Eurocredit

What Is Eurocredit?

Eurocredit refers to a loan whose denominated currency is not the lending bank's national currency. The concept is closely linked to that of eurocurrency, which is any currency held or traded outside its country of issue. For example, a eurodollar is a dollar deposit held or traded outside the U.S., and conversely, a eurocredit loan made by a U.S. bank would be one that is not denominated in USD.

The "euro-" prefix in the term arose because originally such currencies were held, and loans made, in Europe, but that is no longer solely the case and a eurocurrency can now be held or a eurocredit loan made anywhere in the world that local banking regulations permit.

How Eurocredit Works

The eurocurrency market is a major source of finance for international trade because of ease of convertibility and the absence of domestic restrictions on trading. The banks involved in the eurocredit and eurocurrency markets are the same, but the loans involved in the eurocredit market are typically larger and longer term than those of the eurocurrency market.

As the global financial system has deregulated and integrated over the past few decades, with many countries first dismantling capital controls and then opening up participation to foreign banks in their banking sectors, the eurocredit market has been able to expand significantly.

Eurocredit helps the flow of capital between countries and the financing of investments at home and abroad. A major function of banks is matching surplus units (who deposit at the bank) with deficit units (who borrow from the bank). Being able to do this internationally, both across borders and across currencies improves both liquidity and efficiency in the markets for financing.

Banks may also engage in syndicated loans in the eurocredit market, where a loan is made by a group (syndicate) of banks. Syndicated loans reduce the risk of borrower default for each individual bank loaning funds and are often found where the size of the loan is too big for one bank to do by itself. Often, the banks in a syndicate will be headquartered in different countries but lending in one currency—an example of how the eurocredit market can work to improve the flow of funds internationally.

A Eurobond is a debt instrument denominated in a currency other than the home currency of the country or market in which it is issued.

A Brief History of the Eurodollar

The term eurodollar is the most common form of eurocredit. It refers to U.S. dollar-denominated deposits at foreign banks or at the overseas branches of American banks. Because they are held outside the United States, eurodollars are not subject to regulation by the Federal Reserve Board, including reserve requirements. Dollar-denominated deposits not subject to U.S. banking regulations were originally held almost exclusively in Europe—hence, the name eurodollar. They are also widely held in branches located in the Bahamas and the Cayman Islands.

The eurodollar market dates back to the period after World War II. Much of Europe was devastated by the war, and the United States provided funds via the Marshall Plan to rebuild the continent. This led to the wide circulation of dollars overseas, and the development of a separate, less regulated market for the deposit of those funds. Unlike domestic U.S. deposits, the funds are not subject to the Federal Reserve Bank's reserve requirements. They are also not covered by FDIC insurance. This results in higher interest rates for eurodollars.

Many American banks have offshore branches, usually in the Caribbean, through which they accept eurodollar deposits. European banks are also active in the market. The transactions for Caribbean branches of U.S. banks are generally executed by traders physically situated in U.S. dealing rooms, and the money is on loan to fund domestic and international operations.