multiple deposit creation by euro banks

8/3/2019 Multiple Deposit Creation by Euro Banks

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Presented by:

NISHANT MISHRA MBA/1029/2010

RAVI KR. GOYAL MBA/1061/2010

HRISHIKESH KR. SINGH MBA/1065/2010

HARSH KAUSHAL MBA/1068/2010

GANESH PRASAD MBA/1112/2010


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EUROMARKETS

It is mainly an interbank market trading in timedeposits and various debt instruments. AEUROCURRENCY deposit is a deposit in a relevant

currency with a bank outside the home country of thatcurrency.

Examples:

US dollar deposit with a bank in London is aEurodollar deposit,

A sterling deposit with a bank iin Luxembourg is aEurosterling deposit.


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Only location of the bank matters neither the

ownership of the bank nor the ownership of thedeposit.

Example

A dollar deposit belonging to an American companyheld with the Paris subsidiary of an American Bank is

still a Eurodollar deposit.


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EVOLUTION OF EUROMARKETS Eurocurrency market is said to have originated with the Russian

authority seeking dollar- denominated deposits with banks in Britainand France during 1950.

The impetus of growth was derived from various restrictions imposedby US authorities on domestic banks and capital markets.

During 60s and 70s Domestic banks in US were subjected to reserverequirements which mean that a part of their deposit were locked up inrelatively low yielding assets.

Due to the importance of the dollar as a vehicle currency ininternational trade and finance many European Corporations havecash flows in dollars., hence temporary dollars surpluses.


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EURO BANKS

A bank that regularly accepts foreign currency-denominated deposits and makes foreign currency loans.

The emergence of eurobanks has facilitated trade andinvestment between countries, which were difficult in thepast for lack of intermediaries that would accept foreigncurrencies.

The mechanism through which the changes in themonetary base are channelled and magnified into changesof the quantity of money in the economy is called theMultiple Deposit Creation Process.


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FUNCTION OF EURO BANKS

Euro banks operate in many different countries,

accepting and lending money that is denominated inother currencies to that of the country involved. Eurobanks are not subject to any one jurisdiction but doface more risks (such as country and sovereign risk).

Euro banks generally offer high interest rates ondeposits and lower rates on loans (due to thecompetitive nature and the fact that they are viewed asriskier investments)


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How It Works/Example

If an American company wants to buy parts from a

European company, it can use a eurobank to obtain theproper currency. Rather than holding foreign currencyin its own account, an American company can simplypay a eurobank in dollars, and the eurobank will

complete the transaction in euros.


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Why It Matters

Euro bank facilitates global trade and flows of capitalbetween countries, promoting international economicgrowth and development. In addition to providinginternational financial services, eurobanks creates ratecompetition among banks and meets the demand ofinternational investors wanting to hold foreigncurrencies.


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MULTIPLE DEPOSIT CREATION BY

EUROBANKS Eurobanks can generate multiple expansion of euro

deposits on receiving a fresh injection of cash.

Traditional approach to this issue treats eurobanksanalogously with banks within a domestic monetarysystem except that the cash reserve ratio of the formeris voluntary decided while for the latter it is oftenstatutorily fixed.

Following the traditional approach, deposits give riseto loans, which in turn give rise to deposits, a fractionbeing added to reserves at each stage.


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According to modern approach, a fresh injection ofcash will put downward pressure on the interest ratewhich will induce some marginal depositors to shifttheir deposits out of the eurobanks, while it will

increase the demands for loans.

The total size of the eurobanks balance sheet willexpand but the extent of increase cannot be

determined by the traditional approach; it depends onthe elasticities of the schedules of supply and demandfor funds in the Euromarkets.


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Example

Suppose a bank in London receives a deposit of $1000 from a firm.The bank maintains reserves of 3% against all eurodeposits i.e. $30is kept as reserves in the banks account with its correspondentbank in New York and $970 is loaned to a customer.

Possibilities may be: The borrower retains the loan proceeds as cash or deposits them

with a bank in US. There is no further expansion of eurodeposits. The borrower coverts the dollars into his home currency, say, euro

and deposits the euro in a german bank. The bank which sellshim the euro deposits the dollar received with a bank in US. Once

again no further expansion. Borrower deposit the dollars with another eurobank or convert

the dollars into another currency which ends up as anothereurodeposit. If this process continues, than assuming each bankin the process keeps 3% reserves. Hence total amount ofeurodeposits created will be 1000+1000 x 0.97 + 1000 x (0.97)2 +

1000 x (0.97)3 + .. = 1000 / (1 0.97) = 33333.33


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Multiple Deposit Creation Model

When the Fed supplies the banking system with a ($1) ofadditional reserves deposits increase by a multiple of thisamount.

This is called "Multiple deposit creation".

Deposit Creation: a single bank:Assume that open market purchase of a ($100) was

conducted with bank (A). The bank reserves increased by($100). How bank (A) will use the ($100) now? The ($100)can be seen as an additional reserves to bank (A); butassume that bank (A) does not want to hold any excessreserves (since no interest is paid on reserves):


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Deposit Creation:

The Banking SystemBank A Bank A

Assets Liabilities Assets Liabilities

Reserves +$100 Checkabledeposits

+$100 Reserves +$10 Checkabledeposits

+$100

Loans +$90

Bank B Bank B

Assets Liabilities Assets Liabilities

Reserves +$90 Checkabledeposits

+$90 Reserves +$9 Checkabledeposits

+$90

Loans +$81


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The Formula for Multiple Deposit Creation

Assuming banks do not hold excess reservesRequired Reserves ( ) = Total Reserves ( )

= Required Reserve Ratio ( ) times the total amount

of checkable deposits ( )

Substituting

=

Dividing both s

RR R

RR r

D

r D R

ides by

1=

Taking the change in both sides yields

1=

r

D Rr

D Rr


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Remember:

The single bank case: Can create deposits equal only tothe amount of its excess reserves: cannot by itself

generate multiple deposit expansion because when thebank loses its excess reserves, the reserves may leavethe bank to another.

Single bank cannot make loans greater than its excess

reserves. The banking system:

Can generate multiple deposit expansion because whenthe bank loses its excess reserves, the reserves

do not leave the banking system (move from one bankto another).

This process continues until the initial increase inreserves results in multiple increases in deposits.


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ECONOMIC CONCERN OF

EUROMARKET

The emergence and vigorous growth of Euromarkets

and their ability to create multiple deposit expansionwithout any apparent control mechanism have givenrise to a number of concerns regarding their impact oninternational liquidity, on the ability of national

monitory authorities to conduct an effective monitorypolicy and on the soundness of the internationalfinancial system.


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The market facilitate short term speculative capitalflows creating enormous difficulties for central banks

in their intervention operations designed to stabiliseexchange rate.

National monetary authorities lose effective controlover monetary policy since domestic residents can

frustrate their efforts by borrowing and lending abroaddue to fixed or managed exchange rates.

The absence of a lender of last resort a small crisis caneasily turn into a major disaster.

In the absence of a central coordinating and regulatoryauthority such as central bank they might create tomuch liquidity contributing to inflationary tendenciesin the world economy.


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REFERENCESApte P.G., The McGraw-Hill Companies, 5th Edition,

International financial management.

www.flatworldknowledge.com

en.wikipedia.org/wiki/Money_creation


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THANKYOU

multiple deposit creation by euro banks

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