OFF – SHORE FINANCIAL CENTRES (OFC’s):
The rise of the Petro – Dollars market shifted the focus of Euro-Currency operations away
from Europe. With the Globalization of the Euro-Currency market, it was now referred to as
the ‘Offshore-Currency market’ and the prefix ‘Euro’ was replaced by the prefix ‘Offshore’
to denote the particular brand of banking transactions which these markets represented.
OFC’S act as channels for global trade and facilitate international capital flows.
International joint ventures are often structured as companies in an offshore location when
neither party in the joint venture wishes to form the company in the other party’s home
jurisdiction for fear of unnecessary tax consequences. A fundamental characteristic of
OFC’s is that they are created out of deliberate intention by host governments whereas the
Euro-Currency market evolved out of specific type of banking transactions.
CHARACTERISTICS OF EURO-CURRENCY (OFFSHORE) MARKET:
1. Transactions in each currency take place outside the country of origin of that
2. Even though the transactions are recorded outside the country of issue, it continues
to be held in the country of issue. This is because a currency cannot be used for
settlement of commercial liability outside its domestic area. (The existence of the
foreign exchange market is based on this feature.)
3. Euro-Currency deposits and loans fall outside the regulatory and supervisory control
of the monitoring authority in the country of origin.
4. Euro-Currency market is distinct from the foreign exchange market. It is a market for
deposits and for loans between banks and between banks and their customers. It is a
market in which foreign currencies are lent and borrowed whereas in the foreign
exchange market, foreign currencies are bought and sold. This market therefore
converts short term deposit resources into short and medium term loans for financing
projects. While the Euro- Currency market operates on interest rates, the foreign
exchange market operates on exchange rates.
5. Due to absence of regulation, deposits in this market are unsecured. Due to this
deposits are received only on short term basis (max: one year) whereas loans are
demanded on medium to long term basis. This creates an asset-liability mismatch
which results in Euro-banks being exposed to both liquidity and interest rate risks.
6. To eliminate interest rate risk Euro-banks developed the credit roll-over concept
which involves resetting the interest rates on loans at fixed pre-decided intervals. To
achieve this loans/credits are provided on ‘floating rates of interest’. To ensure that
the Interest rates are reset on a fair and equitable basis the concept of reference
rates called LIBOR. (LIBOR – London Interbank Offered Rate) was developed.
7 Each Euro-Currency credit (loan) specifies the periodicity of the roll-over and the
LIBOR to which it is referenced. To provide a uniform profit margin for the lender a
‘MARKUP’ is specified over and above the LIBOR. The interest cost to the borrower
is therefore the applicable LIBOR + Mark-up. The mark-up normally remains constant
through the life-span of the loan.
8. Financial assets and liabilities in a currency by way of deposits, loans and
instruments can be traded only in the domestic market of that currency. Such
markets are called the ‘Domestic or Onshore’ markets. However in the case of freely
convertible currencies, it is possible to trade in assets and liabilities in such
currencies outside their home country. Such markets are called “Euro-Currency or
Offshore” markets. Consequently such markets deal only in freely convertible
currencies such as USD, GBP, EUR, JPY, CHF, CAD, AUD etc. The predominant
currency is USD.
9. It is essentially a wholesale market dealing only is standardised deposit amounts and
large volume Euro-credits involving substantial credit risk. Lending in this market is
therefore done on a ‘Consortium’ basis, i.e. a syndicate of banks collectively finance
a project on uniform terms and conditions thereby distributing the risk among the
10. The Euro-Currency market can be broadly divided into 4 components:
(i) Euro-Currency deposit market involving short term deposits.
(ii) Euro-Currency loan market (Euro-credits) involving syndicated loans.
(iii) Euro-Bond market in which Corporate entities issue debt instruments to raise
resources from investors through banks operating as underwriters.
(iv) Euro-Notes market in which international borrowers raise resources directly
from the investors without using banks as intermediaries or any underwriting