What Is Eurocurrency?
Eurocurrency is currency deposited by national governments or corporations, outside of its home market. Commonly it is currency held in banks located outside of the country which issues the currency.
It is important to note that the term eurocurrency applies to any currency and to banks in any country. Having "euro" doesn't mean that the transaction has to involve European countries. For example, South Korean won deposited at a bank in South Africa is considered eurocurrency. US dollars held in a UK bank would also be considered eurocurrency. And Euros held in an Asian bank would be considered eurocurrency, too. However, in practice, European countries are often involved.
- Eurocurrency is when an institution uses money from another country, but not in the originating country's home market.
- Despite the name, eurocurrency can involve any currency.
- Deals made in eurocurrency are usually brokered to take advantage of discrepancies in lending practices or currency exchange rates.
A History of Eurocurrency
In an essay on international finance for Princeton University Press, economist Ronald I McKinnon explained the rise of eurocurrency markets. In the late mid-70s, when he wrote the essay, it was largely not understood why eurocurrency markets came to be. He wrote, "the Eurocurrency market is unnecessary." This is because "to finance foreign trade for their customers, commercial banks could "easily obtain spot or forward foreign exchange in the interbank market that operates internationally, or draw on the balances of foreign currency held within correspondent banks."
This changed with the eurocurrency market. In the eurocurrency market, "banks resident in country A accept deposits and make loans in the currencies of countries B, C, D and so on, and depositors and borrowers are often non-residents."
This market arose due to the "peculiarly stringent and detailed official regulations governing residents operating with their own national currencies." According to McKinnon, "these regulations contrast sharply with the relatively great freedom of nonresidents to make deposits or borrow foreign currencies from these same constrained national banking systems."
Essentially, the market eases local regulations and gives access to foreign currencies to offshore business. It has made doing business in one currency, in a market that does not issue that currency, much easier.
A Real World Example of Eurocurrency
Bank A is based in Canada, whereas Bank B is based in the United States. Bank A is planning to make some rather large loans to a client of theirs and has determined that they would be able to make more money if they borrowed money from Bank B—in US dollars—and loaned it out to their client.
Bank B makes interest from the loan they offer to Bank A, whereas Bank A profits from the difference in the loan terms between their client and the loan terms offered from Bank B. Although in theory Bank A might do this at zero cost in order to satisfy their client, it is much more often the case that they use eurocurrency as a way to take advantage of an interest-rate discrepancy.