Eurocurrency is

currency A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins. A more general def ...

held on deposit outside its home market, i.e., held in banks located outside of the country which issues the currency. For example, a deposit of

US dollars The United States dollar (Currency symbol, symbol: Dollar sign, $; ISO 4217, code: USD; also abbreviated US$ or U.S. Dollar, to distinguish it from Dollar, other dollar-denominated currencies; referred to as the dollar, U.S. dollar, American ...

held in a bank in

London London is the capital and largest city of England and the United Kingdom, with a population of just under 9 million. It stands on the River Thames in south-east England at the head of a estuary down to the North Sea, and has been a majo ...

, would be considered eurocurrency, as the US dollar is deposited outside of its home market. The ''Euro-'' prefix does not refer exclusively to the "

euro The euro ( symbol: €; code: EUR) is the official currency of 19 out of the member states of the European Union (EU). This group of states is known as the eurozone or, officially, the euro area, and includes about 340 million citizens . ...

" currency or the "

eurozone The euro area, commonly called eurozone (EZ), is a currency union of 19 member states of the European Union (EU) that have adopted the euro (€) as their primary currency and sole legal tender, and have thus fully implemented EMU policies ...

", as the term predates the creation of the euro. Instead, it can be applied to any combination of deposits in a foreign bank outside of its home market e.g. a deposit denominated in

Japanese yen The is the official currency of Japan. It is the third-most traded currency in the foreign exchange market, after the United States dollar (US$) and the euro. It is also widely used as a third reserve currency after the US dollar and the ...

held in a

Swiss Swiss may refer to: * the adjectival form of Switzerland * Swiss people Places * Swiss, Missouri * Swiss, North Carolina *Swiss, West Virginia * Swiss, Wisconsin Other uses *Swiss-system tournament, in various games and sports *Swiss Internation ...

bank is a Euroyen deposit. Eurocurrency is used for short-to-medium term financing by banks,

multinational corporation A multinational company (MNC), also referred to as a multinational enterprise (MNE), a transnational enterprise (TNE), a transnational corporation (TNC), an international corporation or a stateless corporation with subtle but contrasting senses, i ...

mutual fund A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICAV i ...

s, and

hedge fund A hedge fund is a pooled investment fund that trades in relatively liquid assets and is able to make extensive use of more complex trading, portfolio-construction, and risk management techniques in an attempt to improve performance, such as sho ...

s. Eurocurrency is generally seen as an attractive source of global funding due to its ease of convertibility between currencies as well as typically lower regulatory measures compared to sources of funding in domestic markets. Eurocurrency and Eurobond markets avoid domestic

interest rate An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, th ...

regulations, reserve requirements and other barriers to the free flow of capital. The relevance of eurocurrency deposits has been disputed ever since its inception in the 1950s by notable economists including

Ronald McKinnon Ronald McKinnon (born September 20, 1973) is a former American football linebacker in the National Football League. He was originally signed as an undrafted free agent by the Arizona Cardinals out of the University of North Alabama where he won ...

, yet it remains a prevalent aspect of the global financial system.

History

Background Information

The emergence of Eurocurrency is closely tied to the origins of the

Eurodollar Eurodollars are U.S. dollars held in time deposit accounts in banks outside the United States, which thus are not subject to the legal jurisdiction of the U.S. Federal Reserve. Consequently, such deposits are subject to much less regulation than ...

as it was the first type of Eurocurrency. Eurodollars began from large quantities of US dollar-denominated deposits being held in European, namely London, banks during the 1950s. Over several decades, economists have produced several explanations of how eurocurrency came about, why it occurred in London , and how London managed to maintain a

competitive advantage In business, a competitive advantage is an attribute that allows an organization to outperform its competitors. A competitive advantage may include access to natural resources, such as high-grade ores or a low-cost power source, highly skilled ...

in the market as eurocurrency expanded globally. Environmental and political factors commonly underpin most theories, influencing the decisions of nations during this period known as the Bretton Woods Era. The Bretton Woods Era spanned from 1944 to 1973 and saw national policymakers, notably those of Britain and the US, agree to a fixed or pegged exchange rate system. Under this system, national currencies were "pegged" against the US dollar which itself was now convertible into

gold Gold is a chemical element with the symbol Au (from la, aurum) and atomic number 79. This makes it one of the higher atomic number elements that occur naturally. It is a bright, slightly orange-yellow, dense, soft, malleable, and ductile met ...

. This was done to promote freer world trade in response to a sharp decline in imports and exports after the 1930s financial crises and World War 2 (WW2). As a result, national governments had raised their

barriers to trade Trade barriers are government-induced restrictions on international trade. According to the theory of comparative advantage, trade barriers are detrimental to the world economy and decrease overall economic efficiency. Most trade barriers work ...

in an attempt to boost their domestic performance, causing major declines in world trade.

Drivers of Eurocurrency in the 1950s

By mid-1955, US and foreign businesses and nations were regularly using Eurodollars to hold US-dollar balances or obtain US-dollar denominated loans outside of the US. The eurocurrency market was birthed organically from the rise of the Eurodollar. Ultimately, there was multiple causes for the rise of the Eurodollar which lead to the creation of Eurocurrency. Firstly, large holdings of US dollars entered Europe shortly after WW2. This was a result of the fixed exchange rate system that lead to more countries using US dollars for trade, as well as increased imports into the US itself from Europe. Moreover, the US provided

economic aid In international relations, aid (also known as international aid, overseas aid, foreign aid, economic aid or foreign assistance) is – from the perspective of governments – a voluntary transfer of resources from one country to another. Ai ...

to European nations after WW2 in the form of damage assistance under the US governments'

Marshall Plan The Marshall Plan (officially the European Recovery Program, ERP) was an American initiative enacted in 1948 to provide foreign aid to Western Europe. The United States transferred over $13 billion (equivalent of about $ in ) in economic re ...

. Secondly, after WW2

communist Communism (from Latin la, communis, lit=common, universal, label=none) is a far-left sociopolitical, philosophical, and economic ideology and current within the socialist movement whose goal is the establishment of a communist society, a s ...

governments including the

Soviet Union The Soviet Union,. officially the Union of Soviet Socialist Republics. (USSR),. was a transcontinental country that spanned much of Eurasia from 1922 to 1991. A flagship communist state, it was nominally a federal union of fifteen national ...

and

China China, officially the People's Republic of China (PRC), is a country in East Asia. It is the world's most populous country, with a population exceeding 1.4 billion, slightly ahead of India. China spans the equivalent of five time zones and ...

transferred their holdings held in the US over to European banks. This is believed to have been done for two primary reasons; (1) over fears that US authorities will seize their assets, and (2) to accumulated goodwill with Eurobanks as a strategy to nurture a future source of loans and funding. Thirdly, the 1957 sterling crises forced the UK's strongest movement toward alignment with the Bretton Woods plan. Here, the

Bank of England The Bank of England is the central bank of the United Kingdom and the model on which most modern central banks have been based. Established in 1694 to act as the English Government's banker, and still one of the bankers for the Government of ...

banned sterling-financed trade for non-sterling countries as a result of a sharp increase in the

bank rate Bank rate, also known as discount rate in American English, is the rate of interest which a central bank charges on its loans and advances to a commercial bank. The bank rate is known by a number of different terms depending on the country, and ...

to 7%, compelling London-based banks to join the rest of the world and use dollars for trade. This alongside the demand for other types of eurocurrencies outside of their home markets lead to the innovation of the eurocurrency market.

Competitive Advantage of London

The inception of eurocurrency occurred in London with the introduction of the Eurodollar in 1955. Even after eurocurrency had expanded globally however, London maintained its position as the centre of the Eurodollar market which is still true of today. Economists provide disputed explanations for why London was able to gain and maintain this competitive advantage. Ronald McKinnon theorised that it was attributed to London's pre-existing foreign financing expertise retained from Britain's dominant trade history in the 19th Century and servings as the centre of the sterling when it was a major international currency. However, criticisms of this theory deemed it "rather static and deterministic" and lacking any archival evidence. McKinnon also emphasised the regulatory freedom provided to

commercial bank A commercial bank is a financial institution which accepts deposits from the public and gives loans for the purposes of consumption and investment to make profit. It can also refer to a bank, or a division of a large bank, which deals with cor ...

s in London by the Bank of England, aligning with recounts of the

Treasury A treasury is either *A government department related to finance and taxation, a finance ministry. *A place or location where treasure, such as currency or precious items are kept. These can be state or royal property, church treasure or in p ...

questioning whether financial institutions in London had excessive influence on decisions made by the Bank of England. Nonetheless, both the Treasury and Bank of England agreed that London should remain an important financial centre even after the sterling was no longer a major international currency. Therefore, imposing restrictive regulations would have been counterintuitive, leading to London's permissive environment. In reality, eurocurrency market centres in general enjoyed freedom from supply side restrictions such as reserve requirements and

interest rate ceiling An interest rate ceiling (also known as an interest rate cap) is a regulatory measure that prevents banks or other financial institutions from charging more than a certain level of interest. Interest rate caps and their impact on financial inclusi ...

s which allowed them, in particular London, to gain a competitive advantage by providing high and low rates of interest according to the class of the borrower and

lender A creditor or lender is a party (e.g., person, organization, company, or government) that has a claim on the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property ...

. Additionally, London's competitive advantage was enhanced by tight restrictions throughout the rest of Europe due to possible risks of " hot money", increased bank liquidity, and potential reliance on reserves in the case of

bank run A bank run or run on the bank occurs when many clients withdraw their money from a bank, because they believe the bank may cease to function in the near future. In other words, it is when, in a fractional-reserve banking system (where banks no ...

Currencies

The four main Eurocurrencies are the

US dollar The United States dollar (symbol: $; code: USD; also abbreviated US$ or U.S. Dollar, to distinguish it from other dollar-denominated currencies; referred to as the dollar, U.S. dollar, American dollar, or colloquially buck) is the official ...

, the

Euro The euro ( symbol: €; code: EUR) is the official currency of 19 out of the member states of the European Union (EU). This group of states is known as the eurozone or, officially, the euro area, and includes about 340 million citizens . ...

, the sterling and the

; the currencies of the major economies of the world.

Eurocurrency Markets

A eurocurrency market is the money market for any currency deposited outside of its home market. The key participants in these markets includes banks, multinational corporations, mutual funds, and hedge funds. Eurocurrency markets are generally chosen as a source of finance over domestic banks for their ability to offer lower interest rates of borrowers and higher interest rates for lenders situationally. This because eurocurrency market have less regulatory requirements,

tax law Tax law or revenue law is an area of legal study in which public or sanctioned authorities, such as federal, state and municipal governments (as in the case of the US) use a body of rules and procedures (laws) to assess and collect taxes in a ...

s, and typically no interest caps. Nonetheless, there are higher risks, particularly when banks experience periods of poor

solvency Solvency, in finance or business, is the degree to which the current assets of an individual or entity exceed the current liabilities of that individual or entity. Solvency can also be described as the ability of a corporation to meet its long-ter ...

which can lead to a

run on the banks A bank run or run on the bank occurs when many clients withdraw their money from a bank, because they believe Bank failure, the bank may cease to function in the near future. In other words, it is when, in a fractional-reserve banking system (w ...

. There are several eurocurrency markets, with the two most widely used being the Eurodollar market and the Euroyen market. There are also various smaller eurocurrency markets including the Euroeuro market and the Europound market.

Eurodollar Market

The Eurodollar market involves holdings of US dollars outside of the

jurisdiction Jurisdiction (from Latin 'law' + 'declaration') is the legal term for the legal authority granted to a legal entity to enact justice. In federations like the United States, areas of jurisdiction apply to local, state, and federal levels. Jur ...

of the US Central Bank. These holdings may arise via two primary ways. Firstly, from purchases of goods and services made in US dollars to suppliers who maintain European bank accounts - these suppliers may be European or non-European. Secondly, Eurodollar deposits arise from investments of US dollars in European banks, generally for more favourable returns on interest. Today, the Eurodollar market is the largest source of global funding for businesses and nations, estimated to be financing over 90% of

international trade International trade is the exchange of capital, goods, and services across international borders or territories because there is a need or want of goods or services. (see: World economy) In most countries, such trade represents a significant ...

deals. It is the most widely used eurocurrency. Accounting for approximately 75% of all eurocurrency accounts held worldwide. This prevalence is often attributed to economic and political factors. Firstly, the economic power of the US, particularly its influential position in the world economy and steady deterioration of the other currencies during the inception of Eurocurrency in the 1950s. Secondly, the lack of interest caps and limited regulation in the Eurodollar market enables favourable rates of interest for both lenders and borrowers.

Euroyen Market

The Euroyen market involves deposits of yen in banks outside the jurisdiction of the Japanese Central Bank. The market emerged in 1984, at the beginning of the Japanese asset price bubble that saw Japan pursue financial liberalisation and internalisation. During the 1990s, interest rates in Japan experienced substantial declines, making the relatively high rates of interest paid by Euroyen accounts attractive investments. Today Euruyen deposits are used by non-Japanese companies to efficiently obtain investments from Japanese investors. Euroyen bonds allow foreign companies to avoid the regulations enforced by the Bank of Japan (BoJ) and in bond registration with the Tokyo Stock Exchange (TSE).

Euroeuro Market

The Euroeuro market involves deposits of euros outside of the jurisdiction of the

European Central Bank The European Central Bank (ECB) is the prime component of the monetary Eurosystem and the European System of Central Banks (ESCB) as well as one of seven institutions of the European Union. It is one of the world's Big Four (banking)#Intern ...

Europound Market

The Europound market involves sterling deposits outside of the jurisdiction of the

Eurocurrency Network

The concept of eurocurrency can have two implications. Firstly, it can be the accumulation of all the currencies and banking facilities worldwide that are participating of the offshore banking network. This is not limited to the four eurocurrencies (US dollar, euro, yen, sterling) or the home markets of those eurocurrencies. For example, a bank in

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that chooses to keep holdings of

Swiss franc The Swiss franc is the currency and legal tender of Switzerland and Liechtenstein. It is also legal tender in the Italian exclave of Campione d'Italia which is surrounded by Swiss territory. The Swiss National Bank (SNB) issues banknotes and the f ...

in London would also be considered a part of the eurocurrency network. Secondly, it can refer to the sum of all the technologies i.e.

data processing Data processing is the collection and manipulation of digital data to produce meaningful information. Data processing is a form of ''information processing'', which is the modification (processing) of information in any manner detectable by an ...

and communication lines, used to enable stakeholders around the world to interact and participate in the eurocurrency market. Eurocurrency marks function within the global financial system with market centres spread across the global. Therefore, powerful financial technologies and information systems are required to connect market centres to enable communications and transactions to occur. For example, technologies such as high-speed communication lines link market centres enabling fast eurobanking transactions, and also giving rise to the

overnight market The overnight market is the component of the money market involving the shortest term loan. The overnight market is primarily used by banks and other financial institutions. Lenders agree to lend borrowers funds only "overnight" i.e. the borrowe ...

Regulations and Domestic Policy

Regulatory History

In the 1970s, regulating the eurocurrency market became a key priority for policymakers globally. This was because the growth of Eurodollars forced domestic banks to participate in offshore banking in order to stay competitive against rapidly growing foreign banks. Offshore banking allowed domestic banks to avoid the rising costs and restrictions resulting from national banking regulations. National governments struggled to monitor

money supply In macroeconomics, the money supply (or money stock) refers to the total volume of currency held by the public at a particular point in time. There are several ways to define "money", but standard measures usually include Circulation (curren ...

and accurately predict economic outcomes in the global financial system due to unregulated and regulated financial markets existing in parallel. Since this realisation, governments have attempted various regulatory measures such as imposing reserve requirements, ceilings on interest rates and extending supervisory authority into the unregulated eurocurrency market. Overall, critics today maintain that regulation in offshore banking as a whole remains largely insufficient.

Usage of Reserve Requirements

Reserve requirements refer to a particular predetermined amount of

cash In economics, cash is money in the physical form of currency, such as banknotes and coins. In bookkeeping and financial accounting, cash is current assets comprising currency or currency equivalents that can be accessed immediately or near-imm ...

which banks must have on-hand for the purpose of meeting liabilities in the case of sudden withdrawals. In the case of eurocurrency, this is a crucial regulatory measure with the high risk of bank runs. Typically, the central banks of individual nations enforce reserve requirements for its commercial banks. For example, the US central bank - The Federal Reserve, requires commercial banks to retain money in reserves against their commitments to depositors under the Monetary Control Act 1980. However, little progress has been made in imposing reserve requirements on eurocurrency deposits as nations continually fail to reach consensus over eurocurrency reserve amounts. Thus, it is the extension of national reserve requirements to the eurocurrency markets that has some level of mitigation between eurocurrency deposits and domestic bank balances.

Eurocurrency and Interest Rates

A key attraction for eurocurrency deposits are favourable interest rates for both lenders and borrowers relative to domestic interest rates. However, studies including the Granger causality test show that the “ stickiness” of eurocurrency interest rates only exists with respect to the Eurodollar market. Interest rates for other eurocurrencies often move in parallel with corresponding domestic interest rates, seen as a control used by national governments to limit international capital flows.

Eurobanks

A eurobank is a financial institution anywhere in the world which accepts deposits or makes loans in any foreign currency.

Eurocredits

Eurocredit is a loan whose denominated currency is not the lending bank's national currency. A eurocredit loan would be made by a U.S. bank to a lender requiring a denominated currency which differs from the bank's local currency (USD) for specific reasons, most likely some sort of business operations or trade requirements. Despite the inclusion of the word "euro," a eurocredit is not immediately derived from the euro. Eurocredits are short-to-medium-term loans of Eurocurrency extended by Eurobanks to corporations, sovereign governments, nonprime banks, or international organizations. The loans are denominated in currencies other than the home currency of the Eurobank. Because these loans are frequently too large for a single bank to handle, Eurobanks will band together to form a bank lending syndicate to share the risk. The credit risk on these loans is greater than on loans to other banks in the interbank market. Thus, the interest rate on Eurocredits must compensate the bank, or banking syndicate, for the added credit risk. On Eurocredits originating in London the base lending rate is

LIBOR The London Inter-Bank Offered Rate is an interest-rate average calculated from estimates submitted by the leading banks in London. Each bank estimates what it would be charged were it to borrow from other banks. The resulting average rate is u ...

. The lending rate on these credits is stated as LIBOR +X percent, where X is the lending margin charged depending upon the creditworthiness of the borrower. Additionally, rollover pricing was created on Eurocredits so that Eurobanks do not end up paying more on Eurocurrency time deposits than they earn from the loans. Thus, a Eurocredit may be viewed as a series of short-term loans, where at the end of each time period (generally three or six months), the loan is rolled over and the base lending rate is repriced to current LIBOR over the next time interval of the loan.