International Financial Markets Prices and Policies. Second Edition Richard M. Levich. The Eurocurrency Market. Overview

Transcription

1 Prices and Policies econd Edition 2001 Richard M. evich 9B The Eurocurrency Market Overview Pricing Of Pricing in the Case of One Currency and Two Financial Centers Can Offshore and Onshore Markets Coexist? The Impact of Capital Controls and Taxes Market hare and Pricing in Competing Offshore Centers The General Case with Many Currencies and Many Financial Centers Chap 9 (B), p. 2

2 Consider the case of one currency (the U.. dollar) and two financial centers (New York and ondon). How will U$ interest rates compare across these two centers? What are incentives for depositors and borrowers to go offshore? $$ Chap 9 (B), p. 3 In the onshore market... Interest Rates R When banks incur costs X, equilibrium deposit rate = R, lending rate = R, market size = Q. R The demand () for funds depends on the required rate of return on available projects, X while the supply ( ) of funds depends on individuals rates of time preference. A In the absence of transaction costs, the equilibrium is at A. Q Quantity of Funds Chap 9 (B), p. 4

3 In the offshore market... Interest Rates X R R R R Eurobanks incur cost X < X, resulting in offshore deposit rate R, lending rate R, market size Q. Q X Q ince R can be earned in the onshore market, the supply curve to the offshore market () will begin at R. A imilarly, the demand curve for offshore funds () must begin at R. Quantity of Funds Chap 9 (B), p. 5 The relationships among onshore and offshore interest rates are : R R R R In other words, for U$ : New York lending rate ( Prime ) ondon ondon Interbank Interbank > Offered Rate > Bid Rate > (IBOR) (IBI) $$ New York deposit rate Chap 9 (B), p. 6

4 Onshore and Offshore eposit and Borrowing Rates Percentage per Annum as of June 20, 2000 Canada Euro Area Japan witzerland United Kingdom United tates Prime ending Rate (R ) 7.50 NA Offshore Borrowing Rate: IBOR (R ) Offshore eposit Rate: IBI (R ) Onshore eposit Rate (R ) Note: Prime lending rates may not be comparable as lending practices may vary across countries. IBI, IBOR, and deposit rates are for three-month maturities. Chap 9 (B), p. 7 Costs of Collecting eposits and ervicing oans ONHORE MARKET (U..) Zero interest on mandatory reserves FIC insurance Credit review / loan collection Asset-iability risk management efault risk Interest rate risk Pre-payment risk Taxes Administrative overhead OFFHORE MARKET Market interest on voluntary reserves No deposit insurance Known, higher quality credit risks Floating rate interest + maturity matching Tax havens or other incentives arge volume, shell operation, low overhead Chap 9 (B), p. 8

5 Onshore and Offshore U$ eposit Rates Figure 9.6 eposit Rates for U$ Onshore (C Rate) and Offshore (IBI) 18 Percent per annum Jan-82 Jan-84 Jan-86 Jan-88 Jan-90 Jan-92 Jan-94 Jan-96 Jan IBI - C Rates (ee Right cale) IBI and C Rates (ee eft cale) Jan-00 Monthly ata IBI C Rate IBI - C Rate Zero Chap 9 (B), p. 9 Onshore and Offshore U$ ending Rates Figure 9.7 Borrowing Rates for U$ Onshore (Prime) and Offshore (IBOR) Percent per annum Jan-70 Jan-73 Jan-76 Jan-79 Jan-82 Jan-85 Jan-88 Jan-91 Jan-94 Jan-97 Jan-00 Monthly ata Prime IBOR Prime-IBOR Zero Chap 9 (B), p. 10

6 Can Offshore and Onshore Markets Coexist? If the offshore market provides a similar service at a lower cost, what prevents all onshore transactions from migrating there? Offshore depositors bear the additional risk of exchange controls or taxes, plus the inconvenience of having deposits outside their home country. For borrowers, size and credit quality may act as barriers that restrict some firms from access to the offshore market. Chap 9 (B), p. 11 The Impact of Capital Controls and Taxes When capital controls are present, the inequality R R R R may be affected. When there are controls on the movement of funds into the onshore market, it is possible that R. R When interest rate ceilings or central bank lending guidelines lead to a shortage of funds, borrowers may be prepared to pay R. R Chap 9 (B), p. 12

7 Market hare and Pricing in Competing Offshore Centers Consider the case of one currency (the U.. dollar) and several offshore centers (ondon, Frankfurt, ingapore, and Beijing). How will U$ interest rates compare across these different centers? How will market sizes compare across these different centers? $$ Chap 9 (B), p. 13 Market hare and Pricing in Competing Offshore Centers Interest The supply of funds to each offshore Rates center depends on the assessed costs Beijing ingapore and risk of using the center. R Frankfurt ondon 8.25% Then for ondon, X deposit rate = 8.00%, 8.00% lending rate = 8.25%, market size = Q R Once the most A. efficient and least uppose risky center has set The demand for each center the price, the others offshore dollars incur cost X must follow suit. = 0.25%. Q Q C Q B Q A Quantity of Funds Chap 9 (B), p. 14

8 The General Case with Many Currencies and Many Financial Centers U$ UK Fr $ Real United tates NY U$ NY IBF U$ NY IBF NY IBF NY IBF Fr regulatory costs and political risk vary United Kingdom ondon U$ ondon ondon ondon Fr ondon $ Germany witzerland ingapore Brazil Frankfurt U$ Frankfurt Frankfurt Frankfurt Fr U$ Fr $ ingapore U$ ingapore ingapore ingapore Fr ingapore $ exchange risk vary Rio Real Onshore market Offshore market Chap 9 (B), p. 15 Arbitrage and Interest Rate Parity The interest rate differential between an onshore market and an offshore market has been analyzed using a loanable funds approach. Arbitrage and regulatory competition should keep the offshore interest rates for a single currency nearly equal. The interest rate differential between offshore instruments should conform to the interest rate parity condition. i i ( F ) $,, / Chap 9 (B), p. 16