Chapter 6 The Eurocurrency Market and International Banking

Chapter 6

The Eurocurrency Market and

International Banking

Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa

Slides prepared by Afaf Moosa

Objectives

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

centres• To identify reasons for the growth of the

Eurocurrency market

(cont.)

6-2



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

6-3



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

6-4



Eurocurrencies

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

6-5



Prerequisites for Eurocurrency centres

• Political stability• Favourable environment for international finance• Good telecommunications system• Favourable time zone• High quality of life

6-6



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)

6-7



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.)

6-8



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.)

6-9



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

6-10



Features of Eurobanking

• International banking encompasses Eurobanking• Liabilities are time or call deposits• Eurobanks cannot create deposits by writing claims

against themselves

(cont.)

6-11



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.)

6-12




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

of the local authorities

(cont.)

6-13




• The market is dominated by interbank operations• Participants include multinationals and central banks• Eurobanks do not have to hold reserves against

deposits

6-14



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

6-15



Interest rate determination

QQ

i

MSTD

TS

MD

ai

bi

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

6-17



Risk premium associated with low-quality borrowers

Q

iMS

LDHD

ρai

aiρ

6-18



International banking

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

6-19



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

6-20



Traditional activities

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

6-21



New activities

• Dealing in Eurocurrencies• Syndicated Eurocredit• Investment banking

6-22



Innovative activities

• Innovative financing • Global money market• Managing the loan portfolios of developing countries• Private banking

6-23



The organisational set-up

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

6-24



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

6-25



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

6-26



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

6-27



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

6-28



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

6-29



Consortium banks

• Joint ventures established by large international banks to deal with large companies and governments

6-30



Global banks

• A global bank takes deposits and offers loans and other banking services in a variety of national markets through local presence

6-31

Documents

Chapter 6 The Eurocurrency Market and International Banking