The Weekend Eurodollar Game

A growing number of large U.S. banks have used artificial Eurodollar transactions in connection with the heavier weighting of Fridays in the calculation of required reserves to significantly reduce the impact on them of that requirement. This reserve avoidance behavior bestows an unintended and inequitable benefit on those banks engaging in it, unnecessarily increases risks from credit exposures and potentially distorts money stock measures. The incentive for this activity and hence its practice can best be removed by paying interest on required reserves or weighting Fridays equally with all other business days in the reserve requirement calculations. CURRENTLY FEDERAL RESERVE MEMBER banks must meet reserve requirements with noninterest-bearing assets-vault cash and deposits at the Federal Reserve. This requirement constitutes a tax on certain categories of member bank liabilities, and has led to ingenious efforts by banks to attract lendable funds in nontaxable (i.e. nonreservable) ways. Unfortunately, the contribution of the reserve requirement instrument to monetary control has been somewhat compromised by these avoidance activities and by the reluctance of the Federal Reserve to tighten the instrument's application for fear of losing members.' This paper examines the largest known example of a class of transactions undertaken solely in order to artificially reduce required reserves. The reserve saving achieved by these transactions is artificial in the sense that required reserves are lowered without any reduction in the size or scale of a bank's operations or of its "true" deposit base. Until 6 October 1979, these reserve avoidance transactions typically consisted of weekend purchases of Eurodollars from U.S. branches and agencies of foreign banks by the foreign branches of the participating member banks and are commonly referred to as "weekend arbitrage." However, these transactions are not arbitrage in the usual sense at all and are, therefore, here dubbed the Weekend Game. * This paper originally was written while on leave to the Board of Governors of the Federal Reserve. I am more than usually indebted to Allen B. Frankel and Thomas D. Simpson for the many hours of discussion which helped shape and form the analysis in this paper. I also benefited from discussions with Darwin Beck, Sterie Beza, David Lindsey, and Perry Quick. Microbank data were provided by the Board of Governors of the Federal Reserve and research assistance by Jim Brackett, Mary McLaughlin, and Jack Walton. The views expressed here are those of the author and are not necessarily shared by either the Board or the International Monetary Fund where he is a Senior