Eurocurrency is currency 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 held in a bank in London, would be considered eurocurrency, as the US dollar is deposited outside of its home market.
The Euro- prefix does not refer to the Euro currency or the Eurozone, as the term predates the creation of the euro. Instead, it can be applied to any currency held in a foreign bank outside of its home market e.g. Japanese yen held in a Swiss bank is a Euroyen deposit. (Euros held outside the European Union would be "Euroeuro"). The prefix "Euro" comes from "Eurobank", the telex address of Banque Commerciale pour l'Europe du Nord – Eurobank (BCEN), a Soviet-Union controlled bank which pioneered eurodollar accounts in the 1950s.
Eurocurrency is used for short-to-medium term financing by banks, multinational corporations, mutual funds, and hedge funds. 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 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, yet it remains a prevalent aspect of the global financial system.
History
Background Information
The emergence of Eurocurrency began with the Eurodollar. US dollar-denominated deposits began to be 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 the market as eurocurrency expanded globally.
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.
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. 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. 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 laws, and typically no interest caps. Nonetheless, there are higher risks, particularly when banks experience periods of poor solvency which can lead to a run on the banks.
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 or Eurosterling market.
Eurodollar Market
The Eurodollar market involves holdings of US dollars outside of the jurisdiction of the Federal Reserve System, 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 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. 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 Euroyen 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).
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. 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.
Usage of Reserve Requirements
Reserve requirements refer to a particular predetermined amount of cash 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. 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.