What is International Financing?
When LPG (Liberalisation, Privatisation And Globalisation) was accepted by the country in 1991, the aspect of Globalisation broadened the avenues with which businesses can arrange funds. Prior to this policy, firms were constrained only to the four walls of the country. But after Globalisation came into the picture, the scope for raising money expanded widely. Now the firms of our country can look up to external funders as well to replenish their financial needs which was not allowed earlier. Now, they are not restricted to the boundaries of the country rather the reach has increased and the local market is now exposed to the global capital market.
International Financing (also referred to as International macroeconomics) is the branch of financial economics broadly concerned with monetary relationships at a global level. It examines the dynamics of foreign direct investment, exchange rates, balance of payments, allocation of funds at the global level and other aspects of financial management.
International financing encourages monetary transactions between two or more countries. There are different sources around the world from which money might be obtained, and that will be discussed in detail.
Sources of International Financing
Mainly these are classified into three categories which are as follows:
A. Commercial Banks
Commercial banks not only fund businesses and firms in the home country rather it extends to the global level. Commercial banks provide foreign currency loans and advances all over the world. Loans are generally provided for business purposes and are a very famous source for funding non-trade operations internationally. Different banks across countries offer a different and wide range of loans/advances and services to firms. The market of international finances and the export-import industry is incomplete without commercial banks. Commercial banks have a lot to offer in international financing.
B. International Agencies and Developmental Banks
These are named Developmental banks because these were introduced by the government for developmental purposes only. International Agencies and Developmental banks have emerged throughout the years with the goal to fund finance internationally. These institutions were set up by governments of developed countries to uplift and develop the weaker section of the economy by making loans easily available. These loans are usually advanced for a medium and long period of time. These financial institutions are developed at local, regional and global levels. Very common examples are EXIM Bank, European Investment Bank (EIB), European Bank for Reconstruction and Development (EBRD), Asian Developmental Banks (ADB), etc.
C. International Capital Market
International Capital Market exists with the aim of enhancing efficiencies in economies and generating economies of scale. It is the most consumed source of financing. Organisations in current times, including global corporations, are dependent on a large amount of funds in rupees in addition to foreign currency. Under this source of international financing, there are several financial avenues available which are as follows:
1. Global Depository Receipts (GDRs)
- Earlier in a country, generally finances were raised domestically, but now it can be raised from foreign as well. This can happen by issuing securities and shares in foreign countries. To make this process convenient, there exist a financial instrument called GDR. The shares are first issued in the currency of the domestic country. These shares are forwarded to a depository bank, and this depository bank is then responsible for issuing depository receipts in exchange of these shares.
- The denomination for these depository receipts or GDR is US Dollars. When it comes to India, GDR is considered to be a financial instrument issued to raise foreign exchange, i.e., in foreign denominations than in Rupees.
- It is a negotiable instrument that can be traded like any other instrument freely. Just like any other security, GDR can exchange hands very easily.
- GDRs are listed on the foreign stock exchange.
- The righteous entity is authorised to claim any dividend and bonus receivable on account of GDRs but does not hold any right to vote.
- It provides the facility of transferring depository receipts anytime into the total of shares it stands for. The investor can not only easily transfer GDR into equity shares, but can also sell shares these shares mentioned in the GDR through the depository or so-called local custodian. Once issued GDR, the facility for converting them into shares gets activated after 45 days, i.e., 45 days from the date of issue.
- The main motive of issuing GDR is to attract investors globally. Issuing GDR provides a low-cost mechanism where investors can take easily part in. Apart from their local capital market, foreign investors get a chance to participate in or access the capital markets globally.
- Corporations like ICICI, Wipro, Reliance & Infosys in India raise foreign exchange through GDRs.
- A few of the international banks like Citigroup, and JPMorgan issue GDR in replace of shares.
2. American Depository Receipts (ADRs)
- The American Depository Receipts are quite similar to the Global Depository Receipts.
- The process of issuing shares in local currency and then sending the shares to the depository bank to convert them into depository receipts remains as it is.
- The prime difference between both of the depository lies in the fact that ADRs can only be issued in the USA.
- The sale and purchase of ADRs can only happen in the capital market of America. These depository receipts are listed only on the stock exchange of the USA and nowhere else.
- American Depository Receipts like GDRs are negotiable certificates issued by a U.S. depository bank.
- With the issuance of ADRs, US investors get an opportunity to invest in overseas companies, which would otherwise be not available to them. So this widens the horizons of investing opportunities.
- Before any investor could invest in companies globally, they are required to access financial information. So, US banks are required to provide correct knowledge of the financial health of the company.
- Unlike Global depository receipts, American depository receipts can’t be offered for sale-purchase to any random foreign country rather can only be issued to residents of the United States of America.
- There are two types of ADRs: sponsored ADR and unsponsored ADR.
- ADRs are just like any other ordinary stock for the Americans who are dealing out there in the capital market of the USA.
3. Indian Depository Receipts (IDRs)
- As the name implies, Indian Depository Receipts are exclusively available in the Indian markets.
- Just like for GDRs, here also the shares are forwarded to the depository banks to get depository receipts in exchange for those respective shares. But it is slightly different from the GDRs because the depository here is of Indian origin. The depository receipts are denominated in Indian rupees. Hence it allows any foreign investors to raise funds from India’s capital market in the form of IDRs as a replacement for shares/securities.
- An Indian Depository Receipt is a negotiable financial instrument.
- IDRs are nothing, but an Indian version of Global Depository Receipts.
- The depository in India is none other than the Securities and Exchange Board of India, which is the watchdog of all the securities listed on the stock board.
- There is an interesting aspect of IDRs that these are available to Indian investors too, as in they can also access IDRs, just like any normal security of the Indian capital market. Residents of India are invited to the bidding process the same way they are called for the issuance of Indian shares.
- The company need not necessarily follow the listing and regulatory requirements of every country where it is willing to sell shares.
- Investing in IDRs is a successful alternative to buying stock on a foreign exchange.
- Standard Chartered Bank was the first foreign corporation to issue any kind of IDR.
4. Foreign Currency Convertible Bonds (FCCBs)
- Foreign Currency Convertible Bonds are a combination of debt and equity instruments.
- Just like any other convertible securities, these bonds are also convertible meaning thereby that on a nearby future date after a passage of a stipulated time these bonds can be changed to any depository receipt or some equity shares.
- The bearer of the bond can exchange their FCCBs with some equity shares for whom the price is already decided or for any exchange rate.
- The bearer can also opt for holding back their FCCBs with them.
- FCCBs are always bought and sold in foreign financial markets.
- The fixed rate of interest over foreign currency convertible bonds is generally lesser as compared to any other debt instruments, which are non-convertible in nature.
- At the time of maturity, the whole complete face value of the bond is redeemed. And usually, the time period for redemption of Foreign Currency Convertible Bonds is around 5 years.
- Its functioning is quite similar to the Indian convertible financial avenues.
- Issuance of Foreign Currency Convertible Bonds dilutes the ownership, and earnings per share decrease for other shareholders.
- Here, holders cannot control the conversion rate.
Overall, it can be said that there are various external sources of funding through which money can be raised, but it is important to choose the best financial alternative among all. But, as we all know, no avenue is perfect, they all have some limitations so sometimes it is required to form a portfolio of all the funds, i.e., a mix of two or more than two avenues. Certain factors, like purpose and duration of business, risk-taking capacity, benefits of the tax, the financial strength of the investor and many more, help firms to decide what will be the best from all the available options.