Chapter 6
The Eurocurrency Market and
International Banking
Objectives
• To define the Eurocurrency market
• To identify Eurocurrencies and Eurocurrency
banking centres
• To identify reasons for the growth of the
Eurocurrency market
(cont.)
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Objectives (cont.)
• To identify the main features of Eurobanking
• To illustrate the determination of the bid-offer spread
and the risk premium in Eurocurrency deposit rates
• To describe international banking
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The Eurocurrency market
• The market is comprised of banks that accept shortterm deposits and make short-term loans in
currencies other than that of the country in which
they are located
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Eurocurrencies
•
•
•
•
•
US dollar
Euro
Japanese yen
British pound
Swiss franc
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Prerequisites for Eurocurrency centres
•
•
•
•
•
Political stability
Favourable environment for international finance
Good telecommunications system
Favourable time zone
High quality of life
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Eurocurrency centres
• European centres: London, Luxembourg, Paris,
Zurich and Frankfurt
• Centres outside developed countries: the Bahamas,
Dubai and Hong Kong
• North America and Japan: International Banking
Facilities (IBFs) and the Japan Offshore Market
(JOM)
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Evolution and growth
• The market started in the 1950s.
• In 1957, the Bank of England introduced tight
controls
• In 1958, European currencies were made convertible
(cont.)
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Evolution and growth (cont.)
• The rise of oil prices in the 1970s produced huge
financial surpluses for oil-exporting countries. These
surpluses were deposited at Eurobanks
(cont.)
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Evolution and growth (cont.)
• Eurobanks are efficient because:
they are not subject to regulations, such as Regulation
Q, interest equalisation tax
no reserve requirements
economies of scale
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Features of Eurobanking
• International banking encompasses Eurobanking
• Liabilities are time or call deposits
• Eurobanks cannot create deposits by writing claims
against themselves
(cont.)
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Features of Eurobanking (cont.)
• Eurobanks accept deposits and make loans in a
variety of currencies
• A Eurobank is often a branch of an international
bank
• There are no formal restrictions on entry
(cont.)
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Features of Eurobanking (cont.)
• Transactions are large
• The geographical spread is very wide
• The market is not subject to the regulatory measures
of the local authorities
(cont.)
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Features of Eurobanking (cont.)
• The market is dominated by interbank operations
• Participants include multinationals and central banks
• Eurobanks do not have to hold reserves against
deposits
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Determination of the bid-offer spread in
interest rates
• The bid rate is determined by the demand by market
makers and the supply of price takers
• The offer rate is determined by the demand by price
takers and the supply of market makers
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Interest rate determination
i
S
M
D
T
S
T
ia
ib
Q
DM
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Q
6-16
The risk premium
• Only borrowers of high quality can borrow at the offer
rate quoted by market makers
• Others have to pay a risk premium
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Risk premium associated with low-quality
borrowers
i
SM
ia  ρ
ρ
ia
DL
DH
Q
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International banking
• International banking operations encompass those
conducted with non-residents as well as those
involving foreign currencies
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Reasons for the emergence of international
banking
•
•
•
•
Meeting the needs of foreign subsidiaries
Participation in the FX market
Circumventing capital controls
Provision of custodial services
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Traditional activities
• Export-import finance
• Buying and selling foreign exchange
• Provision of foreign loans
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New activities
• Dealing in Eurocurrencies
• Syndicated Eurocredit
• Investment banking
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Innovative activities
•
•
•
•
Innovative financing
Global money market
Managing the loan portfolios of developing countries
Private banking
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The organisational set-up
•
•
•
•
•
•
Correspondent banks
Representative offices
Bank agencies
Foreign branches, subsidiaries and affiliates
Consortium banks
Global banks
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Correspondent banks
• When a bank has no branch in a particular country it
uses a foreign bank located in that country to settle
transactions on its behalf
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Representative offices
• A representative office is established by a bank in
another country with the primary task of providing
information about business conditions in that country
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Bank agencies
• A bank agency is similar to an ordinary commercial
bank, except that it does not handle ordinary
deposits
• Its function is to deal in money and FX markets,
arrange loans and clear cheques
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Foreign branches
• If the volume of international business of the
customers of a bank is large enough, it may be
viable to open a branch in another country
• Branches are subject to regulation by the home and
host governments
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Foreign subsidiaries and affiliates
• These are banks established in another country and
owned solely or jointly with other parties
• Unlike branches, they do not have the name of the
bank
• The degree of control is greater in the case of a
subsidiary
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Consortium banks
• Joint ventures established by large international
banks to deal with large companies and
governments
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Global banks
• A global bank takes deposits and offers loans and
other banking services in a variety of national
markets through local presence
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