Outline
 Introduction to the international capital market
 The players of the ICM
 Growth of the ICM
 Offshore banking and offshore currency trading
 Growth of Eurocurrency trading
 Importance of regulatory asymmetries
Introduction to the ICM
Introduction to the ICM
 Definition: the market in which residents of different
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countries trade assets
It is not a single market
There is no physical location
Most activity is in a network of world financial centers
The ICM exists because of international trade
The ICM also adds to the gains of trade by lowering
transaction costs
The Players of the ICM
The Players of the ICM
 Commercial banks
 Bulk of the ICM
 Run the international payments mechanism
 Broad range of financial activities
 Free to pursue goals overseas that they can’t do domestically
 Multinational Corporations
 Finance investments through foreign sources of funds
 Use equity securities as well as debt securities
 Denominate their bonds in the foreign currency
The Players of the ICM
 Nonbank Financial Institutions
 Insurance companies, pension funds, mutual funds, hedge funds
 Investment Banks
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Not banks; specialize in underwriting sales of stocks and bonds by
corporations and governments
Glass-Steagall Act of 1932: commercial and investment banks were
required to remain separate within the U.S. until 1999
However, banks do not have such restrictions overseas
 Central Banks and Other Government Agencies
 Central banks are routinely involved in the ICM
 Government agencies routinely borrow from abroad
 Developing countries and state-owned enterprises borrow
from foreign commercial banks
Growth of the ICM
Growth of the ICM
 The ICM has grown faster than world GDP since 1970
 Fewer barriers to private capital flows across borders,
especially in OECD countries
 Advances in communication technologies
 The demise of fixed exchange rates
Growth of the ICM
 The Impossible Trinity
• A country can pick one side but must
give up far corner
Free capital flows
• Under the Bretton-Woods system,
every country had to choose between
Option 1
Option 2
options 2 or 3
(U.S.)
(Greece)
• Without the Bretton-Woods system,
countries could now pick option 1
Independent
Fixed • This allowed for more free movement
monetary
exchange
Option 3
of capital and led to the growth of the
policy
rate
(P.R. of China)
ICM
Offshore Banking and Offshore
Currency Trading
Offshore Banking and Offshore
Currency Trading
 Offshore banking – business that banks’ foreign offices
conduct outside of their home countries
 Banks conduct foreign business through 3 institutions
 Agency offices abroad
 arranges loans, transfers funds
 does not accept deposits
 Subsidiary banks abroad
 A foreign bank is the controlling owner
 Subject to regulations in foreign country, but not subject to
regulations in the parent bank’s country
 Foreign branches
 An office of the home bank in another country
 Carry out same business as local banks
 Subject to home and foreign banking regulations
 Branches often can take advantage of cross-border regulatory
differences
Offshore Banking and Offshore
Currency Trading
 Offshore currency deposit – a bank deposit in a currency
other than that bank’s home country currency
 For example, dollar deposits in a bank in Frankfurt
 Offshore currency deposits are often referred to as
“Eurocurrencies”
 The term “Eurocurrency” does not mean the “euro”
currency
 Eurocurrency trading happens all over the world – not just
in Europe
 Banks that accept Eurocurrency deposits are called
Eurobanks – even if they’re not in Europe
Offshore Banking and Offshore
Currency Trading
 Rapid growth of offshore banking and currency trading
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has been caused, in part, by an increase in international
trade and the multinational nature of corporate activity
Firms involved in international trade require overseas
financial services
Another reason for rapid growth is banks’ desire “to
escape” domestic regulations and taxes
Banks shift some operations abroad and into foreign
currencies
Depositors hold currency outside the issuing country
also for political reasons
Growth of Eurocurrency Trading
Growth of Eurocurrency Trading
 Remember . . . “Eurocurrency” DOES NOT
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MEAN the “euro” currency!
Eurodollars were born in the late 1950s to respond to the
needs caused by growing international trade
London started and is the leader in Eurocurrency trading
European firms involved in trade needed to hold dollar
deposits or borrow dollars
Those firms found it cheaper and more convenient to
deal with local banks familiar with their circumstances
rather than do business with banks in the U.S.
Growth of Eurocurrency Trading
 Early Eurodollar trading grew due to regulations and
political concerns
 Federal Reserve Regulation Q – imposed a ceiling on
interest rates U.S. banks could pay on time deposits
 Cold War spurred growth of Eurodollar market
 The move to floating exchange rates slowed growth of
Eurocurrency markets
Importance of Regulatory
Asymmetries
Importance of Regulatory
Asymmetries
 Major factor behind the continuing profitability of
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Eurocurrency trading
Domestic currency deposits are heavily regulated to
control money supply
Banks are given far more freedom in dealing with
foreign currencies
Example: reserve requirements
Financial centers with the fewest government
restrictions on foreign currencies are the main
Eurocurrency trading centers