s going to happen to the United States, and 

it’s not wanted. 

So basically the administration’s stated policy is to 

create the benign scenario. But the administration is 

not living in a vacuum, and the Congress is capable of 

forcing protectionist measures onto an unwilling administration if it gets irritated enough by what is seen as 

unfair competition from abroad. That could thwart the 

administration’s policy of creating the conditions for a 

benign adjustment. 

MR. BROWN: So protectionism would be the one 

policy to avoid? 

MR. KUBARYCH: It would do the most damage. 

And that protectionism can be in two basic types, one 

of which is trade protectionism. The most extreme form 

of that is a movement backward from the kind of system 

we have now—where consumers choose—to where 

governments choose how the trade patterns work. 

But you can also have protectionism on the investment side. If you go back to 1987, one of the triggers 

for a lot of the concern in both the foreign exchange 

markets and then the bond markets, which spilled 

over into stocks later that year, was the denial of an 

application by a Japanese company to buy Fairchild 

Semiconductor. That really left a bad taste in the 

mouths of not only the Japanese, who were denied 

from making the acquisition, but also many other 

foreign investors. Eventually Fairchild was sold to 

Schlumberger, a French oil-field services provider. But 

the damage was done. 

“This big current account 

adjustment, the unfriendly one, 

would be inflationary.” 

Roger Kubarych 

What do you think would happen if the Chinese decide 

that they are going to take some of their $700 billion 

in reserves and buy an American company, and then 

Congress says no, we don’t want China owning that 

company, and they pass a special law forbidding it? 

FDIC OUTLOOK 20 SUMMER 2005 
In Person: Two Perspectives on Global Financial Imbalances 

Well, that’s protectionism on the investment side, and 

it can be very damaging. 

To look at the flip side, the chairman of United 

Airlines, which is struggling to try to get out of bankruptcy and become a regular shareholder-owned 

company again, has complained about American 

protectionism as to who can own a U.S. airline. If 

you didn’t have limits on foreign ownership of U.S. 

airline companies, there is more than one foreign 

airline that might be a natural bidder for a United 

Airlines coming out of bankruptcy. 

“[Foreign governments and their 

agencies] have been running a 

classically mercantilist policy by 

using the exchange rate to make 

their goods more competitive on 

a global basis, not just against 

the United States. And they’re 

getting away with it.” 

Roger Kubarych 

We don’t have a totally pure system either in the trade 

area or in the investment area, so it is very easy to see 

how a tightening or a broadening of such restrictions 

could have a negative effect. 

MR. BROWN: One last question. Financial institutions manage risks according to the quantitative 

relationships they can measure in the world as it is 

today. It is sometimes difficult to prepare for a big 

sea change—such as the dollar falling from its status 

as the world’s de facto reserve currency—that can 

profoundly affect inflation and interest rates. What sort 

of risk management strategies can financial institutions 

use to insulate themselves from the possibility of such 

a big change in the macroeconomic environment? 

MR. KUBARYCH: Well, I have a few things to say 

here. The key is that foreign governments and their 

agencies are preventing exchange-rate changes that 

would be associated with reducing the dollar share in 

world reserves and in the use of the dollar internationally. They have been the ones keeping the dollar as the 

main currency, not the United States. 

Now, why are they doing that? They’re doing that for 

trade advantages, because they see the United States as 

the only fast-growing major industrial country, and 

they’re trying to build their market share. So they have 

been running a classically mercantilist policy by using 

the exchange rate to make their goods more competitive on a global basis, not just against the United 

States. And they’re getting away with it. 

The international monetary system is really not 

governed in any explicit way. The International 

Monetary Fund has essentially been relatively passive, 

if not negligent, in monitoring the situation. Because 

there are short-term benefits to the United States 

from this situation, the United States hasn’t really 

pushed the issue very much either. The Europeans, 

who are irritated at the United States because of Iraq, 

have been tardy in recognizing that they are among 

the ones that are most hurt. 

So the interesting question is, what if foreign countries 

and central banks decide to change their minds? Well 

then, of course, there would be a substantial systemic 

change. That’s happened before. We had a major 

realignment in currencies in 1971 and again in 1973. 

And we’ve struggled with the Japanese for 30 years 

in terms of the relationship between the yen and the 

dollar. Anybody managing funds in an international 

context, knowing this history, has to know that there 

will be a major change. Not whether there might be, 

but that there will be. So how do you prepare for that? 

Well, you assume that it is going to happen, and you 

act ahead of it; you diversify before everybody else does. 

That’s lesson number one. 

Another way to prepare efficiently and quietly, anonymously, is by using modern techniques in the financial 

derivatives markets. If I wanted to protect myself 

against a really big systemic change in the world’s 

financial markets, I would be a buyer of deep out-ofthe-money options. This is basically saying that I’ll 

pay a certain premium, like an insurance premium, to 

insure myself against a big change. I would look at the 

values of those deep out-of-the-money options today 

and find that they were quite cheap, because, in fact, 

markets are being kept unrealistically steady. The 

degree of volatility in the markets has been essentially 

suppressed by all of this activity. So I would be a buyer 

of volatility. That’s how you would do it. 

FDIC OUTLOOK 21 SUMMER 2005 
In Focus This Quarter: U.S. Banking in a Global Economy 

MR. BROWN: Very good. Roger, this has been really Relations, including “Paradox of Plenty” (April 2005, 

useful to us to get the benefit of your long experience http://www.cfr.org/pub7987/roger_m_kubarych/ 

and your insights into how the markets work. paradox_of_plenty.php). 

Mary Ledwin Bean provided editorial assistance for this 

Roger M. Kubarych is the author of numerous article. 

recent articles published by the Council on Foreign 

FDIC OUTLOOK 22 SUMMER 2005 
In Person: Two Perspectives on Global Financial Imbalances 

Other Opinions on the Current Account Deficit
 

Stephen Roach, Chief Economist and Director of 

Global Economic Analysis, Morgan Stanley 

In a U.S.-centric global economy, that spells 

one thing—over-reliance on the over-extended 

American consumer. Should the U.S. 

consumer cave—a distinct possibility in the 

event of a long overdue current account 

adjustment— 

Asia would be toast.” 

Source: “Asia’s Only Hope,” Global Economic Forum, Morgan 

Stanley, April 29, 2005. 

Nouriel Roubini, Associate Professor in the 

Department of Economics and International 

Business at the Stern School of Business, New 

York University 

“Investors should worry about such concentration [of U.S. government bonds in the 

hands of foreign central banks] and the possibility of foreign exchange diversification out of 

U.S. dollar assets. If such diversification were 

to occur, there would be a significant risk of a 

hard landing for the U.S. and the global economy.” 

Source: “Does Overseas Appetite for Bonds Put the U.S. Economy at Risk?” Wall Street Journal, March 29, 2005. 

Barry Eichengreen, George C. Pardee and Helen 

N. Pardee Professor of Economics and Political 

Science at the University of California, Berkeley 

“The United States has little incentive to 

precipitate the consequent adjustment. To the 

contrary, it is happy living beyond its means. 

Rather, adjustment will have to be forced by 

Asia...Doing so will require allowing the real 

exchange rate to rise.” 

Source: “Global Imbalances and the Lessons of Bretton Woods,” 

National Bureau of Economic Research (working paper, no. 

10497, May 2004). 

Maurice Obstfeld, Professor of Economics, 

University of California, Berkeley; and Kenneth 

Rogoff, Thomas D. Cabot Professor of Public 

Policy and Professor of Economics, Harvard 

University 

“That global capital markets may have deepened (as emphasized by U.S. Federal Reserve 

Chairman Alan Greenspan) does not affect 

significantly the extent of dollar decline in the 

wake of global current account adjustment. 

Rather, the dollar adjustment to global 

current account rebalancing depends more 

centrally on the level of goods–market integration. Whereas the dollar’s decline may be 

benign as in the 1980s, we argue that the 

current conjuncture more closely parallels the 

early 1970s, when the Bretton Woods system 

collapsed.” 

Source: “The Unsustainable U.S. Current Account Position 

Revisited,” National Bureau of Economic Research (working 

paper, no. 10869, October 2004). 

Michael Dooley, Special Advisor, Deutsche Bank; 

David Folkerts-Landau, Managing Director, 

Global Markets Research, Deutsche Bank; and 

Peter Garber, Global Strategist, Deutsche Bank 

“Moreover, it is very hard to find any hint of a 

crisis in the non-price financial data. While the 

official statistics show that the U.S. is a net 

debtor to the tune of $2.5 trillion, the U.S. 

continues to earn more on its assets abroad 

than it pays on its liabilities. Net investment 

income earnings are positive and have actually 

increased in H2 2004 relative to H1 2003. In 

part, the official numbers are just wrong. The 

U.S. has made a whopping capital gain on the 

dollar value of its foreign liabilities that is not 

captured in the statistics.” 

Source: “The Revived Bretton Woods System: Alive and Well,” 

Deutsche Bank, December 2004. 

FDIC OUTLOOK 23 SUMMER 2005 
In Focus This Quarter: U.S. Banking in a Global Economy 

David Altig, Vice President and Associate Director of Research, Federal Reserve Bank of Cleveland, and Adjunct Professor of Economics, 

Graduate School of Business at the University of 

Chicago 

“First, I don’t think anyone is arguing about 

whether an adjustment in U.S. external 

balances is coming. They are big, to be sure, 

and cannot continue to grow. But those observations alone aren’t sufficient to support a 

hard-landing scenario.” 

Source: “Does Overseas Appetite for Bonds Put the U.S. Economy at Risk?” Wall Street Journal, March 29, 2005. 

Ben S. Bernanke, Governor, Federal Reserve 

Board 

“...[T]he underlying sources of the U.S. 

current account deficit appear to be mediumterm or even long-term in nature, suggesting 

that the situation will eventually begin to 

improve, although a return to approximate 

balance may take some time. Fundamentally, 

I see no reason why the whole process should 

not proceed smoothly.” 

Source: “The Global Saving Glut and the U.S. Current 

Account Deficit,” speech, Virginia Association of Economics, 

Richmond, Virginia, April 14, 2005. 

Quotes compiled by Nathan Powell, Financial 

Economist. 

FDIC OUTLOOK 24 SUMMER 2005 
The Globalization of the U.S. Banking Industry
 

Following the overall economic trend of the past 

several decades, the banking industry has become 

increasingly global. U.S. banks insured by the Federal 

Deposit Insurance Corporation (FDIC) have steadily 

grown their international operations over time, while 

foreign banks also have expanded their profile in the 

U.S. marketplace. At the same time, consolidation 

in the U.S. banking industry is having a profound 

effect on the structure of its international operations, 

as the vast majority of the foreign assets of U.S. 

banks are held now by just a few large institutions. 

U.S. banking companies tend to share a similar objective in building an international banking presence— 

namely, to increase revenue growth. However, the 

strategies they employ in pursuit of this goal differ 

widely. Some institutions seek to establish a significant 

market presence in potentially high-growth international markets, while others employ narrower strategies 

such as servicing the global financing needs of their 

banking customers or leveraging their existing product 

expertise in a single line of business. U.S. banks have 

also been eager to expand their nonbanking business 

lines and capital markets activities overseas. 

This article summarizes how globalization is affecting 

the U.S. banking industry. It focuses, in turn, on the 

structure of U.S. banks with international activities, 

the global strategies of U.S. banks, and performance 

differences between banks that are internationally 

focused and those with primarily domestic operations.1 

(See the box entitled “International Operations of U.S. 

Banks and U.S. Operations of Foreign Banks” for more 

information on the regulatory reporting structure of 

foreign banking operations.) 

Global Banking Assets Are Growing Larger and 

More Highly Concentrated 

During the past 20 years, international banking— 

measured in terms of both overseas banking assets 

held by U.S. banks and foreign bank assets in the 

United States—has expanded steadily (see Chart 1).2 

1 Data for foreign banking operations of U.S. banks and bank holding 

companies and foreign banks operating in the United States were 

obtained from various reports required by U.S. banking regulations. 

2 If assets owned in bank subsidiaries with foreign ownership were 

included, the trend would be more pronounced. At year-end 2004, 

Chart 1 

Assets of Foreign Banks’ U.S. Offices Have Grown
 

More Rapidly Than Assets in Foreign Offices of
 

U.S. Banks
 Assets
 

(dollars in billions)
 

$1,400 

$1,200 

$1,000 

$800 

$600 

$400 

$200 

$0 

$1,153 U.S. offices of foreign banks 

$945 

$401 Foreign offices of U.S. banks 

$272 

1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 

Note: Assets are shown gross of claims on related parties. Offices include branches,
 

agencies, and International Banking Facilities.
 

Sources: Federal Financial Institutions Examination Council and Federal Reserve.
 

Foreign-owned banking assets in the United States 

have exceeded international assets of U.S. banks since 

the mid-1980s. Overall, foreign banking assets in the 

United States have grown at a rate roughly consistent 

with that of assets held by domestic institutions, 

remaining at approximately a 4 to 5 percent share of 

total U.S. banking assets.3 

As the banking industry has become more consolidated 

over the past two decades, so too have the international activities of FDIC-insured U.S. banks.4 In 1984, 

Citibank NA held the largest share of international 

assets (17 percent) of any U.S. bank, while the top five 

banks together held slightly more than half of all international assets reported by U.S. banks.5 Twenty years 

later, the share of international assets held by the top 

five banks had increased to 87 percent, and the single 

largest bank share, again held by Citibank NA, had 

increased to 42 percent (see Table 1). 

an additional $661 billion of assets was reported by foreign-owned 

institutions in the United States, compared with some $275 billion 

in foreign banking subsidiaries owned by U.S. companies. 

3 Adrian E. Tschoegl, “Who Owns the Major U.S. Subsidiaries of 

Foreign Banks? A Note,” Wharton Financial Institutions Center, 

April 2003. 

4 The FDIC released a series of studies in 2004 describing consolidation and other long-term changes in banking. See FDIC Future 

of Banking Study, http://www.fdic.gov/bank/analytical/future/. 5 Data from FFIEC 031, Consolidated Reports of Condition and 

Income for a Bank with Domestic and Foreign Offices. 

FDIC OUTLOOK 25 SUMMER 2005 
In Focus This Quarter: U.S. Banking in a Global Economy 

International Operations of U.S. Banks and U.S. Operations of
 

Foreign Banks: Organizational Structures and Regulatory Reporting
 

U.S. banking activities in overseas markets take a 

number of legal forms, ranging from representative 

offices, shell branches, Edge Act corporations, and 

foreign subsidiaries to arrangements with affiliated and 

nonaffiliated foreign banks.6 The choice of structure is 

influenced not only by an institution’s international 

strategy and specific banking activities, but also by the 

needs of its clients and the legal framework and banking 

culture of the host country. In addition, a bank’s 

accounting and tax framework, as well as the powers 

associated with its particular banking charter, will affect 

how it structures its international operations. 

Banks engaging in international business often accommodate the needs of their foreign banking customers through 

foreign branches or agencies, which are typically less 

costly to operate than foreign subsidiaries. Many banks 

may be able to satisfy their clients’ international banking 

needs without establishing a separate office or subsidiary 

outside the United States. These banks typically offer 

more limited international financial services, such as 

commercial lending relationships, trade letters of credit, 

foreign exchange services, and other capital markets services, to foreign customers from their U.S. offices. 

In compliance with U.S. banking regulations, reporting 

of foreign banking operations is based on the structure of 

6 Edge Act corporations refer to section 25(a) of the Federal Reserve 

Act of 1919, which enabled U.S. banks to create limited-purpose 

”Edge” corporations to participate in international banking. These 

corporations were named after the original sponsor of the legislation, New Jersey Senator Walter Edge. For more information, see 

Ernest T. Patrikis, “The Federal Reserve System’s Supervision and 

Regulation of the Foreign Operations of United States Banking 

Organizations,” speech given in Miami, Florida, April 2, 1998, 

http://www.cemla.org/pdf/pub-di-col-patrikis.PDF. 

the banking entity. For regulatory purposes, a U.S. bank 

may engage in international operations within the bank 

itself or through a bank holding company subsidiary. For 

instance, international operations of U.S. banks can be 

housed in foreign offices, branches, and subsidiaries, 

while U.S. bank holding companies can conduct international operations through either foreign banking or 

nonbanking subsidiaries. Similarly, U.S. operations of 

foreign banks may be housed in U.S. offices and 

branches, in nonbanking subsidiaries, or through ownership of U.S.-based banks or bank holding companies. 

Balance sheet and income statement information that 

describes the international activities of U.S. and nonU.S. banks and bank holding companies is collected 

through the following regulatory reports: 

•	 Federal Reserve (FR) Form Y-9C, Consolidated 

Financial Statements for Bank Holding Companies 

•	 Federal Financial Institutions Examination Council 

(FFIEC) Form 031, Consolidated Reports of Condition and Income for a Bank with Domestic and 

Foreign Offices; and Form 041, Consolidated Reports 

of Condition for a Bank with Domestic Offices Only 

•	 FFIEC Form 030, Assets of Foreign Branches of U.S. 

Banks 

•	 FR Form 2314, Assets of Foreign Banking and Nonbanking Subsidiaries of U.S. Banking Organizations 

•	 FFIEC Form 002, Report of Assets and Liabilities of 

U.S. Branches and Agencies of Foreign Banks 

•	 FR Form 7-N, Financial Statements of U.S. Nonbank 

Subsidiaries Held by Foreign Banking Organizations 

FDIC OUTLOOK	 26 SUMMER 2005 
The Globalization of the U.S. Banking Industry 

Table 1 

FDIC-Insured U.S. Bank Share of Foreign Office Assets 

1984 versus 2004 (dollars in billions) 

December 31, 1984 

Share of 

All U.S. 

Bank 

Foreign Foreign 

Office Office Cumulative 

Bank Assets Assets Share 

December 31, 2004 

Share of 

All U.S. 

Bank 

Foreign Foreign 

Office Office 

Bank Assets Assets 

Cumulative 

Share 

Citibank NA $ 67 17% 17% Citibank NA $ 395 42% 42% 

Chase Manhattan JPMorgan 

Bank NA* 46 11% 28% Chase Bank NA 326 34% 76% 

Bank of America Bank of 

NT&SA 40 10% 38% America NA‡ 56 6% 82% 

Morgan Guaranty State Street Bank 

Trust Co.* 33 8% 46% & Trust Co. 25 3% 85% 

Manufacturers Hanover Bank of New York 24 3% 88% 

Trust Co.* 25 7% 53% Wachovia Bank 

Bankers Trust Co. 21 5% 58% National Association 22 2% 90% 

Chemical Bank* 18 4% 62% MBNA America 

First National Bank Bank NA 18 2% 92% 

of Chicago* 13 4% 66% Fleet National 

Continental Illinois Bank‡ 17 2% 93% 

NB&T† 10 2% 68% Northern Trust Co. 13 2% 95% 

Security Pacific HSBC Bank USA 

National Bank† 9 2% 70% National Association§ 10 1% 96% 

Total $ 281 Total $ 906 

*Now part of JPMorgan Chase Bank NA. 

†Now part of Bank of America NA. 

‡ Subsidiaries of Bank of America Corporation. 

§A foreign-owned bank. 

Source: Federal Financial Institutions Examination Council Bank Call Reports. 

Similarly, the share of foreign offices operated by U.S. 

banks also has become more concentrated in fewer 

large institutions. The number of U.S. banks operating foreign offices has steadily declined from 266 

banks in 1984 to 122 banks at year-end 2004.7 Three 

banks dominate the list of U.S. banks with foreign 

offices. At the end of 2004, Citigroup, JPMorgan 

7 Fifty-nine of the 266 U.S. banks with foreign offices in 1984 remained in 

operation at year-end 2004; of these, only 7 banks no longer had foreign 

offices, according to data from banks filing FFIEC Call Report Form 031, 

Consolidated Reports of Condition and Income for a Bank with Domestic 

and Foreign Offices, for December 31, 2004. Foreign offices include 

branches and subsidiaries in U.S. territories and possessions, Edge Act 

or Agreement subsidiaries (Agreement corporations are state-chartered 

counterparts of Edge Act corporations, which are federally chartered), 

foreign branches, consolidated foreign subsidiaries, and International 

Banking Facilities (IBFs). (IBFs allow depository institutions in the United 

States to offer services to foreign residents and institutions free of some 

Federal Reserve requirements and some state and local income taxes; 

IBF operations are under the jurisdiction of the Federal Reserve and 

other federal and state regulators.) 

Chase, and Bank of America collectively owned 651 

(or 84 percent) of the 777 total foreign branches of 

U.S. banks. 

International Strategies of U.S. Banks 

Financial institutions, continually on the hunt for 

new sources of revenue, have increasingly looked 

beyond domestic borders for new business. For example, Citigroup and JPMorgan Chase, the two largest 

U.S. banks in terms of total assets, earned 53 percent 

and 48 percent, respectively, of their net income 

from operations outside of North America in 2004.8 

And Citigroup’s international net income increased 

8 Citigroup, “Citigroup Net Income: Regional View,” 2004 Annual 

Report; and JPMorgan Chase, “Note 30: International Operations,” 

2004 Securities and Exchange Commission form 10K. 

FDIC OUTLOOK 27 SUMMER 2005 
In Focus This Quarter: U.S. Banking in a Global Economy 

43 percent in 2004 over 2003, outpacing growth in its 

U.S. businesses.9 

International banking strategies may differ across banks 

in terms of geography or product choice. Several key 

objectives drive foreign expansion by U.S. banks, 

including 

•	 increasing profits by expanding distribution channels 

into new, potentially high-growth geographic 

markets and across demographic groups; 

•	 providing commercial lending and capital markets 

products and services to support global expansion 

plans of corporate and commercial clients; 

•	 increasing revenue diversification; and 

•	 cross-selling and leveraging existing product expertise in foreign markets. 

Some banks limit their international operations to 

certain areas of expertise, while others establish a 

physical presence in foreign markets to offer a wider 

array of products to their foreign customers. 

Geographically, U.S. banks have increasingly focused 

their international activities in Europe and Asia, while 

U.S. bank assets in Latin America and the Caribbean 

have declined. For example, at year-end 2004, Europe 

represented roughly half the foreign branch assets of 

U.S. banks, and Asia represented approximately onequarter of these assets (see Table 2). (For a discussion 

of foreign banking trends in America over the past 20 

years, see the box entitled “Foreign Bank Presence in 

the United States.”) 

The Attraction of China 

Attracted by the opportunity to develop a strategic 

foothold in one of the world’s largest economies, interest in China among U.S. and foreign-owned financial 

institutions is intensifying. As part of its 2001 accession 

into the World Trade Organization, China committed 

to remove restrictions on foreign participation in its 

financial industry over a five-year period.10 As the 

9 Citigroup, “Letter to Shareholders,” 2004 Annual Report.
 10 Business Daily Update, “Foreign Banks Still Expanding,” December 6,
 

2004.
 

Table 2 

Location of Foreign Branches of U.S. Banks 

(dollars in billions) 

December 31, 1994 

Location Assets Asset Share 

December 31, 2004 

Assets Asset Share 

Asia $76 23% 

Canada 0 0% 

Europe 161 48% 

Latin America 13 4% 

Caribbean 63 19% 

Other 21 6% 

Total $333 100% 

$104 23% 

11 2% 

245 54% 

13 3% 

41 9% 

41 9% 

$456 100% 

Note: Assets are net of claims on related parties. 

Source: Federal Financial Institutions Examination Council Call Reports (Form 030). 

deadline for reform completion nears, reports suggest 

that interest from abroad in China’s banking market 

has increased.11 Likewise, indications are that the 

Chinese government is becoming more receptive to 

foreign investment in that country’s banking sector.12 

According to a 2004 special edition of The McKinsey 

Quarterly, China, the world’s most populous nation, 

will represent “a golden opportunity” for foreign banks 

to provide credit card loans once foreign lending restrictions are lifted. China’s large, consumption-driven 

economy, potential deregulation of consumer lending 

laws, and a projected decline in demand for corporate 

banking products all point to consumer lending as the 

line of business with the largest intermediate-term 

potential. Credit card revenues from interest income 

and merchant fees in China are projected to increase 

50 percent annually and reach $5 billion by 2013. 

According to the report, partnerships with existing 

Chinese banks may be the best way to enter China’s 

consumer lending market during this period. Foreign 

banks will not be able to accept deposits or issue cards 

until 2007, and card holders currently place little value 

on credit cards issued by foreign banks.13 The recent 

announcement of a strategic alliance between Discover 

Financial Services, issuer of Discover Network Cards, 

and ChinaUnionPay (CUP), China’s only national 

bankcard association, exemplifies the importance of 

11 Financial Services Distribution, “Country Survey-China: Banks
 

Going for Gold in China,” May 27, 2005.
 

12 RiskCenter.com, “Reform of China’s Banks, Burdened by Bad Loans,
 

Is Priority for Government,” May 25, 2005. The report indicates that
 

foreign banks have invested in 11 Chinese banks, including Citigroup’s
 

5 percent investment in Shanghai Pudong Development Bank.
 

13 David A. von Emloh and Yi Wang, “Retail Banking in China,” The
 

McKinsey Quarterly, 2004 Special Edition: China Today.
 

FDIC OUTLOOK	 28 SUMMER 2005 
The Globalization of the U.S. Banking Industry 

Foreign Bank Presence in the United States
 

As foreign bank activity in the United States has steadily expanded over the past 20 years, some new trends have 

emerged. First, the composition of the foreign banking presence in the United States has shifted as Asian (primarily 

Japanese) investment has lagged and European investment has grown. At year-end 1984, European-owned banks 

represented about 45 percent of the assets of all foreign-owned U.S. commercial banks and savings institutions; by 

year-end 2004, that share had risen to more than 75 percent. Concurrently, the share of foreign-owned U.S. bank and 

thrift assets controlled by Asian banks declined from 40 percent to 10 percent.14 

In addition, while the number of branches and agencies of foreign banks in the United States has declined (from 593 

at the end of 1991 to 270 at the end of 2004), their assets have grown.15 In fact, these banking vehicles have been the 

primary source of growth in the U.S. assets of foreign banks. Since 1991, gross assets of foreign branches in the United 

States have grown from $704 billion to $1.153 trillion, or roughly twice the growth in assets of subsidiaries of foreign 

banks and thrifts, which totaled $661 billion at year-end 2004 (see Table 3 for the ten largest foreign-owned financial 

institutions in the United States).16 

Table 3 

Ten Largest Foreign-Owned, FDIC-Insured Commercial Banks and

December 31, 2004 (dollars in billions) 

Savings Institutions 

Name City, State Assets 

HSBC Bank USA NA Wilmington, DE $138.3 

LaSalle Bank NA* Chicago, IL 63.7 

Charter One Bank NA† Cleveland, OH 50.9 

Standard Federal Bank NA* Troy, MI 39.1 

Bank of the West San Francisco, CA 38.8 

Deutsche Bank Trust Co. Americas New York, NY 33.3 

Citizens Bank of Massachusetts† Boston, MA 31.3 

Citizens Bank of Pennsylvania† Philadelphia, PA 29.8 

Harris Trust & Savings Bank Chicago, IL 21.5 

RBC Centura Bank Rocky Mount, NC 18.4 

Total 

* Subsidiaries of ABN AMRO Holding N.V. 

† Subsidiaries of Royal Bank of Scotland Group, PLC 

$465.1 

Source: Federal Financial Institutions Examination Council Call Reports. 

The predominant type of asset held in U.S. branches of foreign banks is commercial and industrial (C&I) loans. 

In fact, some 54 percent of total loans held by U.S. branches of foreign banks are C&I loans, a share that is twice as 

high as the 26 percent C&I share in U.S. subsidiaries of foreign banks. However, recent trends suggest that foreign 

banks may be increasing their focus on the U.S. consumer banking market, as exemplified by HSBC’s acquisition of 

Household International, Inc., in 2003.17 

14 Data from the Federal Reserve’s National Information Center database and the FDIC.
 

15 These figures represent the number of offices filing a consolidated branch report; multiple offices in a single metropolitan area can file
 

on one consolidated report.
 

16 If net of claims on related parties, these amounts would be $616 billion in 1991 and $797 billion in 2004. 


17 Tanya Azarchs, “Foreign Banks Use Acquisitions to Broaden U.S. Base,” Standard & Poor’s, March 31, 2005.
 

FDIC OUTLOOK 29 SUMMER 2005 
In Focus This Quarter: U.S. Banking in a Global Economy 

partnerships as a point of entry to China’s credit card 

market. The agreement is designed to allow CUP 

card holders to use their credit cards while traveling 

in the United States while also providing access to 

the Discover ATM network. Similarly, Discover cards 

will be accepted in China.18 

Despite the attraction of a rapidly growing economy 

and the relaxation of some banking restrictions, significant cultural and legal challenges remain that could 

constrain the realization of profits by foreign banks in 

China.19 Nevertheless, although China may not be a 

direct source of banking profits for U.S. banks in the 

near term, that country is a key economic driver in 

Asia and represents considerable potential as an important strategic component of an institution’s global 

banking presence. 

Commercial and Industrial Lending Is a Key 

Component of Overseas Operations 

C&I lending continues to be a significant part of the 

overseas operations of U.S. banks and the U.S. operations of foreign banks. As shown in Chart 2, C&I lending continues to represent a majority of foreign loans 

in U.S. banks, in spite of changes in the lending mix.20 

Commercial lending relationships often open the door 

for additional banking services, and U.S. banks have 

responded to demand for commercial loans from 

corporate borrowers as a way to enter foreign markets. 

According to a recent survey by Greenwich Associates, 

the establishment of a credit relationship is the key 

factor when companies and financial institutions determine banking partners for foreign exchange, interest 

rate derivatives, and other capital markets business.21 

Establishing foreign lending capabilities, in addition 

to offering other nonlending services to customers with 

18 Discover Financial Services, Inc., “Discover Financial Services and 

China UnionPay Announce Strategic Alliance,” news release, May 26, 

2005. 

19 Business Daily Update, “Foreign Banks Still Expanding,” December 

6, 2004. 

20 This is true at both of the largest U.S. banks. In 2004, C&I lending 

represented 79 percent and 71 percent, respectively, of Citigroup’s 

and JPMorgan Chase’s corporate and wholesale loans outside the 

United States. For more information, see Citigroup 2004 Annual 

Report, “Loans Outstanding,” and JPMorgan Chase 2004 Securities 

and Exchange Commission form 10K, “Note 11, Loans.” 

21 Jennifer Hughes, “Creditor Banks Have the FX Edge,” Financial 

Times, April 14, 2005. 

Chart 2 

Commercial and Industrial Loans Account for 

Over Half of All U.S. Bank Foreign Loans 

(1984 versus 2004) 

Percent of Total U.S. Bank Foreign Loans 

Source: Federal Financial Institutions Examination Council Call Reports (Forms 031 

and 041). 

1984 

2004 

0 

10 

20 

30 

40 

50 

60 

Loans to 

Foreign

Government/

Agencies 

Loans to 

Depository

Institutions 

Leases Real 

Estate 

Loans 

Commercial 

and 

Industrial 

Loans 

an international scope, has been cited by U.S. banks 

of various sizes as a strategic priority.22 

The benefits of leveraging commercial lending relationships into the ability to provide other types of 

financial services are evident in the growth of trading 

and derivatives activities of internationally active 

U.S. banks. Since 1984, the foreign offices of U.S. 

banks have reported an increase in trading assets from 

22 percent to 36 percent of total assets. In addition, 

between 1994 and year-end 2004, these same foreign 

branches of U.S. banks reported a fivefold increase in 

their notional holdings of derivatives contracts, from 

$8.1 trillion to $43.6 trillion.23 These changes reflect 

both the effects of a more integrated global economy 

and acceleration in the worldwide demand by U.S. 

bank corporate customers for investment banking and 

asset management services. 

International Nonbanking Subsidiaries Also 

Generate Revenue for U.S. Banks 

Nonbanking subsidiaries have been the fastest-growing 

source of foreign assets reported by U.S. bank holding 

companies over the past ten years. These subsidiaries 

engage in a variety of activities, including securities 

underwriting, real estate brokerage, and commercial 

22 Geeta Sundaramoorthy, “Nat City Plan: Act Locally, Grow Globally,”
 

American Banker, May 16, 2005.
 23 The share of foreign loans to all assets in foreign offices of U.S.
 

banks declined from 63 percent in 1984 to 36 percent of foreign-office
 

assets by the end of 2004. Adjusted for inflation, the share of all loans
 

to foreign borrowers at U.S. banks (in both domestic and foreign
 

offices) has declined 21 percent since 1984. 


FDIC OUTLOOK 30 SUMMER 2005 
The Globalization of the U.S. Banking Industry 

enterprises (see Chart 3).24 The growth of these nonbanking subsidiaries underscores the long-term trend 

toward diversification of earnings beyond traditional 

banking products and services. The increase in 

nonbanking assets at U.S. bank holding companies 

also coincides with the enactment of the GrammLeach-Bliley Act of 1999, which removed domestic 

restrictions on certain nonbanking activities. Moreover, 

depending on the laws of the particular host country, 

a foreign bank subsidiary may be able to engage in a 

broader array of activities than its U.S. banking affiliates or even foreign branches of U.S. banks. 

U.S. Banks Export Consumer Lending Expertise 

International expansion also represents an important 

long-term trend among large U.S. credit card companies. As the American consumer lending market 

matures and becomes saturated, U.S. consumer lenders 

with expertise in information technologies and the 

development of products and services find foreign 

markets increasingly attractive. International operations provide an opportunity for successful domestic 

credit card lenders to leverage existing product or 

marketing expertise, take advantage of economies of 

scale, and expand their revenue base. 

While the potential benefits are attractive, expansion 

into international consumer lending poses unique 

challenges. Before exporting consumer lending products, U.S. financial institutions must understand the 

host country’s laws, particularly consumer protection 

laws, because interest rate ceilings and restrictions on 

the distribution of consumer credit histories can differ 

significantly across countries.25 Limitations imposed 

by other countries on the sharing of consumer credit 

data can significantly reduce the usefulness of credit 

scoring models. In addition, local customs and cultures 

are important determinants of consumer borrowing 

behavior, the willingness to use consumer debt, and, 

ultimately, the demand for various types of consumer 

loans across international markets. 

24 Data on assets of foreign banking and nonbanking subsidiaries of 

U.S. banking organizations were collected from Form FR 2314, Financial Statements of Foreign Subsidiaries of U.S. Banking Organizations. 

25 Moody’s Investors Service, “U.S. Consumer and Commercial 

Finance Companies in Europe: Climbing the Learning Curve,” April 

2001. 

Chart 3 

Nonbank Subsidiaries Have Driven Most of the Recent

 Foreign Asset Growth in U.S. Bank Holding Companies 

Assets
 

(dollars in billions)
 

$1,400
 Nonbank Subsidiaries 

$1,200 Branches 

$1,000 Bank Subsidiaries
 

$800
 

$600
 

$400
 

$200
 

$0 

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 

Note: Claims on unrelated parties represent total assets less intercompany transactions. 

Sources: Foreign Branch Reports of Condition and Financial Statements of Foreign 

Subsidiaries of U.S. Banking Organizations. 

Foreign Banking Operations Underperform 

Domestic Operations 

Despite the growth of international activities among 

U.S. banks, most available financial indicators fail 

to show a performance advantage accruing to institutions with overseas operations. In fact, performance 

measures specifically reported for the international 

operations of U.S. banks have tended to consistently 

lag indicators for domestic operations over the past 

decade (see Chart 4).26 For example, in 2004, the 

average return on assets (ROA) specifically attributed to international operations was 0.96 percent, 

compared with an overall 1.26 percent at all banks 

with international operations.27 Similarly, net interest 

income as a percentage of assets averaged 2.18 percent 

for international operations, compared with an overall average of 2.76 percent for domestic and foreign 

operations combined. While the average efficiency 

ratio reported for the international operations of these 

institutions was, at 59 percent, better than the 61 

percent efficiency ratio for their combined operations 

for 2004, we note that the international efficiency 

ratio had been worse than the overall ratio in each 

of the previous seven years.28 

26 The downward spikes in the return on assets from international 

operations during the late 1980s reflect the impact of the Latin 

American debt restructuring that resulted in losses in foreign 

banking operations of several U.S. banks. 

27 Represents results for banks filing Call Report Form 031. 

28 The efficiency ratio is the noninterest expense as a percentage 

of net operating revenue (net interest income plus total noninterest 

income). 

FDIC OUTLOOK 31 SUMMER 2005 
In Focus This Quarter: U.S. Banking in a Global Economy 

Chart 4	 Chart 5 

Commercial Banks Report Lower and More Volatile The Profitability of International Banks Has Trailed 

Profitability in Their International Operations Industry Averages 

(insured commercial banks with foreign offices)	 Annual Return on Assets
 

(percent)
 Annual Return on Assets 

(percent) Overall Return 

2% 

1% 

0% 

-1% 

-2% 

-3% 

-4% 

Source: Federal Financial Institutions Examination Council Call Reports (Form 031). 

199019881986 

on Assets 

1984 1992 1994 1996 1998 2000 2002 2004 

Return on Assets from
 

International Operations
 

Similar performance differences exist between large 

U.S. banks with sizable international operations and 

purely domestic U.S. institutions. The performance 

of international banks (that is, U.S. banks with more 

than $10 billion in assets and at least 25 percent of 

their assets in foreign offices) relative to the overall 

performance of the U.S. banking industry fails to show 

that sizable international operations have given a 

significant boost to overall performance (see Chart 5). 

In fact, the international banks have earned less than 

the industry-average ROA in 14 of the past 15 years, 

and their return on equity has been below the industry 

average in eight of those years. 

Traditional Performance Ratios May Understate 

Role of Foreign Banking Operations 

While traditional performance measures suggest that 

international banking operations may not be as profitable as domestic operations, these metrics may not 

fully reflect their intangible contributions to overall 

banking performance. Several factors may limit the 

ability to accurately measure the contributions of 

foreign operations from an enterprise perspective. 

First, some of the differences in performance may 

reflect the accounting treatment and tax consequences of allocating costs and profits among a financial institution’s domestic and foreign operations. 

Second, performance measures may not fully capture 

all the benefits of maintaining a strategic position in 

a foreign banking market. These benefits may include 

cross-selling opportunities and the opportunity to 

1.60% 

1.29% 

1.40% 

1.20% 

1.00% 

0.80% 

0.60% 

0.40% 

0.20% 

0.00% 

0.76% 

International Banks 

All Insured Banks and Thrifts 

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 

Note: International banks are those with assets of greater than $10 billion and more than
 

25 percent of total assets in foreign offices.
 

Source: Federal Financial Institutions Examination Council Bank Call Reports.
 

manage an extensive relationship with existing domestic clients that have foreign operations. Although a 

U.S. bank’s office in a foreign country may not report 

the same profitability as offices in other markets, its 

presence in that market may facilitate relationships 

such as lending, trading, and other banking services 

with clients that operate or are headquartered in its 

host country. Conversely, the lack of a foreign presence could lead to the loss of customers with global 

operations. 

Performance comparisons between domestic and 

international banks underline the cultural challenge 

of achieving high performance in unfamiliar markets 

and raise the question of whether performance 

optimization should drive expansion into overseas 

markets. Domestic limits to growth in a bank’s 

home market may be a contributing factor when 

large banks seek to expand internationally.29 Research 

also indicates that banks are motivated by the foreign 

banking needs of their domestic client base, and 

tend to “follow the customer” to foreign countries 

where large corporate borrowers operate. However, 

establishing corporate banking relationships with 

mid-sized and smaller commercial customers in 

foreign markets may be more difficult than doing 

so with large corporations, as host-country lenders 

typically are more familiar with the local business 

community and borrowing culture. On the other 

hand, research also suggests that in developing or 

emerging banking markets that are credit-supply 

constrained, foreign lenders with technologically 

29 See note 3. 

FDIC OUTLOOK	 32 SUMMER 2005 
The Globalization of the U.S. Banking Industry 

advanced credit underwriting capabilities may have a 

competitive advantage over local lenders.30 

Global Integration of U.S. Banks Remains 

Incomplete 

Notwithstanding the motivations favoring expansion 

into foreign markets, the results for U.S. banks in 

recent years suggest that the international integration 

of the U.S. banking industry may be following, rather 

than leading, the wider expansion of global commerce. 

Indications are that better performance may be more 

easily attained in the domestic U.S. market, and most 

U.S. banks remain satisfied with a purely domestic 

focus. Overseas, a few large institutions continue to 

dominate the foreign banking activities of U.S.-based 

banks. Data limitations make it difficult to draw definitive conclusions about the performance benefits of 

foreign banking activities of U.S. banks. Nevertheless, 

as globalization brings foreign markets ever closer to 

us, more U.S. financial institutions will be motivated 

to consider the benefits and drawbacks of conducting 

international banking activities. 

Kevin Brown, Senior Financial Analyst 

Kathy R. Kalser, Regional Manager, 

New York Regional Office 

Ross Waldrop, Senior Financial Analyst 

30 Allen N. Berger, Iftekhar Hasan, and Leora F. Klapper, “Further 

Evidence on the Link between Finance and Growth: An International 

Analysis of Community Banking and Economic Performance,” 

Federal Reserve Board, 2004. 

FDIC OUTLOOK 33 SUMMER 2005 
In Focus This Quarter: U.S. Banking in a Global Economy 

Opportunities and Risks Facing Community 

Lenders That Support International Trade 

The role of international trade in the U.S. economy is 

increasing. And although smaller firms (those with less 

than 500 employees) accounted for almost one-third of 

U.S. exports in 2001, they are continually challenged 

to obtain financing to produce export goods or to 

finance the sale of exports. This circumstance presents 

opportunities for community banks that are looking 

for ways to increase small business fee income and 

strengthen loan demand. This article looks at those 

opportunities as well as the risks facing community 

lenders in supporting small and mid-sized enterprises 

(SMEs) engaged in international trade. 

Small and Mid-Sized Firms Play a Significant Role 

in U.S. Exports 

Although only about 1 percent of the 23 million U.S. 

small businesses are involved in exporting, these enterprises play a surprisingly large role in U.S. trade.1 As of 

2001 (the latest data available), approximately 230,000 

SMEs engaging in export operations accounted for 

about 97 percent of all U.S. exporters. This number 

reflects a doubling in the prior ten years and an almost 

two-and-a-half-fold increase over 15 years (1987– 

2001). California had the highest number of SME 

exporters (55,000 firms), followed by Florida, New 

York, Texas, and Illinois. 

In 2001, SMEs accounted for $182 billion, or 30 

percent, of U.S. export sales, a percentage that has held 

fairly constant since 1992.2 But in some states the share 

was notably higher—for instance, SMEs in Wyoming 

accounted for 80 percent of that state’s exports. In eight 

other states, including populous New York and Florida, 

they accounted for 40 percent or more of exports. (See 

the box entitled “A Regional Look at U.S. Export 

Activity” for information on merchandise exports.) 

1 Doug Barry, “From Appalachia to India: U.S. Small Businesses are 

Going Global,” Business Credit, June 2000. 2 Office of Trade and Economic Analysis of the International Trade 

Administration, “Small and Medium-Sized Exporting Companies, A 

Statistical Handbook: Results from the Exporter Data Base,” October 

2003. As more recent data are not available, assuming that the share 

of SME exports were to remain at 30 percent, 2004 U.S. SME exports 

are estimated to have totaled close to $245 billion, or 30 percent of 

total U.S. merchandise exports of $818 billion, based on the U.S. 

Census Bureau’s origin-of-movement export series. 

Lack of Overseas Affiliates and Foreign Market 

Expertise Creates Challenges for SMEs 

Unlike large firms, SMEs tend to concentrate their 

business in fewer foreign countries. Nearly two-thirds of 

U.S. small-business exporters sold to only one foreign 

country in 2001, while more than half (54 percent) of 

large firms exporting sold to five or more foreign countries (see Chart 1). Nevertheless, SMEs exported goods 

worth $1 billion or more to 29 foreign countries and 

were responsible for at least half of all U.S. exports to 

93 countries in 2001.3 

Two reasons that explain why smaller businesses choose 

to export to a single country are the absence of major 

affiliates abroad and a lack of familiarity with foreign 

markets.4 SMEs have, in fact, benefited from this 

concentration when their primary export countries 

have been the target of U.S. initiatives to reduce 

foreign barriers to U.S. exports. For example, the 1993 

enactment of the North American Free Trade Agreement helped spur growth in U.S. exports to Canada 

and Mexico, and from 1992 to 2001 the share of U.S. 

SME exports to Canada and Mexico increased from 

24 percent to 33 percent. 

Chart 1 

Nearly Two-Thirds of Small and Mid-Sized Business
 

Exporters Sold Goods to a Single Country in 2001
 

10 or more countries
 

5%
 

1 country 5 to 9 countries 

8% 63%

2 to 4 countries
 

24%
 

Source: U.S. Department of Commerce. 

3 Ibid. 

4 Ibid. 

FDIC OUTLOOK 34 SUMMER 2005 
Opportunities and Risks Facing Community Lenders 

A Regional Look at U.S. Export Activity
 

During 2004, U.S. merchandise exports totaled 

$818 billion with a growth rate of 13 percent, 

thanks to the lower value of the dollar and a robust 

global economy. More than half of these exports 

(56 percent) came from three of the nine U.S. 

Census Bureau divisions (see Map 1): the populous 

Pacific, the rapidly growing West South Central, 

and the industrial East North Central (see Chart 2). 

Approximately 25 percent of the exports originated 

from the South Atlantic and Middle Atlantic states, 

with the remaining 19 percent coming from the less 

densely populated New England, East South Central, 

West North Central, and Mountain Divisions. All 

except the Mountain Division had double-digit 

export growth rates last year—the East South 

Central Division had the fastest growth rate at 20.7 

percent and the Mountain Division the slowest at 

9.6 percent. 

The major 2004 exports for each of the U.S. Census 

divisions are as follows: 

Pacific (Alaska, California, Hawaii, Oregon, and 

Washington). The Pacific Division’s lead exports 

were computers and electronics as well as transportation equipment (mainly aircraft). The division’s relatively strong high-technology and aerospace sectors 

along with their many high-value-added, highpaying jobs generated half of the total value of its 

exports. In addition, the Pacific Division exported a 

large dollar volume of crops and processed foods, 

chemical and machinery manufactures, electrical 

equipment, and fabricated metals. 

West South Central (Arkansas, Louisiana, Oklahoma, and Texas). Because of its location, the West 

South Central Division is a leading exporter of petroleum and coal products (nearly two-thirds of the 

nation’s total last year) and chemical manufactures. 

Agricultural and livestock products were also major 

exports. As home to several high-tech centers such as 

Austin, Dallas, and Houston, large-dollar export 

items included computers, software, and telecommunications equipment. 

Map 1 

The United States Is Divided into Nine 

Census Divisions 

Mountain West North East North New 

South 

Central Source: U.S. Census Bureau. 

Pacific 

West South 

Central 

Central 

South 

Atlantic 

Middle 

Atlantic 

England 

East 

Central 

East North Central (Illinois, Indiana, Michigan, 

Ohio, and Wisconsin). In the heavily industrialized 

East North Central Division, transportation equipment (primarily motor vehicles) accounted for 

nearly a third of total exports. Because of the division’s large industrial base, machinery, electrical 

equipment, fabricated metals, and plastics and 

rubber products were also leading exports. 

Middle Atlantic (New Jersey, New York, and 

Pennsylvania). The Middle Atlantic Division’s leading exports were chemical manufactures and 

computer and electronic products. It also contributed 

a high share (twice the national average) of printing 

products and primary metal exports. 

South Atlantic (Delaware, District of Columbia, 

Florida, Georgia, Maryland, North Carolina, South 

Carolina, Virginia, and West Virginia). The South 

Atlantic Division is undergoing a major transformation. Traditional export mainstays in nondurable 

goods manufacturing (apparel and textiles and wood 

and paper products) are facing mounting pressure 

from overseas competitors, particularly China. 

Replacing these exports in importance are the transportation equipment and high-technology industries 

(computers and electronics), which accounted for 

over one-third of the division’s total exports. 

FDIC OUTLOOK 35 SUMMER 2005 
In Focus This Quarter: U.S. Banking in a Global Economy 

Chart 2	 factured goods, including wood and furniture products, apparel and leather products, and printing and The Pacific Division States Accounted for paper products. Also, the migration of automobile One-Fifth of the Nation’s Exports in 2004 production from the higher-cost Midwest to the relatively lower-cost Southeast has increased the division’s exports of transportation equipment and 

West South Central
 plastic and rubber products. 

19%
 New England

5% 

West North Central (Iowa, Kansas, Minnesota, 

Middle Atlantic Nebraska, North Dakota, and South Dakota). As 

East South Central 11%
 

5%
 it encompasses a large number of farm states, the 

West North Central Division was a leading exporter West North Central
 

5%
 of crop production and processed foods. It was also 

a major exporter of transportation equipment, 

17% computers and electronics, machinery, and chemical 

Source: U.S. Census Bureau. manufactures. 

New England (Connecticut, Maine, Massachusetts, Mountain (Arizona, Colorado, Idaho, Montana, 

New Hampshire, Rhode Island, and Vermont). Nevada, New Mexico, and Wyoming). Although 

Nearly a third of all New England exports were the Mountain Division’s share of total U.S. exports 

computer and electronic products, and another third was the smallest (4.1 percent) of the nine Census 

of exports consisted of chemical and machinery divisions, it accounted for the highest relative share 

manufactures and transportation equipment. of computer and electronic product exports than 

anywhere in the country. In fact, 42 percent of its 

East South Central (Alabama, Kentucky, Missis- exports were computers and electronics, followed by 

sippi, and Tennessee). The East South Central transportation equipment (10 percent) and primary 

Division exports a broad range of nondurable manu- metal manufactures (9 percent). 

South Atlantic 

14% East North Central 

Mountain 

4% Pacific 

20% 

SME Manufacturers Account for More Than 

One-Third of All SME Exports 

SMEs are responsible for a large share of exports from 

a wide range of industries. According to the U.S. 

International Trade Administration, which divides 

exporting SMEs into the categories of manufacturers, 

wholesalers, and “other companies,” manufacturers 

comprised slightly more than one-third of the total 

value of SME exports in 2001.5 Wholesalers, or companies primarily engaged in the distribution of goods to 

businesses, accounted for another third of exports, and 

other companies totaled slightly more than one-quarter 

of all SME exports. SMEs accounted for a large share 

of total U.S. exports within several manufacturing 

industries (see Chart 3), which also generally paid 

5 These three categories are based on the North American Industry 

Classification System. The category of “other companies” includes 

resource extraction companies, retailers, freight forwarders, engineering firms, and miscellaneous service companies that often market 

goods abroad and act as exporters of record. 

below the average manufacturing hourly wage rate. 

However, when ranked by SME export values, the 

largest manufacturing industry groups in 2001 were 

computers and electronic products ($33 billion), 

Chart 3 

Small and Mid-Sized Enterprises Account for
 

a Large Share of Manufacturing Exports
 

in Many Industries
 

(by product, as of 2001) 

Wood Products 

Apparel Manufactures 

Printing and Related Products 

Miscellaneous Manufactures 

Processed Foods 

Furniture and Related Products 

Primary Metal Manufactures 

Leather and Related Products 

Fabric Mill Products 

Non-Apparel Textile Products 

65.5% 

38.6% 

39.9% 

40.9% 

42.6% 

42.8% 

46.5% 

48.1% 

49.2% 

55.6% 

0% 10% 20% 30% 40% 50% 60% 70% 

Source: U.S. International Trade Administration. 

FDIC OUTLOOK	 36 SUMMER 2005 
Opportunities and Risks Facing Community Lenders 

machinery manufactures ($22 billion), transportation 

equipment ($20 billion), chemical manufactures 

($17 billion), and processed foods ($11 billion).6 

With the exception of the processed foods industry, 

these industries paid above the average manufacturing 

hourly wage rate. 

Emerging Opportunities for Community Banks 

Increased globalization creates intense competition 

for large and small businesses alike to develop new 

markets for their products and services. A major 

concern for these businesses is obtaining adequate 

trade finance either to produce the goods to be 

exported (for example, with working-capital loans) or 

to finance the sale of exports (as with letters of credit). 

Despite the tremendous opportunities for community 

banks in small business trade activities, only a small 

number of community banks actually provide trade 

financing. The Small Business Administration (SBA) 

estimated that in 1998, only about 150 to 200 U.S. 

banks out of approximately 9,000 engaged in any 

significant amount of trade financing. Although the 

number of banks engaged in international trade since 

then may have risen, their numbers are still believed to 

be quite low, primarily because of a lack of expertise.7 

One of the chief complaints among small businesses 

is the difficulties they face not necessarily in finding 

buyers for their products, but in helping buyers find 

financing for their purchases. As such, the growth in 

worldwide trade may provide innovative community 

banks an opportunity to generate additional loan 

demand and increase fee income. 

Despite the low number of banks currently involved 

in global trade, more community banks are becoming 

interested in pursuing the matter. Some reasons include 

growth in their potential customer base, a nearby large 

bank’s departure from the business line, an increase in 

experienced international managers due to the consolidation of larger institutions, and growing demand for 

trade finance services. Indeed, smaller institutions are 

now offering many business lines, services, and products 

once thought to be in the realm of large banks. In the 

Pacific Northwest, for example, financial institutions 

6 See note 2. The rankings are based on the North American Industry
 

Classification System.
 

7 Gordon Fairclough and Matt Murray, “Small Banks Expand Their
 

Trade Financing for Exports—Still, Entrepreneurs Going Global
 

Struggle to Get the Services They Need,” Wall Street Journal,
 

February 24, 1998. 


such as Banner Bank, Columbia Banking System, Inc., 

Washington Trust Bank, and Sterling Financial Corporation are reported to have either started or expanded 

international banking departments to serve that area’s 

rapidly growing Asian population.8 Some of the services 

that community banks are beginning to offer include 

issuing international letters of credit, providing trade 

financing loans, and facilitating or executing foreign 

currency transactions and wire transfers. 

Technology Enables SMEs and Smaller Financial 

Institutions to Enter Global Markets 

Advances in technology have facilitated the entry of 

SMEs and community banks into the international 

trade arena. For SMEs, the Internet is fast becoming an 

important tool for locating foreign purchasers of their 

goods and services. For community banks, the delivery 

of online services at a reduced cost is enabling them 

to offer products, such as letters of credit, that were 

previously available only from larger institutions.9 The 

Internet can facilitate the exchange of trade data and 

documentation between cross-border parties and allow 

community banks to make more cost-efficient trade 

financing transactions. 

Ways for Community Lenders to Gain Global 

Trade Expertise 

There are several ways that community banks can 

obtain the expertise needed to succeed in global trade. 

For instance, as a result of ongoing consolidation in 

the U.S. banking industry, smaller community banks 

have gained competence quickly by hiring highly 

skilled bank professionals specializing in international 

trade finance.10 As an alternative, many small community banks bolster their expertise by establishing a 

correspondent relationship with a larger institution. 

Other community banks develop their own proficiency 

in trade finance and then market their services to other 

community bankers. 

According to a recent report, a few lenders with assets 

of less than $1 billion are considering offering trade 

finance services in-house, and several FDIC-insured 

institutions with assets of between $2.5 billion and 

$7 billion are already offering international services.11 

8 Katie Keuhner-Herbert, “Small Banks in Northwest Getting Into
 

Trade Finance,” American Banker, April 4, 2005. 
 9 Ibid.
 

10 Kuehner-Hebert, “Smaller California Players Gain in Trade Finance,”
 

American Banker, December 19, 2002. 
 11 Alan Kline, “Small Southern California Bank Selling Trade Services
 

to Its Peers,” American Banker, April 20, 2000. 


FDIC OUTLOOK 37 SUMMER 2005 
In Focus This Quarter: U.S. Banking in a Global Economy 

In fact, banks and thrifts that provide international trade to and from their native countries.14 The Asian 

financing for their customers range in size from small 

to very large, as illustrated by the asset distribution of 

financial institutions that participate in the SBA Trade 

Finance Program (see Chart 4).12 This program helps 

small businesses enter export markets by providing such 

services as trade counseling, training, legal assistance, 

and Hispanic populations, in particular, have been 

among the fastest growing in the United States. The 

U.S. Census Bureau is projecting these two ethnic 

groups to triple in size over the next half-century—the 

U.S. Asian population is estimated to increase from 

10.7 million in 2000 to 33.4 million in 2050, and the 

and export information. U.S. Hispanic population is estimated to increase from 

35.6 million in 2000 to 102.6 million in 2050.15 

The SBA and the Export-Import Bank of the United 

States offer other programs (for example, the Export 

Working Capital Program) that provide financing 

assistance to SMEs and help lower the risks of international banking transactions by guaranteeing commercial loans.13 The SBA also offers an Internet-based 

service called Export Express to help bankers assess 

overseas credit risk and structure their loans so that 

they meet the government approval process. 

Immigration Trends Bolster Export Business and 

Lending Opportunities 

Community banks are taking notice of these expanding 

populations and their financial potential. Asia and Latin 

America are two of the world’s largest emerging markets, 

and banks that specialize in foreign-trade financing 

are often located in gateway states that host these 

large immigrant populations. According to one report, 

community banks, particularly those in states that trade 

heavily and cater to Hispanic- and Asian-Americans 

such as Florida and California, find that “providing 

working capital or letters of credit is crucial to maintaining relationships with small business customers.”16 

One explanation for the rapid growth of SME exports 

since the 1990s may be the strong role that immigration 

has played during that period. For example, much of the 

U.S. trade to and from Latin America is undertaken by 

Hispanic-American exporters. Similarly, Asian- and 

European-American immigrants often facilitate U.S. 

Chart 4 

Bank and Thrift Participants in the Small 

Business Administration Trade Finance Program 

The 1997 economic census on minority-owned businesses (the most recent available) showed immigrants 

to be highly entrepreneurial, with Asian and Hispanic 

small businesses growing four times faster than the rate 

of U.S. firms overall. Not surprisingly, then, traditional 

and new immigrant gateways, where many Asian and 

Hispanic people live and set up small businesses, often 

coincide with global gateways, where many of these 

ethnic small businesses engage in export activity 

(see Map 2).17 

f Participatinget Category 

Vary by Asset Size 

60 

50 

40 

Lending to SMEs Engaged in Global Trade Has 

Unique Risks 

Estimated Number o

Institutions in Ass

30 

20 

10 

0 

Under $100 $250 $500 $1 $3 Over $10 

Historically, community banks have been reluctant 

to lend to SME exporters because of the inherent 

risks involved. For example, if not familiar with the 

foreign country’s customs, laws, and regulations, small 

$100 million million million billion billion billion 

million to $250 to $500 to $1 to $3 to $10 

million million billion billion billion 

Sources: Small Business Administration and the Federal Deposit Insurance Corporation. 

12 The SBA’s Trade Finance Program Web site (http://www.sba.gov/oit/ 

finance/banks.html) lists banks participating in this program by state. 

A link on this site to the Office of International Trade homepage has 

additional information about the program. 

13 The Export-Import Bank is a federal agency that extends trade 

credits to U.S. companies to facilitate the financing of U.S. exports. 

14 Tom Coyle, “International Trade Financing, Community Banks 

Thinking Global: How to Play the World Trade Game,” Community 

Banker, America’s Community Bankers, June 1999. 15 U.S. Census Bureau, “Census Bureau Projects Tripling of Hispanic 

and Asian Population in 50 Years; Non-Hispanic Whites May Drop 

to Half of Total Population,” news release, March 18, 2004. 

16 Alan Kline, “Why So Shy about International Trade Finance?” 

American Banker, January 13, 2004. 17 Audrey Singer, “The Rise of New Immigrant Gateways,” The Brookings 

Institution, Center on Urban and Metropolitan Policy, February 2004; and 

Economic Outlook Conference, Economy.com, November 2004. 

FDIC OUTLOOK 38 SUMMER 2005 
Opportunities and Risks Facing Community Lenders 

Map 2 

Global Trade and Immigrant Gateways Often Overlap 

Global Trade Only (5) 

Immigrant Only (18) 

Both (19) 

Global Trade and Immigrant Gateways 

MINNEAPOLIS SEATTLE 

SACRAMENTO 

SAN 

FRANCISCO 

OAKLAND 

SAN JOSE 

Sources: Beaverstock, Smith, and Taylor, Cities 16(6), 1999 p 445–458, as cited at

Economy.com’s Economic Outlook Conference, November 4–5, 2004; and Audrey Singer,

“The Rise of New Immigrant Gateways,” Brookings Institution, Center on Urban and

Metropolitan Policy, February 2004. 

LOS ANGELES 

ORANGE COUNTY 

SAN DIEGO SAN ANTONIO WEST PALM BEACH TAMPA RIVERSIDE 

DENVER 

FORT LAUDERDALE 

PHOENIX 

TUCSON 

HOUSTON 

AUSTIN 

DALLAS 

CHARLESTON 

ATLANTA 

JACKSONVILLE 

ORLANDO 

CHARLOTTE 

MIAMI 

RALEIGH 

GREENSBORO 

WASHINGTON, D.C. 

BALTIMORE 

MIDDLESEX 

NASSAUSUFFOLK 

NEW YORK 

BERGEN 

NEWARK 

BOSTON 

PORTLAND 

JERSEY CITY 

CHICAGO 

SALT 

LAKE 

CITY 

LAS VEGAS 

FORT 

WORTH 

lenders may be hesitant to extend credit to foreign 

customers of U.S. exports. Some of the factors that 

have hindered community bank interest in this line 

of business are a general lack of expertise in international finance, the complexities of international 

trade financing, and the belief that the market was 

too small to devote resources to it. 

To successfully conduct international trade-related 

business, lenders must consider not only traditional 

credit, operational, and management risks when establishing a relationship with potential customers, but 

also factors specific to global activity, such as political, 

foreign exchange, offshore-outsourcing, and import competition risks. And when banking relationships cross international borders, even traditional risk areas can be 

harder to understand, monitor, and manage. These 

international banking risks are discussed below. 

Credit Risk. Unlike lending to domestic companies, 

trade finance lenders face legal and cultural issues that 

make it more difficult to adequately assess the risk of 

extending credit to foreign borrowers. To some extent, 

lenders can mitigate this risk by using institutions that 

will guarantee the loan (e.g., Export-Import Bank). 

Moreover, smaller community banks tend to rely on 

correspondent banks that already have the expertise 

and established relationships in foreign countries, 

thereby lessening credit risk. 

Operational Risk. Contingency plans are crucial to 

mitigate operational risk for customers who are heavily 

engaged in trade. If a U.S. firm enters into a joint 

venture with a foreign firm, legal and other considerations also come into play, such as if a U.S. company’s 

foreign customers or suppliers abruptly terminate their 

relationship or fail to deliver per the contract terms. 

As appropriate, lenders can use covenants, differential 

loan pricing, and other steps to manage such risks. 

Management Risk. Lenders must consider management 

risk when customers are heavily involved in foreign 

trade to determine whether they have grown into this 

line of activity over time and learned lessons along 

the way or are jumping into a new line of business 

with little knowledge of local conditions in the foreign 

country. Along with the risks that accompany any new 

line of business, firms operating across international 

borders face legal, shipping and transportation, communication, financing, quality control, marketing, 

and other challenges that may be significantly more 

complex than the same issues for domestic firms. 

Political Risk. Political risk refers to instabilities in a 

foreign government that can lead to civil unrest, or a 

suspension of legal rights and recourse that can result 

in business disruptions and, occasionally, the seizure of 

private property. U.S. lenders can reduce this risk by 

engaging the services of international consulting firms 

that monitor many countries and provide ongoing 

assessments of country risk.18 

Foreign Exchange Risk. More broadly, political risk 

can be related to foreign exchange risk. While many 

countries have freely floating exchange rates that 

can fluctuate over time, others attempt to peg, or fix, 

their exchange rate to one or more major currencies. 

However, even those arrangements can be difficult to 

sustain during periods of market turmoil, which can 

result in even more disruptive exchange-rate movements than those experienced by freely floating 

currencies. An example of a pronounced currency 

adjustment that negatively affected U.S. exporters 

occurred in 1997 when the Asian currency crisis 

caused a sharp realignment of exchange rates between 

the U.S. dollar and certain Southeast Asian currencies. Because of international financial market pressure and a lack of adequate foreign currency reserves, 

these Asian nations could not sustain their former 

currency exchange-rate targets, and, as a result, the 

18 Some of the firms that monitor country risk include: Control Risks 

Group, http://www.crg.com; Business Monitor International, 

http://www.businessmonitor.com; Countrydata.com and the International Country Risk Guide (by the PRS Group), http://www.countrydata.com; The Economist Intelligence Unit, http://www.eiu.com; and 

World Markets Research Centre (by Global Insight), 

http://www.wmrc.com. 

FDIC OUTLOOK 39 SUMMER 2005 
In Focus This Quarter: U.S. Banking in a Global Economy 

Chart 5 Chart 6 

Exchange Rate Adjustments Can Be Abrupt 

Source: Federal Reserve Board. 

1990:Q1 1992:Q1 1994:Q1 1996:Q1 1998:Q1 2000:Q1 2002:Q1 2004:Q1 

20 

25 

30 

35 

40 

45 

50 

2.4 

2.8 

3.2 

3.6 

4.0 

4.4 

4.8 

Malasian ringgit/U.S. dollar

(right axis) 

Thai baht/U.S. dollar 

(left axis) 

value of their currencies fell abruptly. Although this 

drop proved beneficial to U.S. importers doing business with these countries, it was significantly detrimental to U.S. exporters, as the local cost of their 

goods and services rose dramatically (see Chart 5). 

In other examples, crises related to international 

capital markets (such as Mexico in 1994, Russia in 

1998, and Argentina in 1998 and 2000) triggered 

turmoil in currency markets and, in some cases, limited 

the ability of businesses to move funds across borders. 

Shifts in currency exchange rates need not occur 

abruptly to affect SME exporters and their lenders, and 

the shifts need not always have ill effects. For example, 

between first quarter 2002 and first quarter 2005 the 

euro appreciated relative to the U.S. dollar by almost 

49 percent. This decline in the value of the U.S. dollar 

relative to the euro had the effect of enhancing the 

competitive position of U.S. firms that export to the 

European market. In 2001, nearly 20 percent of SME 

exports were sold to European Union nations (see 

Chart 6). And American small businesses making 

items ranging from forklifts to computer security 

hardware to toothpaste are reporting gains in overseas 

sales in response to the declining dollar.19 

Offshore-Outsourcing Risk. Often, domestic firms may 

opt to purchase goods and services from a cheaper 

foreign source, whether actively engaged in international trade or not. This practice is referred to as 

“offshoring,” or “offshore outsourcing.” Offshoring can 

be motivated by shifts in exchange rates that might 

19 Mark A. Stein, “Export Opportunities Aren’t Just for the Big Guy,” 

New York Times, March 24, 2005. 

NAFTA and European Union Countries Account 

for One-Half of All Small and Mid-Sized 

Enterprise Exports 

Rest of the World NAFTA 

34% 33% 

Middle East
 

3%
 

European Union 

4% 

ASEAN 

19% 

South America 

6% 

Source: U.S. Department of Commerce (2001 data).
 

Note: NAFTA is the North American Free Trade Agreement (includes Canada, the United
 

States, and Mexico). ASEAN is the Association of South East Asian Nations.
 

make certain inputs more costly to acquire in one 

country than another. Generally, the more dependent 

a business is on foreign relationships—including U.S. 

firms that have set up production operations overseas, 

those that obtain a majority of their inputs from 

abroad, and those that sell the bulk of their outputs 

abroad—the more significant the potential impact 

from international trade and transactions on the firm’s 

risk profile. In Industrial Distribution’s 58th Annual 

Survey of Distributor Operations, manufacturers ranked 

“moving offshore” fifth as a concern, behind “economic 

conditions,” “price competition,” “customers going out 

of business,” and “increased operating costs.”20 

Import Competition Risk. Finally, community lenders 

may be exposed to internationally driven credit risk 

even when lending to SMEs that do not engage in 

global trade. With today’s trend toward globalization, 

the reality is that firms that produce and sell only 

within U.S. borders are not immune to what is 

happening in the rest of the world. Shifts in the U.S. 

dollar against other currencies and other economic 

factors overseas, such as productivity and wage–cost 

differentials, may significantly affect the competitiveness of domestically oriented SMEs. Several industries 

in the Southeast—including the apparel, furniture, and 

cotton industries—are feeling the effects of cheaper 

imports that are available in the United States. Such 

import competition can harm sales, profits, and the 

ability of some SMEs to service existing commercial 

credit lines. 

20 Victoria Fraza Kickham, “Making Inroads Overseas,” Industrial 

Distribution, March 2005. 

FDIC OUTLOOK 40 SUMMER 2005 
Opportunities and Risks Facing Community Lenders 

Conclusion 

Recent trends suggest that international trade activity 

will continue to grow and that more and more SMEs 

and community banks may be looking to enter this 

marketplace in some fashion. However, lenders need 

to individually weigh the costs and benefits associated 

with offering products and services specifically tailored 

to their customers involved in international trade. 

Lending to internationally oriented small and mid-sized 

businesses carries some unique risks, including political 

risk and foreign exchange risk, while also changing the 

nature of more typical concerns, such as credit risk. 

While the pace of globalization in coming years 

remains uncertain, the process itself is unlikely to 

reverse. Small and mid-sized internationally active 

firms can provide numerous and rewarding business 

opportunities for community lenders, including issuing 

international letters of credit, providing trade financing 

loans, facilitating or executing foreign currency transactions and wire transfers, and providing direct operating 

funds through traditional commercial loans. But lenders 

engaged in these activities also need to be cognizant 

of the unique risks that arise when their borrower is a 

small or mid-sized business active in global trade. 

Shayna Olesiuk, Regional Economist 

Adrian R. Sanchez, Regional Economist 

Joan D. Schneider, Regional Economist 

Paul S. Vigil, Financial Analyst 

FDIC OUTLOOK 41 SUMMER 2005 

In Focus This Quarter

FDIC OUTLOOK 43 SUMMER 2005

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