IDENTIFYING A RESERVE BASE FOR THE EURO-DOLLAR SYSTEM.

The general absence of legal reserve requirements upon the reserves of non-U.S. banks offering dollar-denominated deposit facilities (hereafter Eurobanks) provides a unique opportunity for analysis of reserve determination by a fractional-reserve financial intermediary. This paper presents evidence that the reserve ratio in the Euro-dollar system is low and falling and is in fact determined by behavior which is consistent with the hypothesis that Euro-bank dollar deposits in U.S. commercial banks (excluding loans to home offices) are held as precautionary reserves. The demand for such loans to home offices largely determines their level. Since the theory of precautionary balances held by commercial banks is consistent only with the profit maximization principle of commercial banks' asset management, where commercial banks' responses to market forces determines portfolio behavior, we shall be concerned here primarily with the determination of Euro-banks demand deposit claims on U.S. commercial banks, exclusive of loans to home offices. Evidence reported below does in fact suggest that the behavior of liabilities to foreign branches of U.S. banks is not consistent with the profit maximization principle. [ABSTRACT FROM AUTHOR]