Chapter 8
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.
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Objectives (cont.)
• To identify the main features of
Eurobanking.
• To illustrate the determination of the bidoffer 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 short-term deposits and make shortterm 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, Bahrain 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.
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Evolution and Growth (cont.)
• The rise of oil prices in the 1970s
• Efficiency
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What Explains Efficiency?
• Eurobanks are not subject to regulations
(e.g. 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.
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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.
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PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
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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.
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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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PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
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Determination of the Bid-Offer
Spread
• 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
DT
ST
ia
ib
Q
DM
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Q
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 LowQuality Borrowers
i
SM
ia  ρ
ρ
ia
DL
DH
Q
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International Banking
• International banking operations
encompass those conducted with nonresidents 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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PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
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