A recent post from Liberty Street Economics discussed who is lending and borrowing in the federal funds market. This post examines activity in two other markets for short-term bank debt that are well recognized as substitutes for federal funds: the Eurodollar and “select deposit” markets.
Eurodollar and some deposit markets
Eurodollars are unsecured US dollar deposits booked at bank branches outside the United States. The core feature of Eurodollars is that banks can use them to meet their dollar funding needs. U.S.-based banks (U.S. depository institutions, or U.S. branches and agents of foreign banks) can accept Eurodollars, which typically mature next day, at their offshore branches and transfer the funds onshore. The selected deposits are unsecured US dollar deposits, which tend to mature overnight, similar to Eurodollars. However, unlike Eurodollars and similar to federal funds, selected deposits are recorded at a U.S. bank office.
Historically, Eurodollars and certain deposits have served a similar role to federal funds as a source of short-term, large-scale unsecured funding for banks, but there have been differences in the regulatory treatment of these dollar deposits. For example, federal funds have historically been exempt from reserve requirements. The Eurodollar was also exempted in 1990. Elected deposits were exempt only in 2020, when the Federal Reserve eliminated all reserve holding requirements for certain types of deposits and other bank liabilities, including elective deposits. Additionally, until the repeal of Regulation Q in 2011, banks were not allowed to pay interest on demand deposits, including certain deposits.
The Federal Reserve collects data on deposit transactions between Eurodollars and some U.S.-based banks. As shown in the chart below, since 2019, overnight trading volume for overnight Eurodollars and certain deposits has averaged $150 billion, compared to $800 billion for overnight federal funds. billion dollars. Over this period, the composition of Eurodollars and certain deposits has changed significantly. In 2019, Eurodollars and specified deposits each accounted for about half of overnight trading volume, but starting in 2022, specified deposits will account for 85% of total trading volume.
There are many potential reasons for this shift to selective deposits. For example, as discussed in this post, the introduction of resolution plans or living wills as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act allowed banks to simplify corporate structures, such as eliminating overseas branches. created an incentive to do so. Accepts Eurodollars. Second, prior to the removal of reserve requirements in 2020, the need to hold reserves against certain deposits, rather than Eurodollars, may have slowed the growth of certain deposits. The timing of this demonetization coincides with certain deposit volume increases in late 2020. That said, it is important to note this cost difference between specific deposits and the Fed, given the level of reserves in the US banking system since the Great Financial Crisis. The size of funds/Eurodollars had been shrinking before 2020 as required reserves became a smaller share of total reserves in the US banking system.
Migration from Eurodollars to selected deposits
Source: Federal Reserve Form FR 2420, Report of Selected Financial Market Rates. Author’s calculations.
Note: This chart shows the quarterly average Eurodollar, federal funds, and selected deposit volumes included in overnight bank funding rates from Q4 2015 to Q1 2024. The selected deposit series begins in 2019:Q2. Who is renting it?
The primary borrowers of Eurodollars and certain deposits are U.S. branches and agents of foreign banks (FBO branches). On average, FBO branches borrow between $50 billion and $200 billion a day, accounting for more than 90% of total daily transaction volume since 2016. As explained in a previous post, FBO branches are also major borrowers in the federal funds market. Market share ranges from 65 to 95 percent of total daily sales volume.
FBO branches are the main borrowers of Eurodollars and some deposits
Source: Federal Reserve Form FR 2420, Report of Selected Financial Market Rates. Author’s calculations.
Note: This graph shows quarterly average EURUSD and selected deposit volumes by borrower type included in overnight bank funding rates from Q4 2015 to Q1 2024. The vertical dashed line corresponds to the beginning of the selected deposit series (2019:Q2).
Although FBO branches conduct banking operations similar to domestic banks, with a few exceptions, deposits at FBO branches are not insured by the Federal Deposit Insurance Corporation (FDIC). This means that these FBO branches are unable to accept retail deposits, thus limiting their stable funding sources and relying on wholesale funds such as Eurodollars and certain deposits. Additionally, because they do not pay FDIC deposit insurance valuation fees, most FBO branches have lower real borrowing costs, giving them a comparative advantage over insured institutions when borrowing in the wholesale capital markets.
Who is lending it?
The primary lenders of Eurodollars and certain deposits are non-depository institutions primarily engaged in financial intermediary services such as brokerage, underwriting, credit origination, credit card, insurance and pension services. As the following chart shows, these institutions account for 80% of the lending volume in the overnight Eurodollar and some deposit markets.
Non-depository financial institutions are the primary lenders of Eurodollars and certain deposits
Source: Federal Reserve Form FR 2420, Report of Selected Financial Market Rates. Author’s calculations.
Note: This graph shows quarterly average EURUSD and selected deposit volumes by lender type included in overnight bank funding rates from Q4 2015 to Q1 2024. The vertical dashed line corresponds to the beginning of the selected deposit series (2019:Q2).
Lender type is an important characteristic that distinguishes Eurodollar and certain deposits from federal funds transactions. As we explained in a previous post, the Federal Home Loan Bank (FHLB), a government-backed corporation that supports mortgage lending and community investment, dominates lending in the federal funds market, accounting for about 10% of the total daily trading volume. It accounts for over 90%. Eurodollar and some deposit markets offer a wider range of lenders. However, borrowings from the FHLB receive favorable treatment in a bank’s liquidity coverage ratio (LCR) outflow calculation, meaning that (as explained in this article) federal funds receive more favorable treatment than Eurodollars or certain deposits. It can be fascinating. Consistent with the existence of this regulatory advantage, the graph below shows that banks typically pay higher interest rates on borrowings in the federal funds market compared to Eurodollars and certain deposits. Masu.
Higher interest rates on the federal funds market than on Eurodollars and certain deposits
Source: Federal Reserve Form FR 2420, Report of Selected Financial Market Rates. Author’s calculations.
Note: This chart shows the spread between the volume-weighted average interest rate and the Fed’s interest rate on reserve balances from Q4 2015 to Q1 2024. The vertical dashed line corresponds to the beginning of the selected deposit series (2019:Q2). In total
Changes in regulatory and economic conditions in the U.S. banking system since the Great Financial Crisis have narrowed the differences between Eurodollars, certain deposits, and federal funds, and in recent years certain deposits trading has outpaced the Eurodollar market. Due to low borrowing costs, FBO branches are the primary borrowers in all these markets. However, for Eurodollars and certain deposits, there are significantly more lenders. The regulatory advantages of federal funds continue to make them relatively more attractive, which is reflected in higher trading rates.
Gala Afonso is the Director of Banking Research in the Research and Statistics Group at the Federal Reserve Bank of New York.
Gonzalo Cisternas is a Financial Research Advisor for Nonbank Financial Institutions Research in the Research and Statistics Group at the Federal Reserve Bank of New York.
Will Riordan is a Capital Markets Transactions Advisor in the Markets Group of the Federal Reserve Bank of New York.
How to cite this post:
Gara Afonso, Gonzalo Cisternas, and Will Riordan, “Who Borrows and Lends in the Eurodollar and Selected Deposit Markets?” Federal Reserve Bank of New York Liberty Street Economics, May 13, 2024, https://libertystreeteconomics .newyorkfed.org /2024/05/Who Borrows and Lends in Eurodollar and Selected Deposit Markets/.
Disclaimer
The views expressed in this post are those of the author and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.
