Instruments of Eurobank financing
Term deposits
As we mentioned, Eurocurrency liabilities are typically conventional term deposits of one day to one year’s duration.Conventional term deposits are non-negotiable bank deposits with a fixed term where the interest rate is fixed for the duration of the deposit.Maturities can vary from one day to several years but most Eurocurrency term deposits are in the range of seven days to six months.Although the term of the deposit is fixed at the outset, under certain conditions and after payment of a penalty on the rate of interest, most banks offer the possibility to make an early withdrawal.Early withdrawals are not widespread, however.Investors seem to prefer to keep their maturities short and if they find themselves in need of cash, rather than cash in their deposit, they use it for collateral.
Certificates of deposit
A growing proportion of Eurobank liabilities are in the form of certificates of deposit (CDs).Certificates of deposit are negotiable instruments that can be traded on the secondary markets.This makes them more liquid or closer to cash than a conventional term deposit, which has a penalty for early withdrawal.Because of their greater liquidity CDs usually pay a lower rate of interest than a term deposit.The difference is normally between 6 and 15 basis points (a basis point is 0.01％).In spite of the lower rate of return, they are popular with company treasurers because of the flexibility they offer.
Most Eurocurrency CDs are denominated in dollars or sterling issued by London or New York banks.They can pay as much as 50 basis points or more above the rate on a comparable domestic CD but 20～25 basis points is the norm.Although they can be purchased in denominations as low as USD 25.000, rates tend to be lower on smaller denominations.
The secondary market for Eurocurrency CDs is liquid and active.Because they are issued to “bearer”, trading is facilitated by the lack of documentation.Several London banks act as market-maker and always stand ready to buy or sell.Compensation is effected between banks in London.
Floating rate notes
Floating rate notes (FRNs)are generally medium-term CDs where the interest rate is fixed at a percentage above Libor (usually 15 to 30 basis points).Adjustments are made at regular intervals (every three or six months)according to the prevailing Libor.Some FRNs guarantee a minimum interest rate.The secondary market is liquid and the relatively high yields make them attractive investments.
1.A Eurocurrency is any freely convertible currency, such as a dollar or a pound, deposited in a bank outside its country of origin.It is the residency of a bank and not its nationality that determines the Eurocurrency nature of the deposit.Sometimes the term “offshore currency” is used instead.
2.Eurocurrency deposits are typically conventional term deposits of one day to one year’s duration.In Eurocurrency transactions the currency that is used is always a foreign currency to at least one of the two parties, and one of the two parties is always a bank.The other party can be another bank, a central bank, a government or a large corporate entity.
3.The interbank market is the core of the Eurocurrency market.This interbank Eurocurrency market is organized as an international over-the-counter market, the members of which are linked by telephone and telex.Access to this market is reserved to top quality institutions.The sums involved are huge with USD 1 million the usual minimum transaction size.
4.Eurocurrency markets are outside the jurisdiction of any single regulatory authority and the interest rates are determined by pure supply and demand.As a wholesale market dealing without costly regulations, the Eurocurrency market can offer attractive rates and certain services that are unavailable in the domestic markets.Factors of cost and convenience are behind the emergence and growth of all the Eurocurrencies.
5.Interest rates in the Eurocurrency markets are closely related to interest rates in the domestic markets.Large differentials indicate controls, incremental risk or both.
6.Banks quote bid-ask spreads to each other.Non-banks are usually quoted the bid rate less a small commission when lending, and Libor or Pibor plus a commission that reflects its creditworthiness when borrowing.
7.Money and credit expansion through the Eurocurrency system is possible but Iimited because of “leaks” from the system.Leaks occur through redepositing or spending Eurocurrencies in their domestic markets or when the currency is sold.
8.Except when a central bank is involved, Eurocurrency transactions have no effect on the balance of payments.The role of financial intermediation played by banks through the Eurocurrency markets does, however, influence both the magnitude and direction of trade and capital flows.
9.Eurocurrencies are more difficult for their domestic monetary authorities to manage than non-Eurocurrencies.
10.The international banking system is linked by a sophisticated system of telecommunications.It is organized around informal correspondent agreements and outright physical presence involving representative offices, agencies, branches or subsidiaries.
11.The major source of funds for Eurobanks is the non-negotiable term deposit, but the negotiable CD is popular with corporate treasurers and growing in importance.