Topic: International Money Markets:
The Eurocurrency Markets and
Recall From Lecture 2: Defining the
International Monetary System?
It is the overall financial environment in which global
It is represented by the following two sectors:
Foreign Exchange Markets
Currency markets (and foreign exchange regimes)
International Money and Capital Markets
Eurocurrency Markets (dominated by global banks)
Traditional financial centers (London, New York, etc) and
Offshore Financial Centers and Offshore Financial Markets
(Cayman Islands, Singapore, etc).
Financing Global Operations
The global firm can finance its overseas
activities through either:
Internal sources of funds (i.e., within the corporate
Funds from the parent or “sister subsidiaries.”
External sources of funds (i.e., outside of the
Funds raised in the parent country’s financial markets.
Funds raised in financial markets outside the parent
Can be either debt or equity funds.
External Financing of the Global Firm
Banks & other financial inst.
Capital markets or money markets
Funds (Debt and Equity)
External Financing with
Bank Loans: Local Currency Debt
to Debt in
Eurocurrency Financing: Banks
The financial markets
and Direct Markets
Global Long-term Bond Financing:
Foreign and Offshore Bonds
Financing with Individual foreign shareholders
foreign countries’ Joint venture with foreign partners
International Money Markets
The International Money Market represents the short
and intermediate term borrowing and investment
Global firms have access to the international money
markets either through (1) intermediaries
(commercial banks) or through the direct markets.
The major international money markets are:
Eurocurrency Loan (Euro-Lines of Credit) Markets
Eurocredits (Syndicated) Market
Euro-Medium-Term Notes Market
Eurocommercial Paper Market
Sources of Debt in the International
Money and Capital Markets
Bank Loans Local Currency Bank Loans
Market) Euro lines Offered by Banks
short-to-medium term) Syndicated Euro Credits
Euronote/Paper Euro-Short Term Notes
(Direct Market) Euro-Medium Term Notes
short-to-medium term) Euro-commercial Paper
International Eurobonds (“Offshore” Currencies)
Bond Market * straight fixed-rate debt
(Direct Market) * floating-rate notes (FRN)
(fixed & floating-rate, * equity-related issue
medium-to-long term) Foreign Bonds (Domestic Currency)
Creation of a Eurocurrency Deposit:
Assume a German company sells a product to a US
company and charges $1,000,000 for the sale.
The US company pays by instructing its bank in New
York to transfer $1,000,000 into the account of the
German company (assume the German company has an
account at the same New York bank).
The German company then instructs its US bank to
transfer the dollar deposit to a dollar time deposit at its
bank in London.
Note: Dollars do NOT leave the US, but instead the time
deposit shifts from the US bank to a London bank.
The London bank can now lend out these dollars to its
Brief History of the Eurocurrency Market
Market originated in the 1950s, when communist governments
(mainly the Soviet Union) needing dollars for international trade
and concerned about the potential freeze of their dollar accounts
in US banks, shifted their deposits to London
The original bank in the London market accepting these deposits
was the Banque Commercial pour I'Europe du Nord was best
known by its cable code, EUROBANK; hence the term
By the 1960s, the practice of euro-deposits was extended to
regular business customers.
In 1964, the market size was estimated at $20 billion dollars, with
the majority in the form of US dollar deposits.
As the economies of Europe and Asia grew, the market was
extended to additional currencies other than the US dollar.
By 1995, the market had grown to $7 trillion, but the US dollar
share was down to 44%.
Market is growing about 25% per year!
The Meaning of the “Euro” Prefix
In the Eurocurrency Market, the prefix “euro” is used
to denote the particular offshore currency in which
the transaction is occurring, e.g.,
Euro-dollars, euro-yen, euro-pounds, euro-euros.
Eurocurrencies are only the major currencies of the world.
Although historically the market originated in
Europe, today eurocurrency markets exist all over
Banks accepting euro deposits and making euro
currency loans are commonly referred to as
Note: do not confuse this term with the single
European currency, the “Euro.”
Functions of the Eurocurrency
The Eurocurrency market serves two valuable
functions for global firms:
(1) Investment Market: Eurocurrency deposits are a
convenient way for global firms to earn a return on their
short term excess (“idle”) funds.
Eurodollar time deposits normally have maturities from
overnight to six months, but may be as long as five
years; they are not insured.
Minimum investment of $100,000; and are not
For an example see:
(2) Borrowing Market: Eurocurrency loans are a major
source of short-term and intermediate term loans for global
firms to finance their working capital needs.
Eurocurrency Market Structure
The Eurocurrency market is two tiered:
Wholesale (interbank) market where large global
banks trade euro-currencies among themselves
Represents about 50% of the market. Gross data (next
slide) includes wholesale market
Retail market: where global banks accept euro-
deposits from clients and make euro-currency
loans to clients.
Represents about 50% of the market. Net data (next
slide) includes only retail market.
Major clients include global firms and
Size of Eurocurrency Deposit Market
(Billion of Dollars), 1964-1995
Interest Rates in the Eurocurrency
Within the interbank Eurocurrency market, there are
two important interest rates:
Interbank Offer Rate: The rate charged by banks with
excess currency deposits to lend to other banks
Major market is in London, hence LIBOR.
Interbank Bid Rate: The rate at which a bank will
accept deposits from another bank (“deposit rate”).
Again, the major market is London, hence LIBID.
Offer rates will be higher than bid rates by about 1/8%
The LIBOR rate is often used to scale loan rates to
clients in the retail market.
LIBOR, March 29, 2007
Fixed by the British Bankers Association, 11:00 London time
Importance of LIBOR Rates
(1) Used by foreign exchange market maker
banks to calculate forward rates on currencies.
Recall: Under the interest rate parity the forward
rate must offset market interest rate differentials.
In equilibrium, the forward rate offsets the LIBOR
differential between currencies.
(2) Used by global banks in “scaling” retail market
lending rates to corporate and sovereign entity
Lending rate = LIBOR + “X” basis points
Where “X” basis points is the lender’s estimation of the
unique risk associated with a particular borrower.
LIBOR, LIBID and Domestic Rates
LIBOR and LIBID rates will generally parallel the
rates on equivalent borrowing and deposit
opportunities in each country’s domestic
However, lending rates will generally be lower than
equivalent domestic market rates, and
deposit rates will generally be higher than equivalent
domestic market rates.
This interest rate structure reflects:
Smaller spreads (between deposit rates and lending
rates) in the offshore markets than in the domestic
markets due to cost advantages in the market.
Typical Spreads in Domestic and
Eurocurrency Credit Markets
LIBOR and Domestic Borrowing
Interest Rates, March 29, 2007
12 Month LIBOR Prime Lending Rate
US 5.20% 8.25%
Euro 4.17% 4.58%
Yen 0.78% 1.63%
Eurodollar Deposit Rates and CD
Rates, April 3, 2007
CDs (secondary market) United States
Eurodollar deposits (London)
Eurocurrency Loans (Euro-Lines)
Eurocurrency loans (also called euro lines):
These are short term lines of credit against
eurocurrencies offered by banks.
Specifically these are arrangements between a
Eurobank and a customer allowing the customer
to borrow up to a pre-specified amount of a
There is a fee for the line of credit itself (about 1/4
to 1/2 of 1% per annum on the unused portion of
the line) and then an interest rate applied against
any borrowed amount.
Interest rate on borrowing is scaled to LIBOR
Eurocredits are short- to medium-term euro-
currency loans made by Eurobanks.
Often these loans are too large for one bank to
A number of banks will form a syndicate to share the
size and risk of the loan (hence, syndicated
Eurocredits feature a “roll over provision.”
The loan’s maturity can be extended by mutual
agreement between lender and borrower.
At roll over, the interest rate is re-scaled to the new
Example of a Roll Over Eurocredit
Example: Roll Over of a 6 Month Euro-Credit
Today 1 2 3 4 5 6
etc. etc. etc.
Loan is re-scaled at new LIBOR every six months,
with interest payments made on those roll-over dates
Euronotes are short term promissory notes issued
by a corporation and sold to institutional or private
Maturity is typically three to six months.
Euro-notes are underwritten by international
investment banks or international commercial banks
through “Euronote Programs.”
The program identifies the dealer(s) who will act on
behalf of the borrower in placing issues with investors.
Euro-notes are originally sold at a discount from
their face value and pay back the full face value at
maturity and can trade in secondary markets.
Unsecured short-term notes issued by
corporations and banks in the Eurocurrency
Maturities typically range from one month to 6 months.
Historically, U.S. dollar denominated (about 75%); but
euro is becoming more important.
Placed directly with investors through a dealer.
Through a “Eurocommercial Program” with a dealer
who places the issues with potential investors.
Euro-Medium-Term Notes (MTNs)
MTNs are fixed or floating rate notes issued by a
corporation or government to investors.
Maturities of 9 months to 10 years (but most under 5 years)
MTNs are offered on an on-going basis rather than
all at once like a bond.
Issued through a “Euro-MTN Program.”
With this type of program, the issuer can vary the amount
of notes to be issued at any one time depending upon its
needs and “windows” of opportunity.
Thus, a Euro- MTN-program offers issuers flexibility in the
raising of medium and longer-term funds.
MTNs are placed by dealers and they can trade in
secondary markets (many do on the London Stock
These instruments generally bridge the maturity gap
between Eurocommercial paper and Eurobonds.
Who Uses the Eurocurrency Markets?
Rise of the Offshore Financial Center
Offshore financial centers are best defined as
those money centers that attract a high level
of non-resident financial activity.
Offshore financial centers are not new.
In the 1920, wealthy American, UK and Canadian
citizens established offshore trusts in the
Bahamas and the Cayman Islands (to minimize
In the 1960s and 1970s, US banks established
offshore branches to escape US regulations and
to book euro-currency loans.
Characteristics of Offshore Financial
Many (but not all) offshore financial centers
are sparsely populated small island states
(Switzerland is an exception).
These locations provide some or all of the
following advantages: low or zero taxation;
moderate or light financial regulation; banking
secrecy and anonymity.
Since the 1980s, the number of offshore
financial centers (as identified by the IMF)
has risen from about 30 to just under 70.
Offshore Financial Centers (1999)
Africa Asia and Pacific Europe Middle East Western Hemisphere
Djibouti Cook Islands Andorra Bahrain Anguilla
Liberia Guam Campione (Italy) Israel Antigua
Mauritius Hong Kong Cyprus Lebanon Aruba
Seychelles Japan Dublin, Ireland Bahamas
Tangier Malaysia Gibraltar Barbados
Macao Guernsey Belize
Marianas Isle of Man Bermuda
Marshall Islands Jersey British Virgin Islands
Micronesia Liechtenstein Cayman Islands
Nauru London, U.K. Costa Rica
Niue Luxembourg Dominica
Philippines Madeira Grenada
Singapore Malta Montserrat
Tahiti Monaco Netherlands Antilles
Thailand Netherlands Panama
Vanuatu Switzerland Puerto Rico
Western Samoa St. Kitts and Nevis
St. Vincent and
Turks and Caicos
Web Sites: Offshore Financial Centers
For a good discussion of Offshore Financial
Centers visit the following IMF web site:
To view one offshore financial center, the
Cayman Islands, visit the following web site:
Link to Offshore Banking and Investments
International (Global) Banks
Critical to the functioning of the eurcurrency markets
are global commercial banks.
Why? Global banks accept euro-deposits and make euro-
And they do so within both in the interbank and retail markets.
International (i.e., global) banks can be
distinguished from domestic banks by the:
The types of services they offer
The deposits they are willing to accept
The loans they are willing to make
For a discussion of why banks establish a global
presence, please see Appendix 2
International Banks: Services
Managing Euro-Programs for borrowers.
Financing of cross border trade (exports)
Letters of credit; bankers’ acceptances
Offering foreign exchange services
Market maker banks.
Buying and selling foreign exchange for clients
Offering hedging contracts (forwards and options).
Offering interest rate and currency swap financing.
Consulting services to global firms
Hedging strategies; international cash management.
Underwriting eurobonds, foreign bonds, and equity
issues for global firms.
International Banking: Deposits
International banks may or may not be
involved in accepting domestic (i.e., local
currency) deposits in the various foreign
markets in which they operate.
All global banks, however, participate in
eurocurrency deposit market.
Accepting a wide range of foreign currency
International Banking: Loans
International banks are lenders of eurocurrency
To one another (in the interbank markets)
And to retail customers.
Also, participation in syndicated eurocurrency
loans to large multinational firms and sovereign
Many banks involved in these loan agreements.
Some syndicates have involved up to 200 banks.
Allows for the pooling of resources and the sharing
International Banks Ranked by Asset
1 UBS (Switzerland)
2 Citigroup (United States)
3 Mizuho Holdings* (Japan)
4 HSBC (U.K.)
5 Credit Agricole Groupe (France)
6 PNB Paribus (France)
7 JP Morgan Chase (United States)
8 Deutsche Bank (Germany)
9 Royal Bank of Scotland (U.K.)
10 Bank of America (United States)
*Formed by the 2002 merger of Dai-Ichi Kangyo, Fuji Bank
and The Industrial Bank of Japan.
Appendix 1: Example of a
Corporate Borrower in the
CWB, is a Canadian company, that sells western
Canadian wheat and barley throughout the world.
The company raises money in Canada, the United
States and in various eurocurrency markets through a
Eurocommercial Paper Program and a Euro Medium
Term Notes Program.
CWB’s Web Site
Visit CWB’s web site (as noted below) to see
their recent eurocurrency borrowing activities.
From this site, link to “funding programs,” then go
to eurocommercial paper program and euro
medium term note program.
Appendix 2: Why Do Banks
Establish a Global Presence
and What Organizational
Structures do they Use?
Why do Banks Establish International
Possible Low Marginal Costs in going global.
Apply home knowledge to foreign market.
Knowledge Advantage in global market
Overseas operations can utilize the parent’s
knowledge to compete successfully in foreign market
Home (Headquartered) Information Source
Providing local firms (in foreign countries) with
information about parent’s home market
Home market may be saturated or experiencing slow
Why do Banks Establish International
Global banks may not face the same regulations as do
their domestic banks (e.g., reserve requirements on
Following corporate clients overseas
Providing retail customer overseas services
Greater stability of consolidated earnings.
Example of Global Bank: Citigroup
Financial services firm combining
banking, insurance, and investments under
one global organization.
“Universal or full service bank”
Currently located in over 100 countries
Began international operations in 1912!
Go to home page and view countries and
Services Offered by International
The particular services offered by a global
bank is a function of:
The regulatory environment.
What will foreign (host) governments allow?
Developing countries still somewhat restrictive regarding
The type of banking office established.
Organizational structure will determine type of
servies to be offered.
See next 4 slides on global banking structures.
Correspondent Banking Structure
Correspondent Banking Structure is
Having no physical presence overseas
Headquarters maintains “correspondent
relationships” with other banks in foreign markets
Results in “correspondent” balances held at
overseas correspondent banks.
Allows a bank to service core clients overseas
through correspondent banks with little cost.
Facilities foreign exchange conversion for clients
Facilities trade financing (clearing bankers
acceptances) for clients.
Representative Office Structure
Representative Office is characterized by:
A small overseas service facility staffed by parent bank
The office cannot make loans or accept deposits, but:
Office is there to assist core clients in that country with:
Country and economic information
Introductions to government/business contacts
Credit evaluations of local firms
This is a potentially useful (and relatively low cost) strategy
if a global bank has many important clients in foreign
country and they wish to maintain contact with these firms.
Foreign Branch Office Structure
Foreign Branch Office is characterized by:
Since, legally the branch office is part of the parent bank:
The branch office is subject to regulations both at home and in
Branch lending limits are based upon parent capital (not
branch office “capital’).
Thus, a branch can provide larger loans to overseas clients.
This structure allows for fast global clearing of checks
within the bank’s organization:
Branch to branch and to parent clearing.
This has been the most popular form of U.S. bank
Subsidiary Bank Structure
Subsidiary Bank is characterized by:
A bank locally incorporated (in foreign country).
Bank is either wholly owned by parent, or joint
venture with local partner.
An affiliate bank is a non-controlled subsidiary
(i.e., arising out of a joint venture).
These banks operate under the banking laws of
the country in which it is incorporated.
Arrangement was particularly desirable before
the abolition of U.S. Glass Steagell Act.
U.S. banks incorporated overseas so as to engage in
investment banking activities.