What Is the Eurocurrency Market?
The eurocurrency market is the money market for currency outside of the country where it is legal tender. The eurocurrency market is utilized by banks, multinational corporations, mutual funds, and hedge funds. They wish to circumvent regulatory requirements, tax laws, and interest rate caps often present in domestic banking, particularly in the United States.
The term eurocurrency is a generalization of eurodollar and should not be confused with the EU currency, the euro. The eurocurrency market functions in many financial centers around the world, not just Europe.
- The eurocurrency market is the money market for currency outside of the country where it is legal tender.
- The term eurocurrency is a generalization of eurodollar and should not be confused with the EU currency, the euro.
- There is also a eurobond market for countries, companies, and financial institutions to borrow in currencies outside of their domestic market.
- Eurocurrency markets can offer better rates for both borrowers and lenders, but they also have higher risks.
Understanding the Eurocurrency Market
The eurocurrency market originated in the aftermath of World War II when the Marshall Plan to rebuild Europe sent a flood of dollars overseas. The market developed first in London, as banks needed a market for dollar deposits outside the United States. Dollars held outside the United States are called eurodollars, even if they are held in markets outside Europe, such as Singapore or the Cayman Islands.
There is not necessarily any connection between eurocurrency markets and Europe today, although these markets did begin in Europe.
The eurocurrency market has expanded to include other currencies, such as the Japanese yen and the British pound, whenever they trade outside of their home markets. However, the eurodollar market remains the largest.
Interest rates paid on deposits in the eurocurrency market are typically higher than in the domestic market. That is because the depositor is not protected by the same national banking laws and does not have governmental deposit insurance. Rates on eurocurrency loans are typically lower than those in the domestic market for essentially the same reasons. Eurocurrency bank accounts are also not subject to the same reserve requirements as domestic accounts.
Types of Eurocurrency Markets
Eurodollars were the first eurocurrency, and they still have the most influence. It is worth noting that U.S. banks can have overseas operations dealing in eurodollars. These subsidiaries are often registered in the Caribbean. However, the majority of actual trading takes place in the United States.
The eurodollar trades mostly overnight, although deposits and loans out to 12 months are possible. Transactions are usually for a minimum of $25 million and can top $1 billion in a single deposit.
The offshore euroyen market was established in the 1980s and expanded with Japan's economic influence. As interest rates declined in Japan during the 1990s, the higher rates paid by euroyen accounts became more attractive.
There is an active bond market for countries, companies, and financial institutions to borrow in currencies outside of their domestic markets. The first such eurobond was issued by the Italian company Autostrade in 1963. It borrowed $15 million for 15 years in a deal arranged in London and listed on the Luxembourg stock exchange. Issuing eurobonds remained popular in Italy, and the Italian government sold US$7 billion in eurobonds in October 2019. It is essential to avoid confusing eurobonds with euro bonds, which are simply bonds denominated in euros issued by countries or firms in the eurozone.
Advantages and Disadvantages of Eurocurrency Markets
The main benefit of eurocurrency markets is that they are more competitive. They can simultaneously offer lower interest rates for borrowers and higher interest rates for lenders. That is mostly because eurocurrency markets are less regulated. On the downside, eurocurrency markets face higher risks, particularly during a run on the banks.