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Unit 4: Eurocurrency Markets

Notes

Notes Eurocurrency deposits generally tend to yield more than domestic deposits because
of large transactions and the absence of controls and their attendant costs.

4.1.1 Significance

The Eurocurrency market plays a key role in the capital investment decisions of many firms
since it is a funding source for corporate borrowing. In addition, since this market also rivals
domestic financial markets as a deposit alternative, it absorbs large amounts of savings from
lenders (i.e., depositors) in many countries. In fact, the Eurocurrency market complements the
domestic financial markets, giving greater access to borrowing and lending to financial market
participants in each country where it is permitted to function. Overall, the Eurocurrency market
is now the world’s single most important market for international financial intermediation.
The Eurocurrency market is totally a creation of the regulations placed by national governments
on bankings. If the governments of various countries allowed banks to function without the
stipulation of reserve requirements, capital controls, interest rate restrictions and tax, the
Eurocurrency market would involve only the transnational deposits and loans made in each
country’s banking system. Instead, the governments, in order to achieve the various benefits of
monetary policy, heavily regulate the financial markets. Thus, in order to overcome many of
the limitations placed on domestic financial markets, the Eurocurrency market provides a very
important outlet for flow of funds. And since most of the governments have found the impact of
the Eurocurrency market on their firms and banks to be favourable, they have allowed these
markets to operate.
Thus, Eurocurrency markets serve two valuable purposes: (1) Eurocurrency market is a major
source of short-term bank loans to help meet the corporate’s working capital requirements
including the financing of imports and exports; (2) Eurocurrency deposits are an efficient and
convenient money market device for holding excess corporate liquidity.
For a Eurocurrency market to exist three conditions must be met. First, national governments
must allow foreign currency deposits to be made; second the country whose currency is being
used must allow foreign entities to own and exchange deposits in that currency; third, there
must be a significant reason, such as low cost or ease of use that motivates individuals to use this
market and not the domestic one. The phenomenal growth of the Eurocurrency market testifies
that it has met these conditions for the past three decades now.

Many countries allow foreign currency deposits to be held in their banking systems. While
some countries impose restrictions like interest rate limits, capital controls, etc., on both the
foreign currency deposit as well as on local currency deposit, other countries, specially most of
the developed countries, do not impose restrictions on the foreign currency deposits. These
countries generally tend to be the Euromarket centres as participants find them more acceptable
due to favourable interest rates, greater availability of funds and easy access for moving funds
internationally.

The currencies which have become popular as Eurocurrencies and tend to be widely used include
the US dollar, the British pound, the French franc, the German mark and a few others. The
governments of countries whose currencies are being widely used have generally consented to
allow foreign banks, companies and individuals to hold and use deposits denominated in those
currencies.

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