Lecture International finance: An analytical approach (3/e): Chapter 6 - Imad A. Moosa

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

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

6-3


The Eurocurrency market
• The market is comprised of banks that accept shortterm 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

6-4


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

6-5


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

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)

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

6-7


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.)
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

6-8


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.)
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

6-9


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

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

6-10


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

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.)
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

6-12


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

6-13


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

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

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

6-15

Interest rate determination
i
S

M

DT
ia

S

T

ib
Q

DM

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

Q

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

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

6-17


Risk premium associated with lowquality borrowers
i

S
ia

M

ρ
ia

ρ
DL
DH
Q
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

6-18


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

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

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

6-20


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

6-21


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

6-22


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

6-23


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

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

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

6-25