by 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 exclusively to the “euro” currency or the “eurozone”, as the term predates the creation of the euro. Instead, it can be applied to any combination of deposits in a foreign bank outside of its home market e.g. a deposit denominated in Japanese yen held in a Swiss bank is a Euroyen deposit.
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 over since its inception in the 1950s by notable economists including Ronald McKinnon, yet it remains a prevalent aspect of the global financial system.
Uses of Eurocurrency
Eurocurrency is commonly used by corporations and financial institutions, such as mutual funds and hedge funds, in order to receive financing. It is often seen as an advantageous source of capital and a beneficial way to receive international funding because of its ability to switch to other foreign currencies.
It is also an attractive choice as a financial instrument because local interest rates can be avoided due to relaxed restrictions in comparison to local banking regulations. Therefore, many individuals and businesses use foreign currencies as a way to protect themselves against risks in foreign exchange and international trade.
Eurocurrency Markets
A eurocurrency market is the money market for any currency deposited outside of its home market. 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 market.
Eurodollar Market
The Eurodollar market involves holdings of US dollars outside of the jurisdiction of 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.
Euroyen Market
The Euroyen market involves deposits of yen in banks outside the jurisdiction of the Japanese Central Bank. 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 Euruyen 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).
Euroeuro Market
The Euroeuro market involves deposits of euros outside of the jurisdiction of the European Central Bank.
Europound Market
The Europound market involves deposits of British pounds outside of the jurisdiction of the Bank of England.
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. This is not limited to the four eurocurrencies (US dollar, Euro, Yen, British Pound) or the home markets of those eurocurrencies. For example, a bank in Denmark that chooses to keep holdings of Swiss franc in London would also be considered a part of the eurocurrency network.
Secondly, it can refer to the sum of all the technologies i.e. data processing and communication lines, used to enable stakeholders around the world to interact and participate in the eurocurrency market. 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. For example, technologies such as high-speed communication lines link market centres enabling fast eurobanking transactions, and also giving rise to the overnight market.
Origin of Euro Currency Market
The Eurodollar is considered to be the initial origin of Eurocurrency. The Eurodollar was initially a term that refers to how USD was deposited in banks in Europe, especially London. European banks held a lot of USD after World War II, as the United States provided financial aid to Europe.
The fixed exchange rate system at that time also created an opportunity for more countries to invest in USD. Eventually, the Eurodollar transitioned to become Eurocurrency due to globalization. More individuals around the world began to deposit local currency at a foreign bank outside of Europe.
Although it is used all around the world, London remains the center of the Eurocurrency market at present. It’s been able to maintain a competitive advantage in the market because of the freedom in regulations in the commercial banking sector.
Therefore, banks in London are able to provide interest rates that pertain to the class of the borrower and lender, increasing the use of Eurocurrencies in London, while the rest of Europe adhere to tighter banking restrictions.
