An Analysis of the Foreign and Domestic Balance Sheet Strategies of the U.S. Banks and Their Association to Profitability Performance

Article excerpt

Abstract

* This study analyzed the 1987 data of 176 relatively large U.S. banks that have both foreign and domestic offices. Canonical analysis and the interpretive framework of asset/liability management were used to identify and interpret their foreign and domestic balance sheet strategies in the context of the "crisis in lending to LDCs."

* The analysis found a consistent dichotomy in foreign and domestic asset/liability matching strategies, the former being more generally conservative with respect to interest-rate and liquidity risks. Among the 44 very large banks, those that were found to follow a predominant or consistent foreign strategy are more profitable than those that follow a mixed or, especially, domestic strategy. Further, these banks that follow a consistent foreign (domestic) matching strategy have the smallest (largest) mean proportions of all foreign asset and liability variables.

Key Words

* In conclusion, the least profitable very large banks have the largest proportions of foreign loans, yet they emphasize domestic balance sheet (asset/liability) matching strategies. Conversely, the most profitable very large banks have the smallest proportions of foreign loans, but, nonetheless, they emphasize foreign balance sheet matching strategies.

Introduction

The purposes of this study are (1) to determine the nature and implications of the foreign and domestic strategies reflected on both sides of the balance sheets of U.S. commercial banks and (2) to determine how the types of strategies followed by individual banks relate to relative profitability performance. The analysis uses 1987 balance sheet ratio data computed from the call reports of 176 relatively large U.S. banks that have both foreign and domestic banking offices.

The major impetus for this study is the need for an improved understanding and performance evaluation of the balance sheet strategies followed by U.S. banks within the context of the crisis in lending to less-developed countries (LDCs). The rising trend in these loans began in the early 1970's and peaked in 1983.(2) The high inflation of the 1970's had the effect of reducing the real debt service burden of the LDCs. However, this situation changed in the 1980's as inflation dropped significantly, real interest rates rose, the value of the dollar increased against LDC currencies, and a worldwide recession reduced demand for the exports of LDCs, especially oil. These factors made it extremely expensive for LDCs to service their international debts. The resulting debt crisis has been characterized by loan defaults, rollovers of maturing loans, maturity rescheduling of other loans, nonpayment of loan interest, and new loans to cover contractual interest payments. The subsequent reduction in the market value of U.S. bank portfolios of LDC loans led the banks to increase their capital and to curtail growth in general and loans to LDCs in particular.

The year 1987 was selected for study because it was the first year that banks gave major recognition to the reality of the "crisis in lending to LDCs."(3) The crisis intensified then when two LDCs each declared a moratorium on interest payments. Their creditor banks were then obliged to place large proportions of this debt on "nonperforming" status. This resulted in huge additions to loan-loss reserves and losses for these banks.

Further, 1987 was also a generally bad year for banks. It was characterized by banks earning the lowest return on assets since World War II. This poor performance was attributed to declining net interest margins, increased overhead expenses, and deteriorating credit quality. Thus, from a financial strategy standpoint, 1987 provides a background of likely sharp contrasts for examining the nature and performance implications of bank foreign and domestic balance sheet strategies.

Bank asset/liability management provides a framework for interpreting the general nature and implications of the identified foreign and domestic balance sheet strategies. …