chap 6 international finance

1. Eurocurrency market and
International Banking
M. Kamran
MB2E-17-08
Hamad Ahmad
RMB2E-17-1620

2. Eurocurrency Market
• It is an integral part international financial market in
which transactions involving non-residents or foreign
currencies are settled.
• It comprises 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.
• All these currencies are called EUROCURRENCIES and
banks are called EUROBANKS.
• For long-term operations the instruments are
EUROBOND MARKET and the EUROCREDIT MARKET.

3. Eurocurrency Market
• Eurocurrency market emerge in late 1950s.
• Eurocurrency market totally based on banks.
For example if the bank in London has on its
books an Australian dollar deposit, then the
deposit is a euro deposit. This Australian
dollar is Eurocurrency, if the bank is located
anywhere in the world outside Australia.

4. Prerequisites for Eurocurrency
banking centers
• Political stability
• Favorable environment in which smooth
conduct of international finance, favorable tax
treatment of Eurobanks, respect for financial
privacy.
• Good telecommunication links with other
financial centers.
• Favorable time zone
• A high quality of life

5. Eurocurrency market centers
• European centers
it covers about 60 percent of the Eurocurrency
market. The main centers are London,
Luxemburg, Paris, Zurich and Frankfurt.
• Outside developed countries market centers
it covers about 20 percent of the global
market. These include Bahamas, Bahrain,
Cayman island, Dubai, Hong Kong,
Netherlands Antilles, Panama and Singapore.

6. -Centers-
• North America and Japan centers
it cover other 20 percent of the global market.
In USA 1981 established IBF (international
banking facilities. In Japan established the
Japan offshore Market (JOM).

7. The evolution of Eurocurrency market
• Euro currency market started as Eurodollar
market in 1950s in midst of the cold war as the
soviets faced the problem of keeping their
export-generated dollar balance with running the
risk of freezing or confiscation in US domestic
banks. They deposit their funds in special account
with European banks.
• In 1957 the bank of England introduced tight
controls on pound-denominated transactions
between British banks and non-residents.

8. Evolution
• In 1958 major European currencies were
made convertible, allowing European banks to
hold dollar accounts rather than being
required to exchange dollars with their central
banks for domestic currencies.

9. Growth of Eurocurrency market
• In 1973//74 members of OPEC started all of a
sudden to accumulate massive dollar balances.
These were deposited with Euro banks which
increase the size of market.
• Other main factor for growth of this market
efficiency of euro banks in performing financial
intermediation between borrowers and lenders.
Narrowness of spread between the interest
charged to borrower and paid on deposit

10. Growth
• Eurocurrency market is not subject to regulations
by the monitory authorities of countries where
they are located. For example in US there is
regulation Q. in 1963 interest equalization tax
which was introduced by US authorities to
protect the balance of payments from capital
outflow.
• There ware no reserve requirements applied to
euro banks.
• Utilization of economies of scale.
• Low administrative cost.

11. Features of Euro banking
• International banking encompasses Euro
banking.
• Liabilities are time or call deposit.
• Euro banks can’t create deposits by writing
claims against themselves.
• Euro banks accept deposits and make loans in
a variety of currencies.
• A Euro bank is often a branch of an
international bank.

12. Features
• There Is no formal restrictions on entry.
• Transactions are large.
• The geographical spread is very wide.
• Market is not subject to the regulatory measures of
the local authorities.
• The market is dominated by interbank operations.
• Participants include multinational and central bank.
• Euro banks do not have to hold reserves against
deposit.

13. Interest Rate determination
• Interest rates are determined in money
market, where banks trade assets and
liabilities with other bank as well as non bank
customers.
• Large banks are called the quoting banks or
market maker.
• Therefore interest rates are changed by
change in supply and demand of market.

14. Interest rate determination
• Interest rates are determined in Eurocurrency
market because it is closer to domestic market
latter is regulations are subjected by domestic
market. Interest rates on assets and liabilities
dominated in same currency are closely
related but not equal.
• Like exchange rates, interest rates are quoted
as bid and offer rates.

15. Interest rate determination
• Bid rate is market maker accept deposits and
offer rate is market maker places deposit with
other parties.
• Market maker demand for funds (deposits) is
a decreasing function of bid rate.
• Market maker supply for funds with other
banks is an increasing function of the offer
rate.

16. Interest rate determination
• Supply and demand of market makers, DM and
SM respectively.
• Price taker supply and demand, DT and ST
• Price taker has supply curve and market
maker has demand curve in bid rate.
• Price taker has demand curve and market
maker has supply curve in offer rate.

17. Interest rate determination
• Graph
QQ
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M
S
T
D
T
S
M
D
ai
bi

18. Interest rate determination
• Only big banks with high creditworthiness can
dictate bid and offer rates.
• Banks and non bank customers with lower
creditworthiness can borrow at a higher rate
because lending banks add a risk premium as
a compensation for the higher credit risk.
• Risk premium required to compensate banks
for credit risk association with low
creditworthiness.

19. Interest rate determination
• Graph
Q
i
M
S
L
D
H
D
ρai
ai
ρ

20. International banking
• International banking operations includes
transactions conducted with non-residents
as well as those involving foreign
currencies
• The origin of foreign-branch banking can
be traced in the 19th century
• 1950’s witnessed remarkable development
in international banking lead by U.S

21. Reasons for the emergence of
international banking
• Meeting the needs of foreign subsidiaries of
domestic corporate customers
The spread of International market was due to
the spread of non-bank multinational firms
• Participation in the Foreign exchange market
Banks found it useful to have representative
offices in major foreign exchange centers
falling in different time zones

22. Traditional activities
• Export-import finance
Includes the provision of LC
• Buying and selling foreign exchange
• Provision of foreign loans
Loans to the customers located in other
countries

23. New activities
• Dealing in Eurocurrencies
• Syndicated Eurocredit
• Investment banking
Secondary market trading, mergers and
acquisitions

24. Innovative activities
• Innovative financing using instruments like
SWAPS and other derivatives
• Global money market (24 hours dealing
room)
• Managing the loan portfolios of developing
countries
• Private banking ( which is the provision of
financial services to the wealthy clients

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

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

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
• To provide the information regarding
creditworthiness of actual and prospective
customers

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 Foreign
exchange markets, arrange loans and clear
cheques

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

30. Foreign subsidiaries and affiliates
• These are banks established in another
country and owned solely or jointly with
other parties
• Unlike foreign branches, they do not have
the name of the bank
• The degree of control is greater in the case
of a subsidiary in contrast to the parent
bank

31. Consortium banks
• Joint ventures established by large
international banks to deal with large
companies and governments
• Their activities involves large commercial
and investment banking operations such as
arranging loans, arranging mergers and
acquisitions

32. Global banks
• A global bank takes deposits and offers
loans and other banking services in a
variety of national markets through local
presence
• International banks concentrate on cross
border business, whereas global banks
serve local markets locally