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Prior to 1980 Eurocurrency markets are the only international financial market of any significance. They are offshore markets where financial institutions conduct transactions which are denominated in currencies of countries other than the country in which the institutions currencies of countries other than the country in which the institutions are located. The Eurocurrency market is outside the legal preview of the country in whose currency the finance are raised in the market. Eurocurrencies are bank deposits denominated in currencies other than the currency of the country in which the bank is located. The bank deposits and loans are denominated in Eurocurrencies, particularly dollars. Eurodollars are dollar denominated time deposits held by financial intuitions located outside the US., including such deposits by branches of U.S.,including such deposits held by branches of U.S.,banks. Thus a dollar with a bank in London or Paris is a Eurodollar deposit. Similarly, a Deutsche mark deposit with a bank in London is Euro mark deposit, even a deposit made by a U.S., firm with a Paris subsidiary of a U.S. bank is still a Eurodollar deposit. Similarly a Eurodollar loan made by bank or branch of a bank outside U.S.A. is a Eurodollar market and the deposit are termed as Eurodollar deposits and the loans are called Eurodollar loans. The terms euro’ is affixed to denote offshore currency transactions. Origin and growth of Eurodollar market The Eurodollar market originated in the 1950s. Soviet Union and Eastern European countries, which earned dollars by gold exports and other means, wanted to keep their dollars as deposits with European banks. They avoided the banks in U.S.A. out of the fear that U.S. Government may block deposit in the U.S. banks. Subsequent growth of the market may be attributed to the emergence of dollar as the principal international currency after the World War II. Since 1965 there has been a phenomenal growth of this market. The fast growth of the Eurodollar market during 1965-1980 periods may be attributed to four major factors. 1. Large balance of payments deficits of U.S.A particularly during 1960s resulted in the accumulation of dollars by foreign financial institution and individuals. 2. The Various regulations, which prevailed in the U.S. during 1963-74, encouraged capital outflows. The interest equalization tax of 1963 was lifted and the Eurobond market started flourishing. Side by side there was a revival of the market for foreign bonds in the U.S. regulation Q regulated the interest rates that U.S. banks can pay on time deposits and regulation M required U.S. banks to keep a stipulated percentage of cash reserves against deposits, These restrictions encouraged U.S. banks and multinational corporations to keep dollar deposits and borrow dollars abroad. Thus the main factors behind the emergence and growth of Eurodollar market were the regulations imposed on borrower and lenders by the U.S. authorities that motivated both banks and corporation to evolve Eurodollar deposit and loans. The European and U.S. banks take deposits out of USA. To place them in free centers in Europe. They for short-term lending or for investment used these deposits with outside banks.
sterling. highly competitive and well connected by network of brokers and dealers Eurocurrency Market Characteristics The Eurocurrency market has several interesting characteristics: 1. there are also certificates of deposit (CDs) available in dollars. euro commercial paper. central banks. International banks and foreign branches of domestic banks. The efficiency with which it works and the lower cost has also contributed to the growth of Eurodollar market. The CDs are usually quoted at a discount at a fixed . which means that the transactions take place between banks. The Eurocurrency market is primarily a Eurodollar market (see Fig.. European market as well as Euro sterling.3. It is a wholesale rather than retail market. Public borrowers such as governments. dollar but deposited in bank outside the United States. Although CjDs_^re_availaJ2le_irij^ most are traded in multiples of $1 million or more. medium to long-term floating rate loans. absence of restrictions on lending rates. the market is of wholesale nature. institutions that create Eurodollar deposits do not draw down those deposits into a particular national currency in order to buy goods and services. The Eurocurrency market thus permits the separations of the currency of denomination from the country of jurisdiction Eurocurrency market that started in London found its way in other European cities and in Singapore. In fact. nearly four fifths of the Eurodollar market is interbank.S. Thus these markets are not subject to national controls. The Massive balance of payment surpluses realized by OPEC countries due to sharp increase in oil prices (1973 and 1978) gave rise to what are called “petrodollars”. Large amounts of funds can be raised in this market due to lower interest rated and absence of credit restrictions that market much domestic market. the Cayman Island and Bahamas.2). Most of the deposits are interbank. The market is essentially unregulated. These markets consist of beside Eurodollar market. Also. 2.S. 4. The Eurocurrency market exists for savings and time deposits rather than demand deposits.. Over the years these markets have evolved instruments other than time deposits and short-time loans. and so forth are simply deposits are denominated. In addition to ordinary deposits in the Eurocurrency market. and they tend to be very short term. Deposits are primarily short term. Eurobonds etc. private banks and merchant’s banks are the main dealers on the market. In sum Eurodollar market is the market for bank time deposits denominated in U. These countries preferred to deposit such dollar with financial institutions outside the US. Similarly European. The Eurocurrency loans are generally cheaper due to small lending margins as a result of exemption from statutory cash reserve requirements. since most Eurocurrency loans are for longer periods of time. Asian dollar market Rio dollar Market.. most of the U. Hongkong. 9. That is. The commercial banks in each of these markets accept interest-bearing deposits denominated in a foreign currency and they lend their funds either in the same country or in a foreign country in whose currency the deposit is denominated. and yen. 5. Tokyo. This leads to concern about risk. euro sterling. Those instruments are certificates of deposits. The Eurocurrency market is the market for such bank deposits. _ 4. which means that transactions tend to be very large. 3. banks deal in this market. Euroswiss francs euro French Franc euro-D marks markets etc. economies of scales etc. and public-sector corporations tend to borrow most of the funds.
The demand for Eurocurrencies comes from individuals. loans are made at a certain percentage above the London Inter-Bank Offered Rate (LIBOR). The rate one earns on deposits in the Eurocurrency is usually less than the LIBID. The unique characteristics of the Eurocurrency market allow the borrowing rate usually to be less than it would be in the domestic market. Taiwan. the maturities can extend into the future. Eurocurrencies exist partly for the convenience and security of the user and partly because of the cheaper lending rates for the borrower and better yield for the lender. Eurocurrency deposits tend to yield more than domestic deposits. the Caribbean (the Bahamas and the Cayman Islands). depends on the credit-worthiness of the customer and must be large enough to cover expenses and build reserves against possible losses. in which several banks pool resources to extend credit to a borrower. given that nearly 20 percent of all Eurocurrency transactions in 1989 took place in London. However. which constitute a fairly consistent 6580 percent of the market. Traditionally. The interest rate above LIBOR. Figure 9. Short-term Eurocurrency borrowing has a maturity of less than one year.. which is characterized in Fig.interest rate. and governments that require funds for operating capital.S. EuroGerman marks (Euro-Deutsche marks). and French francs. or other forfns of medium. and the rate-fixing period is generally six months. (2) multinational corporations with cash in excess of current needs. such as British pounds. and the payment of principal and interest on debt. The LIBID is the bid rate that corresponds to the LIBOR. firms. and Canada. However. investment. The security issue arose because some governments feared currency controls in the United ‘ States and decided that they wanted to. A Eurocurrency is any currency that is banked outside of its country of origin. Because of the large transactions and the lack of controls and their attendant costs. A major attraction of the Eurocurrency market is the difference in interest rates as compared with domestic markets. and the difference between the LIBOR and the LIBID is usually about one eighth of a per-centage point. which is the interest rate banks charge one another on loans of Eurocurrencies.and long-term credits.3 illustrates these differences in interest rates. London is the key center for the Eurocurrency market. but dollars held at branches of U. 9. (3) European banks with foreign currency in excess of current needs.5 The major sources of Eurodollars are: (1) foreign governments or individuals who want to hold dollars outside of the United States. .S. Because of the variable nature of the interest rates. Anything over one year is considered a Eurocredit.3 as the Eurocurrency borrowing rate. Dollars held by foreigners on deposit in the United States are not Eurodollars. Luxembourg is the center for EuroDeutsche mark deposits. in-cluding syndication. dollars offshore.and medium-term characteristics. although it could also be one or three months. EUROCURRENCIES The Eurocurrency market is an important source of debt available to the MNE. The Eurocurrency market has short. and (4) the reserves of countries such as Japan. Similar markets exist for Euro-Japanese yen (Euro-Yen). lines of credit. These Eurocredits may be loans. and loans tend to be relatively cheaper than in domestic markets. and other currencies. Large transactions take place in Asia (Hong Kong and Singapore). and Germany that have large balance-of-trade surpluses. but it is often more than can be earned in the domestic market. Most loans are made on variable-rate terms. but they can also be quoted at floating interest rates.hold their U. The Eurocurrency market is worldwide. it is also possible to borrow at maturities exceeding one year. Eurodollars. are dollars banked outside of the United States. as well as in London and other European centers. with Brussels and Paris the centers for Euro-Sterling deposits. Swiss francs. or other banks outside of the United States are Eurodollars.
banks are subject to solvency rules. the bank may use that asset as a basis for making a dollar-denominated loan to someone else. Several factors were behind their birth. As the dollar rises in value.6 Figure 9. so they had a strong incentive to develop business in foreign currencies. banks in the United States were required to hold non-interest-bearing . deposited in another bank.561 trillion by March 1988. Regulation Q put a ceiling on the interest rates that banks operating in the United States could offer to domestic depositors were naturally attracted to Eurobanks that were not bound by Regulation Q. The centrally planned economies were reluctant to hold bank deposits in the United States. By the end of 1958 the main industrial countries had restored full convertibility of their currencies. By 1988 the dollar portion had slipped to less than 70 percent. (3). Gross liabilities usually are just over twice the net size of the market. so they put their dollar earnings on deposit in London. Gradually other European dollar holders did the same. the market in currency trading outside their respective domestic economy. Even though there are no specific Eurocurrency controls. although the importance of the dollar has diminished in recent years. the dollar portion of Eurocurrencies will also rise. In some cases. Once a Eurocurrency (assume dollar) deposit is made in a London bank. Since there are no reserve requirements on Eurocurrency deposits. and Eurocurrency assets and liabilities are a part of the overall assets and liabilities of the bank that are subject to capital ratios and capital provisions. especially as the dollar has fallen in value. (1). the market grew to $4. The growth of the Eurocurrency market was also stimulated by certain monetary regulations in the United States. or used as a basis for another loan. The expansion occurs when the initial loan is spent.2 illustrates that the dollar portion of the Eurocurrency market has remained over 70 percent for most of the past decade. a Central Bank can issue more of its own currency to ease a liquidity crisis. The Origin of The Eurocurrency Market The origin of the Eurocurrency market-that is. Balance of payments pressures made the United Kingdom government limit British banks' external use of sterling. For instance. such as in Britain with the Bank of England. liquidity is monitored very closely. The fraction of the original deposit not loaned out is called the fractional reserve. (2). it is up to the individual bank to determine how much protection it requires in the form of reserves. Market Size The size of the market is difficult to determine and depends on whether the gross or net size is being discussed (the net size eliminates transfers between banks).Eurocurrency Expansion The key to Eurocurrency expansion is the fractional reserve concept. shOWs. The new freedom produced a surge of international banking business. however. As Fig Q . but it would be hampered by a liquidity crisis caused by another currency.1 trillion by September 1989. In addition. In 1971 the total gross Eurocurrency market size was about $150 billion. The totai sjze Qf tne Eurocurrency market is much greater than the actual cash deposited. It was estimated that the market reached $6. a tendency that was particularly marked when the United States ran large balance of payments deficits.
and establishment of international banking facilities (IBFs) in the United States designed to bring the locus of American banking business back "onshore". the Middle East. At the end of the 1960s and during the early 1970s the Eurocurrency markets. Offshore centers have been set up in the Caribbean area.S. total international lending is now the most meaningful lending aggregate. Latin America.S. and it encompasses Eurocurrency market activity. U. With the recent strong growth of domestic currency lending abroad. General controls on the movement of capital also helped to boost the Eurocurrency markets. The number of branches increased from 181 to 699 over the same period. of the Voluntary Foreign Credit Restraint Program (VFCR) in the United States. Between 1964 and 1973 the number of U.reserves. with foreign currency funds deposited by one foreign source and then onlent to another. These were typically small territories that had tax. By diverting dollar deposits to their offshore branches or subsidiaries. banks with overseas branches increased from 11 to 125. their foreign brancheswhich were not subject to the VFCR. .S. One example was the introduction. expanded to a number of other "offshore" banking centers. banks. Instead. The specific goal of the VFCR was to limit the growth of foreign lending by U. which had been located in Western Europe (and centered in London). in 1965. and banking laws favorable to international banks.took deposits and onlent them outside the ceiling. exchange control. banks were able to avoid tying up so much of their funds in reserve requirements at a zero rate. The business was entrepot in nature.
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