What are Euro Feds
Euro feds are interbank wire transmissions that take place between U.S. banks and banks in foreign countries.
BREAKING DOWN Euro Feds
Euro Feds involve eurodollar transactions between a bank in the United States and a bank in another country. Eurodollars refer to deposits of U.S. dollars held at banks chartered in countries other than the United States. Such transfers make up part of the interbank lending system, which involves short-term loans of funds made among banks worldwide to ensure institutions maintain appropriate reserves against customer withdrawals.
Two clearinghouse systems settle Euro Feds: The Clearinghouse Interbank Payments System (CHIPS) and Fedwire. Together these two services settle the majority of large transactions between U.S. banks and their domestic or foreign counterparts. Banks choose between the two based upon speed and cost, since CHIPS transactions happen more slowly than Fedwire transactions. CHIPS maintains a lower minimum amount for fund transfers than Fedwire does, however, and charges banks less for the service. The U.S. Federal Reserve Bank owns and operates Fedwire, which offers banks real-time gross settlements.
Banks keep reserves of cash on hand to pay for withdrawals and to distribute in loans. The amount of money on hand at a given bank on a given day depends upon the mix of deposits and withdrawals alongside loan disbursements and receipt of loan payments. Banks finding themselves with more money than they need to hold in reserve can earn a small amount of interest by lending those funds to other banks which find themselves short on reserves. The size of the assets and the relative liquidity of depository institutions makes them relatively low-risk opportunities for lenders, who typically charge correspondingly low interest rates. Loan terms typically last only until the next business day, so the financial industry calls the interest rate used for interbank lending the overnight rate.
In many countries, central banks maintain a target for overnight rates because they form the basis for interest rates charged to businesses and consumers on short-term debt. Central banks do not necessarily need to set these rates however. In the United States, the Federal Reserve sets a target for overnight rates. The Fed manipulates these rates by buying or selling treasury bonds on the open market, affecting the amount liquidity available in the economy. In general, the lower the overall liquidity in the system, the higher overnight rates become due to supply and demand for excess funds throughout the banking system. Higher liquidity corresponds to lower overnight rates as banks have more money available to lend one another.
Since different central banks can target different overnight rates, it can make sense for banks to lend surplus cash to banks in foreign jurisdictions or to borrow from foreign jurisdictions, depending on the variances in overnight rates in their respective markets.