The Demand for Eurodollars and the Optimum Stock of Bank Liabilities

Abstract

From 1966 to 1970, borrowings of Eurodollars by major U. S. banks rose from about $2 billion to over $15 billion, as measured by their liabilities to foreign branches. This market is but one of the most recent examples of a market primarily developed by banks to issue their own financial claims at a market determined interest rate for the purpose of gaining control over the size of their total liabilities.l In this respect, the Eurodollar market is similar in function to markets for Federal funds, commercial paper as sold through holding companies, and, when market interest rates are below the Regulation Q ceilings, to certificates of deposit (CDs). Traditional banking models such as those developed by Edgeworth [3], Orr and Mellon [9], and Morrison [8] do not allow one to derive a proper demand function for a financial claim such as Eurodollars or to draw out its implications for bank behavior because they, in the customary Phillips-Rodgers tradition, take a bank's stock of total liabilities as exogenous, leaving only the decision about an optimal asset portfolio under its control, especially in the short run. However, given the well developed markets that now exist for Eurodollars, Federal funds, commercial paper, and CDs, the size of an individual bank's total liabilities is more properly considered as a decision variable with a corresponding desired size, rather than as a magnitude largely outside its control. The purpose of the paper is to extend in a simple but precise fashion the microeconomic theory of banking under the assumption that a bank has control over the