Euro-dollars in commercial bank liability management

Abstract

In response to the recurrent tight credit conditions of the new 1960's, the managers of money market banks developed new techniques and instruments to attract funds. This development in commercial banking, which represents a departure from the traditional role of a bank as simply a depository of funds, has led to a concept of banking referred to as liability management. In that context, it examines the demand of United States commercial banks for Euro-dollar borrowings. The analysis is presented in terms of a single stage optimal inventory policy model in which the bank's objective is to maximize profits with uncertainty. The model extends previous work on Euro-dollar borrowing by integrating into the analysis and alternative endogenous source of reserves, Federal funds. The dissertation begins with an historical overview of the development of liability management by commercial banks. The mathematical aspects of Federal funds and Euro-dollar transactions are explained so that their emergence as tools of bank reserve management can be explained in light of concurrent money market conditions. Previous applications of inventory policy models to bank reserve management are reviewed. A theoretical model formally characterizes the decision of a bank to borrow Euro-dollars. From this model, an optimal ordering rule is derived which explicitly takes into account conditions in the Federal funds market. The variables that affect the quantity of Euro-dollars borrowed are the Euro-dollar rate, the Federal funds rate, the rate of return on assets, and the quantity of deposits held by the borrowing bank..