Chapter 10 International Banking and the Eurocurre...
Lead-in
The European Central Bank (ECB)approved yet more stimulus on Thursday to prop up an economy plunged by the coronavirus pandemic into its biggest recession since World War II.Just months after a raft of emergency measures, the ECB said that it would increase the size of emergency bond purchases by 600 billion euros ($674 billion)to 1.35 trillion euros and that the purchases would run until the end of June 2021, six month longer than originally planned.The ECB also said that it would reinvest bonds maturing in its pandemic emergency purchase scheme at least until the end of 2022.
As the downturn runs deeper and longer than expected, governments are running record deficits to cushion the impact of the pandemic, putting a greater burden on the ECB to soak up this new debt and keep borrowing costs manageable.The ECB has always made clear that it will do its part and Thursday’s move should reassure both governments and investors that it will not tolerate a rise in yields that might foster doubts about the viability of European debt.
“The Governing Council continues to stand ready to adjust all of its instruments as appropriate, to ensure that inflation moves towards its aim in a sustained manner, in line with its commitment to symmetry,” the ECB said in a statement.The bank earlier committed to buying up to 1.1 trillion euros worth of bonds this year.But even record purchases have struggled to bring down yields on debt issued by countries on the 19-nation bloc’s periphery, particularly Italy, hit hard by the virus and already struggling with a large debt burden.More bond buys are also becoming urgent because the ECB is on track to exhaust its purchase quota by autumn, raising some doubts about its capacity or willingness to buy the amounts needed to keep yields down.
The programme is designed to create fiscal room for governments delving deep into their pockets to counter the effects of the pandemic.Cash-rich Germany, which can borrow at negative rates for up to 20 years, unveiled a 130 billion euro ($145.85 billion)stimulus package late on Wednesday.The euro initially strengthened on the decision while 10-year German yields eased around 2 basis points.Attention now turns to ECB President Christine Lagarde’s 1230 GMT news conference, at which she will unveil new economic projections and face questions about further measures and the German Constitutional Court’s recent ruling on the ECB’s powers.
Although increasing the size of bond purchases was seen as the biggest step for the ECB, the bank still has some options to discuss at future meetings.It still has to decide whether to buy bonds that lose their investment grade ratings, as the U.S.Federal Reserve does, and could also increase the exemption for banks from its punitive charge on excess reserves.Another key issue for investors will be how the ECB responds to the German Constitutional Court’s recent ruling that the ECB has exceeded its mandate and the German Bundesbank must quit a key bond purchase scheme.
Although the ECB says only the European Court of Justice has jurisdiction over its work, board member Isabel Schnabel, herself a German, has said the bank is ready to play a constructive role in resolving the dispute.With Thursday’s decision, the ECB also kept its main interest rate unchanged at 0 percent and its deposit rate, now its de facto benchmark, at minus 0.5 percent.
Source: The Economic Times, June 04, 2020, https://economictimes.indiatimes.com/markets/ stocks/news/ecb-gives-ailing-euro-zone-economy-another-shot-of-stimulus/articleshow/76196563.cms
International institutions and agreements have evolved over the years in response to the growth in cross-border trade and capital flows as well as the revolution in communications and information processing.The same forces were at work in the evolution of the private component of the international financial system.Nowhere has this been more pronounced than in the domain of international banking.The traditional system of correspondent banking where banks maintain deposits, subject to local regulations, in the domestic currency of the country where they are located, has been overtaken by today’s system of banks taking and holding deposits in any currency, regardless of the banks’ location.Deposits of this type are outside the jurisdiction of the monetary authorities where the currencies are legal tender.They can be bought and sold, borrowed and loaned, with little or no interference from politicians and regulators.Any interference in one location only has the effect of chasing business to another where there is no interference.Furthermore, the development of communications networks and data processing has increased the speed and efficiency of transfer and settlement to the point where geographic location is almost irrelevant.
For the international financial system the consequences have been revolutionary.International liquidity, interest rates, and the magnitude and direction of capital flows have all undergone profound changes.Even domestic banking systems have been influenced because they are cross-linked through the offshore operations in their currencies.
In this chapter we examine this offshore international banking system, called the Eurocurrency market, and see what it is, how it developed and how it functions.We will see how funds are transferred through the system and how international liquidities are created and destroyed in the process.We will study its links to individual domestic banking systems and how it influences the balance of payments, the exchange rate and the magnitude and direction of trade and capital flows.