The Eurocurrency Market Definition The Eurocurrency market is

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The Eurocurrency Market

The Eurocurrency Market

Definition • The Eurocurrency market is the market for deposits placed under a regulatory

Definition • The Eurocurrency market is the market for deposits placed under a regulatory regime different from that applied to deposits used to execute domestic transactions • A Eurobank is an intermediary in non-domestic financial markets which are commonly described as ‘external’ or ‘offshore’. • Eurocurrency markets are made by banks that accept time and other interest-earning deposits and make loans in currencies other than the currency of the country in which they are located (in a foreign currency).

Examples – Eurodollars are dollar deposits in commercial banks situated outside the USA. –

Examples – Eurodollars are dollar deposits in commercial banks situated outside the USA. – Euroeuros are euro deposits in commercial banks located outside the Euro area. • The prefix “euro” was given because the eurodollar system originated in Europe. • Since the Eurocurrency market has expanded to financial centers outside Europe (such as Bahamas, Panama, Caribbean, Singapore, Cayman Islands, Netherlands, Bahrain, Hong Kong) the term OFFSHORE is more appropriate to describe its location.

Origin of the eurodollar market • The practice of banks accepting deposits in a

Origin of the eurodollar market • The practice of banks accepting deposits in a currency other than the native currency was not new, and it had been a normal part of banking for hundred years (at least not in Europe). • After WWII Canadian, Swiss and UK banks commonly accepted US dollar deposits which they placed in US money-market instruments through their New York correspondent banks. • 1950’s – rather than return their US dollars to the US money market these banks elected to lend these funds within Europe to finance foreign trade and other economic projects. • A supply of funds to the Eurodollar market was always present. Europeans held balances in US $to execute transactions, to serve as a store of value, to hedge against the foreign currency risk.

Premises of Eurocurrency market development • 1957 (sterling crises) – The Bank of England

Premises of Eurocurrency market development • 1957 (sterling crises) – The Bank of England introduced tight controls on non-resident use of sterling. It restricted the use of sterling for financing foreign trade and foreign loans. The British merchant banks found as a solution to use the US$ which was nor regulated by Bank of England. • Some holders of dollars (notably the Russians) preferred to hold dollar deposits in banks outside of USA where they were thought to be safe from US control. Rather than risk confiscation, they made US $ deposits at London and Paris. • 1958 several major European currencies were made convertible – so allowing residents to hold dollars rather than having to turn them in to their central banks.

USA Onshore Banking Regulation helped Eurocurrency market development • Regulation Q – FED established

USA Onshore Banking Regulation helped Eurocurrency market development • Regulation Q – FED established ceilings on interest rate that bank could pay on deposits. – No interest was allowed on demand deposits. – 1957 -1964 – a ceiling of 1% was applied to time deposits of less 90 days. • 1963 IET (Interest Equalization Tax) – was adopted in response to the undesired buildup of dollars overseas. • 1965 -1968 Foreign Credit Restraint Program – set specific limits on the volume of bank lending that US banks could conduct with foreigners. Foreign subsidiaries of US multinational firms were included in the ‘foreigners’ category. • All the restrictions conducted the owners of US $ to search favorable opportunities to obtain favorable returns outside USA, in fact on the Eurocurrency markets.

Eurocurrency activity in USA • It hardly exist before 1981 because the regulations presented

Eurocurrency activity in USA • It hardly exist before 1981 because the regulations presented in the former slide which prohibited US resident banks from accepting nondollar deposits. • 1981 – in the attempt to win back business lost to foreign financial centers, the FED created the “International Banking Facilities” which allows bank operating under it to operate as eurobanks. • The US dollars at IBF’s are subject of lower regulatory burden than ordinary dollar deposits in US Banks. • IBF deposits are tantamount to Eurodeposits, but they are available only to nonresidents • IBF accounts may not be used to conduct transactions within the USA.

The process of Eurocurrency creation • The process is described as if the Euromarket

The process of Eurocurrency creation • The process is described as if the Euromarket were a closed banking system whereby funds are deposited, lent, redeposited, and re-lent. • Since the statutory reserve requirement on Eurocurrency deposits is zero, the initial concern was that the Eurodeposit creation process could go on indefinitely. Even though the statutory reserve requirement on Eurodeposits is zero, banks may keep a small amount of prudential reserves.

The concern was not well founded: • The euromarket is one segment of an

The concern was not well founded: • The euromarket is one segment of an international banking market. • The deposit creation process can be stopped abruptly if funds borrowed in the Euromarket are spent, invested, or deposited back in the US in the “onshore” banking system. • The vast majority of deposits are term deposits not demand deposits. So this rule out early withdrawals that might lead to a run of withdrawals on Eurobanks. • The Eurobanks tend to accept short-term deposits with interest rates determined by market conditions, and matching them against loans with interest rates indexed to a market rate that is reset periodically.