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

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

Chapter 6 - The Eurocurrency market and international banking. After reading the material in this chapter, you should be able: To define the Eurocurrency market, to identify Eurocurrencies and Eurocurrency banking centres, to identify reasons for the growth of the Eurocurrency market,… 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

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  1. Chapter 6 The Eurocurrency Market and International Banking
  2. 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
  3. 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
  4. 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 6-4
  5. 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
  6. 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
  7. 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
  8. 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
  9. 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
  10. 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
  11. 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
  12. 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
  13. 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
  14. 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
  15. 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
  16. Interest rate determination i S M DT T S ia ib DM Q 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 6-16
  17. 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
  18. Risk premium associated with low- quality borrowers i M S ia ρ ρ ia 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
  19. 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
  20. 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
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