banks. Interbank deposits, non bank time deposits, and London dollar CDs represent the
bulk of the liabilities of a Eurobank. Interbank transactions bulk particularly large and
we will shortly see why. The final depositor in the Eurocurrency market can choose
among two major financial instruments. Most funds are raised by fixed time deposits
(TDs), the other source being certificates of deposit (CDs). The maturities of time
deposits range from one day to several years but most of them are in the one week to six
months range. Negotiable certificates of two different forms: the top CDs issued in
single amounts by certificates of two different forms: the top CDs issued in single
amounts by a bank, which remain an Interbank financial instrument; and the Tranche
CDs, which are managed issues by several banks and denominated in smaller amounts, so
that they can be attractive to corporations and individual investors.
While borrowers often want to borrow for longer than five years, CDs are not
currently issued for any longer maturities. Thus there have developed forward CDs,
whereby a bank will issue and other banks will agree to contract CDs at a fixed or
floating interest rate at some given future date. This device allows banks to make
medium term loans to corporations or governments which extend beyond five years and
be certain of available resources.
Loans in a specific currency are priced according to a “LIBOR plus” principle.
Three parameters usually determine the cost: a commitment fee, which is per annum fee
expressed as a per cent on the undrawn, uncancelled portion of the loan; a front end fee
which is a one-time payment, expressed as a percentage of the amount of the loan,
usually paid shortly after the signing of the loan; and a spread which is the percent per
annum margin added to the bank’s cost of funds, which is LIBOR. The sum of these
pricing elements allows us to determine a total spread, which is annualized and represents
the total margin of the loan expressed as an annualized percentage over LIBOR. Under
this pricing procedure, the most common in the Eurocurrency market, Euro loans are
floating rate loans which depend on the value of LIBOR. The total spread over LIBOR
varies with market conditions. Historically it has varied between ½ % to 3%. If one
compares the pricing of Euro loans with domestic loans, the principle difference are as
follows: Euroloans do not involve compensating balances but rather involve
commitment fees on the unused part of credit lines, and the front-end fee has become of
substantial importance in the Euromarkets. Since credit standing is measured by markup
over LIBOR, there has arisen a willingness of weaker borrowers to trade larger front-end
fees for lower markups. On a present-value basis the outcome is equivalent, but a lower
markup is supposed to have cosmetic advantages.