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Eurocurrency banking - Coggle Diagram
Definition
Consist of banks called Eurobanks that accept deposits and make loans in foreign countries.
A dollar or convertible currency deposited in bank in foreign country.
Formula
Interest rate : i(t) = r(t) + lending margin
r(t) = reference rate, lending margin = profit margin
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Eurobond's Disadvantages
Foreign Exchange risk:
The fluctuations in exchange rates could impact the bond's value and returns as the Eurobonds issued in a currency different from the issuer's domestic currency.
Probability of bank failure:
Poor risk management practices and excessive risk-taking can elevate the likelihood of bank failure. It float with the great currency rate. It could expose to different risk such as credit risk, interest rate, market risk and more.
An unregulated system could result in the loss of deposits:
The effectiveness of regulatory oversight and supervision plays a significant role in mitigating the probability of bank failure.
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Risk
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Interest Rate Risk
- Mismatch of the maturity date between assets and liabilities
- Deposits are short term and lendings are long-term.
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Features
:pencil2: Unregulated institutions:
Eurocurrency banks operate outside the jurisdiction of a specific country's regulatory framework, which could provide flexibility and expose to risk at the same time.
:pencil2: Not subject to interest rate ceilings:
Eurocurrency banks have more freedom to set interest rates based on market conditions.
Advantage of low-tax location:
Eurocurrency banks often choose to establish operations in countries with favorable tax regimes, allowing them to minimize their tax liabilities and potentially increase profits.
Subject to greater risk than domestic banks:
Eurocurrency banks face higher levels of risk, including credit risk, market risk, and regulatory risk, which could impact their stability and profitability.
:pencil2: Less subject to pressure from government:
Eurocurrency banks operate independently, reducing the direct influence or pressure from government agencies. However, they may still be affected by international regulations and geopolitical factors
Remedies
Political Stability:
Political stability reduces uncertainty and risk for investors and encourages the smooth flow of capital across borders.
Favourable Business Environment:
A favourable environmental to international finance includes factors such as favorable tax policies and financial privacy regulations. These elements attract investment and facilitate the efficient operation of financial markets.
Strong Telecommunication Links:
Good telecommunication infrastructure between financial centres enable efficient transactions and information exchange and enhance the functioning o international finance.
Problems
Reduce stabilization from domestic goverment. Corporations that are restricted to borrowing domestically will turn to borrowing from the Eurocurrency market, restrict the efforts of the Central Bank to fight inflationary pressure.
Exposure to EX and IR risk. Frequent and large flows of liquid funds from one Eurocurrency centre to another can cause instability in the forex rates and interest rates.
The unregulated nature of Eurocurrency centers can lead to instability and systematic risk. A bank panic may cause ripple effects, impacting other banks and lead to broader financial instability.