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Eurodollars
Source: Encyclopedia of Banking & Finance (9h Edition) by Charles
J Woelfel
(We recommend this as work of authority.)
Dollar deposit claims
upon U.S. banks, deposited (transferred) in banks located outside the
US.S, including foreign branches of U.S. banks, so that the funds do not
physically leave the U.S. banks.
These dollar deposit claims in turn may be redeposited in other
foreign banks, lent to business enterprises, invested, or retained to
improve reserves or overall liquidity, reflecting the acceptability of
dollars as a key reserve currency, their availability in Eurodollar form
when domestic monetary policies might make money extremely difficult to
obtain and/or balance of payments restraints encourage use of Eurodollars,
and their competitive rates, as well as freedom from required reserves
until recent years.
The Eurodollar market
is principally maintained by commercial banks in London, Paris, and other
European cities which are willing to accept such U.S. deposit claims as
time deposits, or (since 1966) willing to accept them as time certificates
of deposit in negotiable form. This
market actually includes other currencies, so that it might be more properly
referred to as the Eurocurrency market.
Transactions in dollars, however, constitute about three-fourths
of the volume of transactions, which take place in wholesale amounts on
the order of $1 million to $5 million, with maturities from call basis
to one year, although it is reported that maturities of up to five years
can be negotiated.
Eurodollar deposits
are practically free of regulation by the host country, including U.S.
regulatory agencies. For
example, they are not subject to reserve requirements and FDIC fees.
Regulation D requires that net domestic borrowings from the Eurodollar
market be subject to a 3% domestic reserve requirement.
Negotiable Eurodollar
CDs were desgned by Citibank in London in 1966.
They are usually sold in denominations larger than $250,000, or
more. Eurodollar CDs are
not subject to a 3% reserve requirement and an FDIC fee of about 8 basic
points, as are domestic CDs. Eurodollar
CDs trade in secondary markets.
Default risk and marketability depend on the issuing bank, so the
market is usually limited to the largest banks with strong international
reputations.
Floating-rate Eurodollar
CDs have been introduced in the financial markets.
Such CDs can have maturities extending beyond one year.
Floating-rate notes have maturities ranging up to approximately
20 years. Floating-rate CDs
and notes are priced at a spread off the London interbank offering rate
(LIBOR).
Markets also have
developed for loans and deposits denominated in other currencies, such
as the West German mark, Swiss franc, and Japanese yen, but maintained
outside these countries. These
markets are referred to collectively as the Eurocurrency market.
Interest rates on
Eurodollar deposits are usually higher than the rates paid on deposits
in the United States, while Eurodollar market lending rates tend to be
somewhat lower. Because Eurobanks
operate with lower spreads than banks in the United States, they are able
to compete effectively with domestic U.S. banks for loans and deposits.
Their lower spread is possible because they do not have the additional
costs associated with statutory reserve requirements, deposit insurance
fees, and other regulatory constraints imposed on banks in the United
States.
The Eurodollar market
has grown rapidly since the 1950s, due in part to the U.S. banking regulations
(particularly Regulation Q) that have prevented U.S. banks from paying
competitive interest rates on savings accounts and have raised the costs
of lending. Persistent deficits
in the U.S. balance of payments increased the dollar holdings of foreigners,
as did the steep rise in petroleum prices that created enormous wealth
in the petroleum-exporting countries.
These factors, combined with the relative freedom allowed foreign
currency banking in many countries, spurred the rapid growth of the market.
Eurodollars are
in essence international money, and as such they increase the efficiency
of international trade and finance.
As money, they provide an internationally accepted store of value,
standard of value, and medium of exchange.
Because Eurodollars eliminate the costs and risks associated with
converting from one currency to another, they allow savers to scan the
world more easily for the highest returns and borrowers to search out
the lowest cost of funds. They are a worldwide link among various regional capital markets,
helping to create a global market for capital.
(Eurodollars held by petroleum-exporting countries are sometimes
referred to as petro-dollars.)
Regulation
Since the origins
of the Eurodollar market in the 1950s, the Board of Governors of the Federal
Reserve System has shown an active interest in regulating Eurodollar liabilities,
borrowing, and loans of U.S. banks.
Measures adopted have included the following:
1.
Effective October 16, 1969, member banks were required by Regulation M
(then pertaining
to foreign activities of national banks) to maintain
reserves of 10% against balances above
a specific base due from domestic offices to
their foreign branches.
The rate was raised to
20% effective January 7, 1971.
Regulation D (Reserves of Member Banks) imposed a
similar reserve requirement on borrowings above
a specified base from foreign banks by
domestic offices of member banks.
Indicative of the
Fed's views of the role and impact on monetary policy of Eurodollar activity,
as well as its effects upon the U.S. balance
of payments, the Fed explained that the raise
from 10% to 20% was intended to give banks an
added inducement to preserve their
reserve-free bases, instead of allowing their
bases to be lowered automatically by repaying
their Eurodollar borrowings.
"A matter of increasing concern was the deleterious effect on
the U.S. balance of payments of the repayment
by U.S. banks of their Eurodollar
borrowings.
Such repayments had already assumed heavy proportions, and pressure
toward acceleration of that movement seemed certain
to intensify if U.S. short-term rates
declined further and domestic demands for credit
continued to moderate."
2.
Effective April 1, 1971, Regulation M was further amended to provide a
means by which a
member bank could retain its reserve-free base
with respect to its Eurodollar borrowings
from its foreign branches, by counting within
its base the amount of purchases by its foreign
branches of a U.S. Treasury offering of certificates
of indebtedness to overseas branches
of U.S. banks designed to provide an investment
outlet in the United States for Eurodollars
acquired by the overseas branches.
On January 15, 1971, the Board of Governors had
made a similar amendment to Regulation M regarding
Export-Import Bank securities
offered to foreign branches of U.S. banks as
part of the effort to strengthen the inducement
for such banks to retain their Eurodollar liabilities.
3.
By early 1973 the situation had changed to such an extent that the Board
of Governors
issued an interpretation of Regulation K (Corporations
Engaged in Foreign Banking and
Financing Under the Federal Reserve Act) and
Regulation M, in the form of a statement of
policy, whose purpose was "to give guidance to
member banks having foreign
operations":
(1)
The Board of Governors of the Federal Reserve System, as a central
bank, is
properly concerned with the preservation
and promotion of a sound banking
system in the United States.
The Board of Governors and other Federal
banking supervisory authorities
have been given specific statutory
responsibilities to assure that
banking institutions are operated in a safe and
prudent manner affording protection
to depositors and providing adequate and
efficient banking services to the
public on a continuing basis.
These
responsibilities and concerns are
shared by central banks and bank
supervisors the world over.
(2)
Under Sections 25 and 25(a) of the Federal Reserve Act, the Board
has
particular responsibilities to
supervise the international operations of member
banks in the public interest.
In carrying out these responsibilities, the Board
has sought to assure that the international
operations of member banks would
not only foster the foreign commerce
of the United States but that they would
also be conducted so as not to
encroach on the maintenance of a sound and
effective banking structure in
the United States. In keeping
with the latter
consideration, the Board elieves
it incumbent upon member banks to
supervise and administer their
foreign branches and subsidiaries in such a
manner as to assure that their
operations are conducted at all times in
accordance with high standards
of banking and financial prudence.
(3)
Proper administration and supervision of foreign branches and
subsidiaries require the use of effective systems of records,
controls,
and reports that will keep the bank's management informed of
the
activities and condition of its branches and subsidiaries.
At a
minimum, such systems should provide the following:
(a)
Risk
assets.
To permit assessment of exposure to loss, information furnished
or available to head office should be sufficient to permit periodic
and systematic appraisals of the quality of loans and other extensions
of credit.
Coverage should extend to a substantial proportion of the
risk assets in the branch or subsidiary, and include the status
of all large credit lines and of credits to customers also borrowing
from other offices of the bank.
Information on credit extensions should include (1) a recent
financial statement of the borrower and current information on his
financial condition; (ii) credit terms, conditions, and collateral;
(iii) data on any guarantors; (iv) payment history; and (v) status
of corrective measures employed.
(b) Liquidity.
To enable assessment
of local management's ability to meet its
obligations
from available resources, reports should identify the
general sources
and character of the deposits, borrowings, and
so forth, employed
in the branch or subsidiary with special
reference to
their terms and volatility. Information should be
available on
sources of liquidity - cash, balances with banks,
marketable
securities, and repayment flows - such as well reveal
their accessibility
in time and any risk elements involved.
(c)
Contingencies.
Data
on the volume and nature of contingent items such as loan
commitments
and guaranties or their equivalents that permit
analysis of
potential risk exposure and liquidity requirements.
(d)
Controls.
Reports on the internal and external audits of the branch or
subsidiary
in sufficient detail to permit determination of
conformance
to auditing guidelines.
Such reports should cover
(i) verification
and identification of entries on financial
statements;
(ii) income and expense accounts, including
descriptions
of significant charge-offs and recoveries; (iii)
operation of
dual-control procedures and other internal controls;
(iv) conformance
to head-office guidelines on loans, deposits,
foreign exchange
activities, proper accounting procedures, and
discretionary
authority of local management; (v) compliance with
local laws
and regulations; and (v) compliance with applicable
U.S. laws and
regulations.
4.
By early 1975, the situation had eased, and effective May 22, 1975, the
Board of Governors amended its Regulations M and D to reduce from 8%
to 4% the reserve requirement on member banks' Eurodollar borrowings
and on loans made by member banks' foreign branches to U.S. residents.
5.
Effective November 2, 1977, further amendment to Regulation M reduced
from 4% to 1% the reserve requirement applicable to funds loaned by
foreign branches of U.S. member banks to U.S. borrowers.
No change was made in the 4% reserve requirement on borrowings
by member banks from their overseas branches or from foreign banks.
6.
Amendments of Regulations D and M, effective August 25, 1978, eliminated
the 4% reserve requirement that had been imposed on borrowings - primarily
Eurodollars - or member banks from their foreign branches or from other
foreign banks and on assets held by foreign branches that were acquired
from their domestic offices.
The board also removed the 1% reserve requirement on loans of
foreign branches to U.S. borrowers.
These changes were expected to encourage member banks to borrow
in the Eurodollarmarket.
The board explained that it took these actions in conjunction
with other measures to combat domestic inflation and to counter the
disorder that exsisted in foreign exchange markets.
7.
Subsequently, effective November 1, 1978, the board amended Regulation
D by establishing a supplemental reserve requirement of 2% on all time
deposits of $100,000 or more and on certain other liabilities of member
banks, effective with outstanding deposits beginning November 2, 1978,
for reserves to be maintained beginning November 16, 1978.
This increase in reserve requirements was one of several measures
taken jointly by the Federal Reserve and the Treasury Department to
improve the position of the dollar on foreign exchange markets and to
reduce inflationary pressures.
The action was taken to help moderate the expansion of bank credit
and to increase the incentive for member banks to borrow abroad, thereby
improving the demand for dollar-denominated assets.
8.
On February 14, 1979, the board approved technical amendments that removed
the provisions governing reserve requirements on foreign deposits from
Regulation M and consolidated them within Regulation D.
Effective June 8, 1979, the board also approved substantive revisions
of the regulations governing the international operations of member
banks, Edge Act and agreement corporations, and bank holding companies,
and combined them in a new comprehensive Regulation K, International
Banking Operations.
9.
Effective with the reserve maintenance period beginning October 25, 1979,
a marginal reserve requirement of 8% was added to managed liabilities
in excess of a base amount, and with the maintenance period beginning
April 3, 1980, the requirement was increased to 10%.
(Managed liabilities were defined as large time deposits, Eurodollar
borrowings, repurchase agreements against U.S. government and federal
agency securities, federal funds borrowings from nonmember institutions,
and certain other obligations.)
In general, the base for the marginal reserve requirements was
originally $100 million, or the average amount of the managed liabilities
held by a member bank, Edge Act corporation, or family of U.S. branches
of a foreign bank for the two statement weeks ending September 26, 1979.
For the computation period beginning March
20, 1980, the base was lowered by (a) 7% or (b) the decrease in an institution's
U.S. office gross loans to foreigners and gross balances due from foreign
offices or other institutions between the base period (September 13-26,
1979) and the week ending March 12, 1980, whichever was greater.
In addition, the base would be reduced further after March 19,
1980, to the extent that such foreign loans and balances continue to
decline, the minimum base remaining at $100 million.
10.
However, with the domestic economy slipping into recession, the board
of governors on May 22, 1980, announced a reduction from 10% to 5% in
the reserve requirement imposed on the managed liabilities of member
banks and agencies, branches of foreign banks, and large nonmember institutions
and also raised by 7.5% the base upon which the reserve requirement
was calculated.
This easing of restraints was followed on
July 3, 1980, by announcement of elimination by the Fed of the remaining
5% marginal reserve requirement on managed liabilities of the large
banks and agencies and branches of foreign banks, beginning July 10,
1980, for reserves required beginning July 24, 1980.
In addition, the board eliminated effective the same date the
2% supplementary reserve requirement applicable to member banks on large
time deposits, which had been imposed in November, 1978.
Summary
Review of the actions
taken by the board of governors with respect to Eurodollar liabilities,
borrowings, and loans of U.S. banks and related activities indicates the
continued likelihood of frequent changes in regulations imposing restrictions
or easing them in accordance with domestic considerations of monetary
policy, besides the international aspects of impact upon the balance of
payments and position of the dollar in the foreign exchange markets relative
to that of other currencies and flows of international funds including
"recycling" of oil funds.
BIBLIOGRAPHY
BANK
FOR INTERNATIONAL SETTLEMENTS.
Recent
Innovations in International Banking.
Bank for International Settlements, Washington, DC, April, 1986.
BOARD
OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM.
Federal Reserve Bulletin,
February, 1980.
"Money Stock Measures
and Liquid Assets." September 11, 1986.
DUFEY, G., and GIDDY, I.H.
"Eurocurrency Deposit Risk."
Journal
of Banking and Finance,
December, 1984.
SALOMON
BROTHERS.
An
Analytical Record of Yields and Yield Spreads.
Salomon
Brothers, New York, NY, 1986.
STOAKES, C. "Eurodollar
Deposits on Trial."
Euromoney, August, 1985.
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