The Eurocurrency Market and International Banking Chapter 6 The Eurocurrency Market and International Banking

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.) 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

Slides prepared by Afaf Moosa 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 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

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 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

Slides prepared by Afaf Moosa Eurocurrencies US dollar Euro Japanese yen British pound Swiss franc 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

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

Slides prepared by Afaf Moosa 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) 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

Slides prepared by Afaf Moosa 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.) 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

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.) 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

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 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

Features of Eurobanking International banking encompasses Eurobanking Liabilities are time or call deposits Eurobanks cannot create deposits by writing claims against themselves (cont.) 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

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.) 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

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.) 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

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 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

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 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

Interest rate determination Q i 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

Slides prepared by Afaf Moosa 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 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

Risk premium associated with low-quality borrowers 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

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

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 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

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

Slides prepared by Afaf Moosa New activities Dealing in Eurocurrencies Syndicated Eurocredit Investment 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

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

The organisational set-up Correspondent banks Representative offices Bank agencies Foreign branches, subsidiaries and affiliates Consortium banks Global banks 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

Slides prepared by Afaf Moosa 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 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

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 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

Slides prepared by Afaf Moosa 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 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

Slides prepared by Afaf Moosa 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 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

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 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

Slides prepared by Afaf Moosa Consortium banks Joint ventures established by large international banks to deal with large companies and governments 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

Slides prepared by Afaf Moosa Global banks A global bank takes deposits and offers loans and other banking services in a variety of national markets through local presence 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