It is often stated that eurodollar borrowing is clost substitute for Fed funds borrowing. In other words, when US banks cannot fund themselves domestically, they might go to the eurodollar market and borrow some money to satisfy thier reserve requirment. Although it seems intuitive that in eurodollar borrowing you are borrowing from banks in other countries, I believe it implicitly involve a loss of reserve in a US bank. This is because since foreign banks cannot hold reserve at Fed and the borrower wish to borrow reserve, the only way this can happen is for the foreign bank to demand its US correspondant (the US bank where it deposits its dollar) to transfer the amount of reserve to the borrower. So implicity, a US bank is losing its reserve. Am I correct?

  • $\begingroup$ One of the ways that FF and ED deposits are close substitutes is that neither is subject to reserve requirements. They are thus very good liabilities for the purpose of funding the bank's assets and better than regular customer deposits, which would be subject to reserve requirement. $\endgroup$ – Alex C Dec 15 '15 at 1:24

I think you are right that ultimately all dollar movements are reflected in reserve accounts at the Federal Reserve.

May I make a couple of additional points: Eurodollar borrowing is really not a close substitute for Fed Funds. First of all, not much volume goes through the term eurodollar markets, so it doesn't have the capacity to replace Fed Funds borrowing. In a dire situation where a bank cannot obtain overnight loans in the Fed Funds market, I would think there's no chance it could borrow in the eurodollar market.

I would add that right now all this is moot, because we are in a situation of massive excess reserves due to Quantitative Easing.

  • $\begingroup$ Hello @dm63 , I agree with what you said. Since the reserve funds are all coming from the US banks, if they are not lending in the fed funds market, they are surely not lending through eurodollar market. But lots of articles seem to state that these two are close substitutes. Do you know why? $\endgroup$ – Kun Dec 15 '15 at 18:43
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    $\begingroup$ i think it's because the rate for eurodollar borrowing is usually very similar to the Fed funds rate - for example, 3month libor is usually 20bp or so higher than Fed funds. $\endgroup$ – dm63 Dec 15 '15 at 23:21

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