Lecture 3: Offshore and onshore markets Galina A Schwartz Depatrment of Finance Business School University of Michigan

Plan of today’s lecture n Onshore markets n Offshore markets n Comparison of onshore and offshore n Levich, chapter 9 (and 10)

Onshore markets n Features: u Subject to bank regulations F Interest rate ceilings on deposits (deposit rate ceilings) (Regulation Q) F Reserve requirements n Why offshore? To avoid the regulatory burden

Offshore markets n Ironic birth of the eurodollar market (Bank of England restriction on use of sterling for financing foreign trade and external loans) n Actual reasons for offshore markets emergence (& existence) u Many international contracts are dollar denominated u Fear of expropriation if held in US u Eurodollars are not subject of US bank regulations

Offshore markets (continued) n Feature: narrower spreads between the interest paid on deposits and the interest earned on loans  n Advantages of Eurodollars (from narrow spread and no regulation) u For borrowers: better rates u For depositors: better returns

Onshore & Offshore Markets n Coexist and Compete n Levich, p. 286, Box 9.2 n Arbitrage & competition between onshore and offshore improve efficiency n Regulatory response – a trend to relax regulation

The Wells Fargo- Citibank Case n Levich, p 296 –297, Box 9.3 n June 1983 W-F – 2mln in Citibank Manila Branch (6 months) n October 1983 Philippine government imposes exchange controls n December 1983 Citibank does not repay n QQ: u New-York or Philippine law? u Deposits should be repaid from N-Y or worldwide assets? u Does it violates Philippines exchange control law?

I. Keywords (concepts) n London inter-bank bid rate (LIBID) n London inter-bank offer rate (LIBOR) n LIBID and LIBOR are overnight rates n Feature: extremely competitive (spread rarely exceeds ), p. 285 Levich, Figure 9.5 n New-York Prime lending rate > LIBOR n LIBID>Federal Funds rate (Prime rate – Federal Funds rate spread is 2 –3 %)

II. Keywords (concepts) n International Banking Facilities (IBFs) n Eurodollars = dollar- denominated deposits in the banks outside US. (Thus, not subject to US bank regulation) n Eurocurrencies (Euroyen, Euromark, etc.) n Eurobonds: Euro-$ bond, Euro-DM bond,…