Lecture 3: Offshore and onshore markets

Galina A Schwartz

Depatrment of Finance

Business School

University of Michigan

Plan of today’s lecture

Onshore markets Offshore markets Comparison of onshore and

offshore Levich, chapter 9 (and 10)

Onshore markets

Features: Subject to bank regulations

Interest rate ceilings on deposits (deposit rate ceilings) (Regulation Q)

Reserve requirements Why offshore? To avoid the

regulatory burden

Offshore markets Ironic birth of the eurodollar market

+1957 (Bank of England restriction on use of sterling for financing foreign trade and external loans)

Actual reasons for offshore markets emergence (& existence)

Many international contracts are dollar denominated

Fear of expropriation if held in US Eurodollars are not subject of US

bank regulations

Offshore markets (continued) Feature: narrower spreads

between the interest paid on deposits and the interest earned on loans

Advantages of Eurodollars (from narrow spread and no regulation) For borrowers: better rates For depositors: better returns

Onshore & Offshore Markets

Coexist and Compete Levich, p. 286, Box 9.2 Arbitrage & competition between

onshore and offshore improve efficiency

Regulatory response – a trend to relax regulation

The Wells Fargo-Citibank Case Levich, p 296 –297, Box 9.3 June 1983 W-F – 2mln in Citibank Manila

Branch (6 months) October 1983 Philippine government

imposes exchange controls December 1983 Citibank does not repay QQ:

New-York or Philippine law? Deposits should be repaid from N-Y or

worldwide assets? Does it violates Philippines exchange

control law?

I. Keywords (concepts) London inter-bank bid rate (LIBID) London inter-bank offer rate (LIBOR) LIBID and LIBOR are overnight rates Feature: extremely competitive (spread

rarely exceeds 0.125-0.25), p. 285 Levich, Figure 9.5

New-York Prime lending rate > LIBOR LIBID>Federal Funds rate(Prime rate – Federal Funds rate spread

is 2 –3 %)

II. Keywords (concepts)

International Banking Facilities (IBFs) Eurodollars = dollar- denominated

deposits in the banks outside US. (Thus, not subject to US bank regulation)

Eurocurrencies (Euroyen, Euromark, etc.)

Eurobonds: Euro-$ bond, Euro-DM bond,…