Chapter 8 The Eurocurrency Market and International Banking.

Chapter 8

The Eurocurrency Market and International Banking

Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa

Slides prepared by Afaf Moosa 2

Objectives

• To define the Eurocurrency market.• To identify Eurocurrencies and

Eurocurrency banking centres.• To identify reasons for the growth of

the Eurocurrency market.



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.



The Eurocurrency Market

• The market is comprised of banks that accept short-term deposits and make short-term loans in currencies other than that of the country in which they are located.



Eurocurrencies

• US dollar• Euro• Japanese yen• British pound• Swiss franc



Prerequisites for Eurocurrency Centres

• Political stability• Favourable environment for

international finance• Good telecommunications system• Favourable time zone• High quality of life



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)



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.



Evolution and Growth (cont.)

• The rise of oil prices in the 1970s• Efficiency



What Explains Efficiency?

• Eurobanks are not subject to regulations (e.g. Regulation Q, interest equalisation tax)

• No reserve requirements• Economies of scale



Features of Eurobanking

• International banking encompasses Eurobanking.

• Liabilities are time or call deposits.• Eurobanks cannot create deposits by

writing claims against themselves.



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.




• Transactions are large.• The geographical spread is very wide.• The market is not subject to the

regulatory measures of the local authorities.




• The market is dominated by interbank operations.

• Participants include multinationals and central banks.

• Eurobanks do not have to hold reserves against deposits.



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.



Interest Rate Determination

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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.



Risk Premium Associated with Low-Quality Borrowers

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International Banking

• International banking operations encompass those conducted with non-residents as well as those involving foreign currencies.



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



Traditional Activities

• Export-import finance• Buying and selling foreign exchange• Provision of foreign loans



New Activities

• Dealing in Eurocurrencies• Syndicated Eurocredit• Investment banking



Innovative Activities

• Innovative financing • Global money market• Managing the loan portfolios of

developing countries• Private banking



The Organisational Set-up

• Correspondent banks • Representative offices • Bank agencies• Foreign branches, subsidiaries and

affiliates • Consortium banks• Global banks

Chapter 8 The Eurocurrency Market and International Banking.

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Transcript of Chapter 8 The Eurocurrency Market and International Banking.