Many foreign banks as
well as foreign
branches of U.S.
banks accept deposits of U.S. dollars and grant the depositor an
denominated in dollars. Those dollars are called Eurodollars. As
will see, they exist under quite different constraints from domestic
dollars. While Eurodollar banking got its start in Europe,
such banking is now active in major financial centers around the
Today the Eurodollar
market is the
international capital market of the world. It includes U.S.
corporations funding foreign operations, foreign corporations funding
or domestic operations, and foreign governments funding investment
general balance-of-payment deficits.
Overseas branches of a
U.S. bank are treated
as an integral part of the parent bank. In its published
parent bank consolidates the assets and liabilities of all branches,
and overseas, and it has just one account at the Fed, held by the head
office. However each overseas branch keeps its own books for
Suppose the AAA
Corporation draws a check
for five million dollars on Citibank, its New York bank, and deposits
it at a
London Eurodollar bank. The result is that the ownership of five
U.S. dollars has passed from AAA to the London bank in exchange for a
Eurodollar time deposit. The London bank now holds a deposit at
balanced by a liability, the time deposit credited to AAA.
Since that money earns
no interest at
Citibank, the London bank will use the funds to make a loan, say to the
Corporation which banks at Wells Fargo. Citibank will then show a
decrease of five million dollars on deposit at the Fed and a decrease
liability of that amount to the London bank. Wells Fargo will
deposit at the Fed and an equal liability as a deposit for BBB.
London bank will record a loan of five million dollars to BBB balanced
time deposit owed to AAA.
Leave the U.S.
Regardless of where
they are deposited, London, Bahrain,
or Singapore, and
of who owns them, Americans or foreigners, Eurodollars never leave the U.S.
that throughout both transactions there was no change in banking system
reserves at the Fed, and the $5 million remained on deposit at a U.S.
bank. A somewhat more involved analysis would show this to be
if the Eurodollars had been lent to a foreign corporation.
In this example, the London eurobank
is acting as a financial
intermediary in U.S. dollars. It is doing much the same as any U.S.
intermediary, like a finance company or a pension fund. Unlike
banks, Eurobanks cannot create money in U.S. dollars through the act of
lending. Their lending only transfers ownership of deposits at U.S.
Banking ground rules
in the Euromarket
differ sharply from those in the U.S. domestic arena.
important distinction is in the character of their liabilities.
Euromarket, all deposits with the exception of call money have a fixed
that may range from one day to five years. Also, interest is paid
deposits, the rate being determined by market conditions.
banks, another important
distinction between their domestic and Euro operations is that no
requirements and no FDIC premiums are imposed against their Eurodollar
deposits. Thus they can invest every Eurodeposit they
Euromarket operates outside the control of any central bank.
Eurodollar deposits use the
dollars to make two sorts of investments, loans and interbank placements.
All such placements, like other Eurodeposits, have fixed maturities and
interest. The rate at which banks in London
offer Eurodollars in the placement market is referred to as the London interbank
rate, LIBOR for
The usual practice is
to price loans at
LIBOR plus a spread. Some term loans are priced for the life of
but far more often they are priced on a rollover basis. This
every three or six months, the loan is re-priced at the prevailing
LIBOR for 3-
or 6-month money plus the agreed-upon spread.
The funds that form
the basis for the
Eurodollar market are provided by a wide range of depositors:
corporations (domestic, foreign, multinational), central banks and
government bodies, supranational institutions such as the Bank for
International Settlements, and wealthy individuals. Most of the
come in the form of time deposits with fixed maturities.
The Eurobanks also
receive a certain amount
of call money. A call account can be a same-day value account, a
notice, or a 7-day notice account. The going rate for call money
tracks the overnight Eurodollar rate, which in turn is tied by active
to the U.S. Fed funds rate. The main attraction of a call deposit
liquidity. Time deposits pay more, but a penalty is incurred if
deposit is withdrawn before maturity.
Lender of Last
Two questions arise
regarding the liquidity
of the Euromarket: Who lends if the supply of Eurodollars dries
Who lends if the solvency of a major bank in the Euromarket is
threatened? The dollars don't disappear, but it’s possible that
of Eurodollar deposits could move them back to banks in New York.
Thus Eurobanks could face a
liquidity crisis. To protect against any such risk, many have
standby lines with U.S.
In addtion, central
banks have concluded that each looks after its own. Thus the Fed
is the appropriate lender to a U.S. banker whether its troubles arise
from its New York or London operations. Other central banks are
expected to stand behind their own domestic banks both at home and