FUNCTIONS OF THE EUROMARKETS
We can distinguish three distinct functions served by the offshore financial
system:
- Foreign exchange hedging
In the Eurocurrency markets, commercial banks can take positions that cover the
forward commitments they have made vis-a-vis their customers. Let us suppose, for
example, that the London branch of Citibank has agreed to loan French francs to a French
corporation. It has then acquired a foreign currency asset which it can turn immediately
to a dollar asset by engaging in the forward sale of French francs with the BNP in
London, with the maturity of the forward sale corresponding to the maturity of the loan.
Conversely, a dollar loan can be converted immediately into any foreign currency asset
by a forward purchase of the foreign currency in which the bank wants to have the asset.
Also, forward currency commitments can be hedged by offsetting depositing or
borrowing transactions. It is only a short step from such activities to covered interest
arbitrage, which is an important Interbank activity.
- Domestic intermediation
The offshore markets can at times partially supplant normal channels of domestic
financial intermediation when the government imposed a serve credit policy on the
banking system and at the same time encouraged corporations to seek the necessary
financing they needed in the Eurocurrency system.
- International intermediation
The offshore market channel liquid resources from countries with a loanable
surplus to those with a desire to borrow. The most striking example of this is the so-
called “recycling of petrodollars”. When OPEC countries started rolling in cash in 1973,
almost everyone predicted a collapse of the world financial system because all those
dollars were going to the Arab countries, and everybody wondered how all the importing
countries would pay their bills. The dollars were in fact deposited by the OPEC countries
in the Eurocurrency system and relent to the importing countries as one might have
expected. The real impact of OPEC oil price rise has been a transfer of income it has
brought about, not the financial flows that have resulted.
WHY ARE THERE SO MANY INTERBANK TRANSACTIONS?
As was mentioned earlier when we presented the theoretical balance sheet of a
Eurobank, Interbank transactions represent a large part of the activity of a Eurobank. The
actual figure for the size of the Eurocurrency markets vary depending on the source and
method of calculation. The most agreed-upon figures are those given by the Bank for
International Settlements (BIS) annual reports. Other sources include Morgan Guaranty
Trust and Bankers Trust. More than a third of the volume of transactions is Interbank