Chapter 6

Chapter 6
The Eurocurrency Market and

International Banking
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
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 (Con.)
Political stability
Favourable environment for
international finance
Good telecommunications
system
Favourable time zone
High quality of life
Copyright  2010 McGraw-Hill Australia Pty
6-6
Prerequisites for Eurocurrency centers (Cont.)
• 1: Political Stability and absence of radical Govt.
Changes.
• 2: Good Telecommunication Facility with other
Financial centers.
• 3: A favorable Environment for smooth conduct of
International Finance.
– Favorable tax treatment of Euro Currency.
– Absence of Exchange and Credit control.
– Respect for Financial Privacy.

6-7
Prerequisites for Eurocurrency centers
 4: A Favorable time Zone
 5: High Quality of Life.

6-8
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)

6-9
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.)

6-10
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.)

6-11
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

6-12
Features of Eurobanking
• International banking encompasses Eurobanking

• Liabilities are time or call deposits
• Eurobanks cannot create deposits by writing claims
against themselves
(cont.)

6-13
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.)

6-14
• Transactions are large

• The geographical spread is very wide
• The market is not subject to the regulatory measures
of the local authorities
(cont.)

6-15
• The market is dominated by interbank operations

• Participants include multinationals and central banks
• Eurobanks do not have to hold reserves against
deposits

6-16
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

6-17
Interest rate determination
S M DT
T
S
ia
ib
DM
Q Q

6-18
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

6-19
Risk premium associated with low-quality
borrowers
i
M
S
ia  ρ
ρ
ia
DL
DH
Q
6-20
International banking
• International banking operations encompass those

conducted with non-residents as well as those
involving foreign currencies

6-21
Reasons for the emergence of international
banking
• Meeting the needs of foreign subsidiaries
( See IFM by Eun & Resnik Chapter # 1)
Corporation / East-India Company
Participation in the FX market
• Circumventing capital controls
• Provision of custodial services
Custody services provided by a bank typically include the
settlement, safekeeping, and reporting of customers'
marketable securities and cash. Securities lending can
allow a customer to make additional income on
custody assets by loaning securities to approved
borrowers on a short-term basis.
6-22
Traditional activities
• Export-import finance
• Buying and selling foreign exchange
• Provision of foreign loans

6-23
New activities
• Dealing in Eurocurrencies
• Syndicated Eurocredit
• Investment banking

6-24
Innovative activities
• Innovative financing
• Global money market
• Managing the loan portfolios of developing countries
• Private banking

6-25
The organisational set-up
• Correspondent banks
• Representative offices
• Bank agencies
• Foreign branches, subsidiaries and affiliates
• Consortium banks
• Global banks

6-26
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

6-27
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

6-28
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

6-29
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

6-30
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

6-31
Consortium banks
• Joint ventures established by large international

banks to deal with large companies and
governments

6-32
Global banks
• A global bank takes deposits and offers loans and

other banking services in a variety of national
markets through local presence

6-33

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Chapter 6

The Eurocurrency Market and

• To define the Eurocurrency market

Copyright  2010 McGraw-Hill Australia Pty Ltd

• To identify the main features of Eurobanking

Copyright  2010 McGraw-Hill Australia Pty Ltd

• The market is comprised of banks that accept short-

Copyright  2010 McGraw-Hill Australia Pty Ltd

Copyright  2010 McGraw-Hill Australia Pty Ltd

Copyright  2010 McGraw-Hill Australia Pty Ltd

 5: High Quality of Life.

Copyright  2010 McGraw-Hill Australia Pty Ltd

• European centres: London, Luxembourg, Paris,

Copyright  2010 McGraw-Hill Australia Pty Ltd

• The market started in the 1950s.

Copyright  2010 McGraw-Hill Australia Pty Ltd

• The rise of oil prices in the 1970s produced huge

Copyright  2010 McGraw-Hill Australia Pty Ltd

• Eurobanks are efficient because:

Copyright  2010 McGraw-Hill Australia Pty Ltd

• International banking encompasses Eurobanking

Copyright  2010 McGraw-Hill Australia Pty Ltd

• Eurobanks accept deposits and make loans in a

Copyright  2010 McGraw-Hill Australia Pty Ltd

• Transactions are large

Copyright  2010 McGraw-Hill Australia Pty Ltd

• The market is dominated by interbank operations

Copyright  2010 McGraw-Hill Australia Pty Ltd

• The bid rate is determined by the demand by market

Copyright  2010 McGraw-Hill Australia Pty Ltd

Copyright  2010 McGraw-Hill Australia Pty Ltd

• Only borrowers of high quality can borrow at the offer

Copyright  2010 McGraw-Hill Australia Pty Ltd

• International banking operations encompass those

Copyright  2010 McGraw-Hill Australia Pty Ltd

Copyright  2010 McGraw-Hill Australia Pty Ltd

Copyright  2010 McGraw-Hill Australia Pty Ltd

Copyright  2010 McGraw-Hill Australia Pty Ltd

Copyright  2010 McGraw-Hill Australia Pty Ltd

• When a bank has no branch in a particular country it

Copyright  2010 McGraw-Hill Australia Pty Ltd

• A representative office is established by a bank in

Copyright  2010 McGraw-Hill Australia Pty Ltd

• A bank agency is similar to an ordinary commercial

Copyright  2010 McGraw-Hill Australia Pty Ltd

• If the volume of international business of the

Copyright  2010 McGraw-Hill Australia Pty Ltd

• These are banks established in another country and

Copyright  2010 McGraw-Hill Australia Pty Ltd

• Joint ventures established by large international

Copyright  2010 McGraw-Hill Australia Pty Ltd

• A global bank takes deposits and offers loans and

Copyright  2010 McGraw-Hill Australia Pty Ltd

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