Why is International Financing Required?
International finance plays a very crucial role in terms of international trade and inter-economy relation in the sector of exchange of goods and services. International Financing is important for various reasons, one being the important tool to estimate the exchange rates prevailing, these rates further helps the investors in deciding about their investment in foreign companies.
Also, International Financing helps in utilizing the financial statements made by the countries who have adopted the style of IFRS. This helps the countries to follow the similar reporting systems.
International Finance
International finance also known as international macroeconomics here one will come across monetary interactions that are studied between two or more countries. The study is focused on areas such as foreign direct investment and currency exchange rates.
The understanding of the International Finance can be illustrated in the following points below:
International finance is the study of monetary interactions which happens between two or more countries.
International finance talks about foreign direct investment and currency exchange rates.
Increase in globalization has intensified the importance of international finance.
The concept of International Finance crosses the barriers of the nations and deals about the international funding rather than restricting itself to particular national boundaries.
The International Finance Research is conducted by the large institutes like the International Finance Corporation, National Bureau of Economic Research. All these research institutions are dedicated to the research and development of the global market.
Sources of International Finance
The sources of International finance can be excavated deep in the international economy and international market. The various sources for International Finance are as follows:
Commercial Banks
Global Commercial Banks all over the international market provide loans in the foreign currency to the companies. These banks are very crucial in financing the non-trade international operations. They facilitate international trading to occur smoothly.
International Agencies and Development Banks
The developmental banks and other international agencies have come forth over the years for the purpose of financing in the international sector. The agencies are set up by the government of the developed countries of the world. The highly industrious agencies among this sector are – International Finance Corporation, EXIM Bank and Asian Development Bank.
International Capital Markets
The budding organizations which include the multinational companies depend upon the fairly large amount of loans known as the foreign currency. The financial instruments which are used by these organizations include – American Depository Receipts, Global Depository Receipts, and Foreign Currency Convertible Bonds.
International Finance Examples
We have understood the meaning and the sources of International Financing. Detailing our knowledge by citing a few examples will allow in-depth knowledge about International Finance.
The examples of International Finance are as follows:
Personal Banking
One’s personal banking matters can cross the borders of their nation, their scope of banking increases with personal banking systems. The students studying abroad can set up their foreign accounts, they can move their money from the United States to other overseas accounts.
Company Assets Shifts
A company may need to move the financial assets from the U.S. to any other country. This is international finance that happens in the form of re-allocation of the assets. The companies doing these transactions must be well versed with the prevailing law which is laid down by the government agencies who keep a vigilant alert in this type of cross-border activity.
Sales, Purchases, Trade
The buying, selling, and trading of the foreign commodities is a way for the world's financial systems to operate. Foreign cars, branded foreign clothes, foreign home goods, and even international pet products consist of the world’s populations, all these require a lot of international finance transactions, in the form of buying, selling, and trading with the familiarity of the prevailing laws.
FAQs on International Financing: Choosing Sources of Funds
1. What is meant by international financing and why is it important for a growing business?
International financing refers to the process of raising funds from sources outside a company's home country. It is crucial for a growing business as it provides access to a much larger pool of capital than what is available domestically. This allows businesses to fund large-scale expansion projects, diversify their financial risk, and potentially access capital at a lower cost or on more favourable terms, thereby enhancing their global competitiveness.
2. What are the key factors a business must consider when choosing a source of international finance?
When choosing an international financing source, a business must evaluate several critical factors. These include:
Cost: The total cost, including interest rates, fees, and the effect of currency fluctuations.
Currency Risk: The risk of loss due to adverse movements in exchange rates between the home currency and the foreign currency of the loan.
Control Dilution: Equity-based sources like GDRs can dilute the ownership and control of existing shareholders.
Regulatory Compliance: Adhering to the legal and financial regulations of both the home and foreign country.
Flexibility: The terms and conditions, including repayment schedules and any restrictive covenants, associated with the fund source.
3. What are Depository Receipts like ADRs and GDRs, and how do they function as sources of finance?
Depository Receipts (DRs) are negotiable financial instruments that represent a company's publicly traded shares but are listed and traded on a foreign stock exchange. An American Depository Receipt (ADR) is traded on a U.S. stock exchange, while a Global Depository Receipt (GDR) is typically traded on European exchanges. They function as a source of finance by allowing a company, for example from India, to raise capital from foreign investors without having to list directly on an international exchange, making it easier to access global capital markets.
4. What is the main difference between Foreign Currency Convertible Bonds (FCCBs) and regular international bonds?
The primary difference lies in the conversion option. A Foreign Currency Convertible Bond (FCCB) is a type of bond issued in a currency different from the issuer's domestic currency, which gives the bondholder the option to convert it into a pre-determined number of the issuer's equity shares at a specified price. In contrast, a regular international bond is a pure debt instrument that does not offer any option to convert into equity; it only provides periodic interest payments and principal repayment at maturity.
5. Why would a company choose a more complex source like a GDR over a simple loan from an international commercial bank?
A company might prefer a GDR over an international bank loan for several strategic reasons. Firstly, issuing GDRs helps in building the company's brand and reputation in global markets. Secondly, it provides access to a very large and diverse pool of equity investors, not just a single financial institution. Thirdly, unlike a loan, there is no obligation to pay interest on equity raised through GDRs. While it involves equity dilution, it can be more flexible and less burdensome in terms of fixed repayment obligations compared to a loan with strict covenants.
6. How does currency exchange rate fluctuation affect the cost of international financing?
Currency exchange rate fluctuation introduces currency risk, which can significantly impact the cost of international financing. For example, if an Indian company takes a loan in U.S. Dollars (USD) and the Indian Rupee (INR) depreciates against the USD, the company will need more rupees to make the same interest and principal payments in dollars. This effectively increases the cost of the loan. Conversely, if the rupee appreciates, the cost of servicing the loan decreases.
7. Which international financial institutions primarily assist businesses in raising funds globally?
Several international institutions facilitate global financing, especially for development projects and businesses in developing countries. Key examples as per the CBSE syllabus include:
International Finance Corporation (IFC): An arm of the World Bank Group that provides loans and equity financing to private sector companies.
World Bank (IBRD & IDA): Primarily lends to governments for development projects, which indirectly supports the business environment.
Asian Development Bank (ADB): Provides financing for projects in the Asia-Pacific region.
International Commercial Banks: Global banks like HSBC, Citibank, etc., are major sources of foreign currency loans for corporations.
8. Is international financing only for very large multinational corporations?
While large multinational corporations (MNCs) are the most prominent users of international finance, it is not exclusively for them. With financial liberalisation and globalisation, even medium-sized companies with strong fundamentals and clear growth prospects can access international funds. They might use sources like foreign currency loans from their domestic banks, private equity from international funds, or specialized financing from development banks like the IFC, which specifically supports the growth of the private sector in emerging economies.
