Compensating balances and foreigners' dollar deposits in United States banks

Over the past 15 years, foreigners have been holding increasing quantities of dollars in United States banks. Since returns on Eurodollars consistently have been higher than returns in the United States, and since foreign exchange risk to foreigners is the same in both dollar markets, the quantities are not likely to represent portfolio choices. Some holdings probably are related to dollar transactions needs, but the data indicate that growth in trade is not adequate to explain the growing quantities held. This paper investigates empirically compensating balance requirements as a motive for foreigners holding dollars in the United States and finds these requirements to be important determinants of quantities held.