The money market in which Eurocurrency, currency held in banks outside of the country where it is legal tender, is borrowed and lent by banks in Europe. The Eurocurrency market is utilized by large firms and extremely wealthy individuals who wish to circumvent regulatory requirements, tax laws and interest rate caps that are often present in domestic banking, particularly in the United States.
Rates on deposits in the Eurocurrency market are typically higher than in the domestic market, because the depositor is not protected by domestic banking laws and does not have governmental deposit insurance. Rates on loans in the Eurocurrency market are typically lower than those in the domestic market, because banks are not subject to reserve requirements on Eurocurrency and do not have to pay deposit insurance premiums. A.Eurocurrency market
Definition and background
The Eurocurrency market consists of banks (called Eurobanks) that accept deposits and make loans in foreign currencies. A Eurocurrency is a freely convertible currency deposited in a bank located in a country which is not the native country of the currency. The deposit can be placed in a foreign bank or in the foreign branch of a domestic US bank. [Note of caution! The prefix Euro has little or nothing to do with the newly emerging currency in Europe.]
In the Eurocurrency market, investors hold short-term claims on commercial banks which intermediate to transform these deposits into long-term claims on final borrowers.
The Eurocurrency market is dominated by US $ or the Eurodollar. Occasionally, during weak dollar periods (latter part of 1970s and 1980s), the EuroSwiss franc and the EuroDM markets increased in importance. The Eurodollar market originated post WWII in France and England thanks to the fear of Soviet Bloc countries that dollar deposits held in the US may be attached by US citizens with claims against communist governments!
Thriving on government regulation
By using Euromarkets, banks and financiers are able to circumvent / avoid certain regulatory costs and restrictions. Some examples are:
b)Requirement to pay FDIC fees
c)Rules or regulations that restrict competition among banks
Continuing government regulations and taxes provide opportunities to engage in Eurocurrency transactions. However, ongoing erosion of domestic regulations have rendered the cost and return differentials much less significant than before. As a result, the domestic money market and Eurocurrency markets are closely integrated for most major currencies, effectively creating a single worldwide money market for each participating currency.
German firm sells medical equipment to institutional buyer in the US. It receives a US$ check drawn on Citicorp, NY. Initially this check is deposited in a checking account for dollar working capital use. But to earn a higher return (or rate of interest) on the $ 1 million the German firm decides to place the funds in a time deposit with a bank in London, UK.
One million Eurodollars have thus been created by substituting a dollar account in a London bank for the dollar account held in NY. Notice that no US $ left NY but ownership of the US deposit has moved from a foreign corporation to a foreign bank. The London bank would not like to leave the funds idle in NY account. If a government or commercial borrower is unavailable, the London bank will place the $ 1 million in the London interbank market. The interest rate at which such interbank loans are made is called the London interbank offer rate (LIBOR).
This example demonstrates that the Eurocurrency market is a chain of deposits and a chain of borrowers and lenders. The majority of Eurocurrency transactions involve transferring control of deposits from one Eurobank to another Eurobank. Loans to non-Eurobank borrowers...