EUROCURRENCY OR OFFSHORE FINANCIAL MARKETS Lecture # 02

Eurocurrency  It refers to commercial bank deposits outside the country of their issue. For example, a deposit denominated in US Dollars in a British commercial bank or even in a British branch of a US bank is called a Euro Dollar.  Similarly a pound sterling deposit in a French commercial bank or in a French branch of a Swiss bank is simply a Euro deposit(to avoid the awkward Euro Euro)

.  These balances are usually borrowed or loaned by international banks, international corporation and govts when they need to acquire or invest additional funds.

Eurocurrency Market The market in which this borrowing and lending takes place is called Eurocurrency market. The Eurocurrency market consists mostly of short term funds with maturity of less than six months.

Reasons for the Development of the Eurocurrency Markets One reason was a higher interest rates often prevailing abroad on short term deposits. As a result short term dollar deposits were attracted to European banks and became Eurodollars. Another reason is that international corporations often found it very convenient to hold balances abroad for short periods in the currency in which they needed to make payment.

 Since the dollar is the most important international and vehicle currency in making and receiving international payment,it is only natural for a large proportion of the currency to be in Eurodollars.  Still another reason is that international corporations can overcome domestic credit restriction s by borrowing in the Eurocurrency markets.

 The Eurocurrency market originated form the desire of communist nations to keep their dollar deposits outside the United States for a fear that the might be frozen in a political crisis.  European banks are willing to accept deposits denominated in foreign currencies and are able to pay higher interest rates on these deposits than US banks because they can lend these deposits still at higher rates.

Operation and Effects of the Eurocurrency Market The existance,size, and rapid growth of the Eurocurrency market have created certain problems. One of the most serious problem is that the Eurocurrency market reduces the effectiveness of domestic stabilization efforts of national govts.For example, large firms that can not borrow domestically because of credit restrictions often can and do borrow in the Eurocurrency market,thus frustrating the govt efforts to restrict credit to fight domestic inflationary pressure.

 This is particularly true for smaller nations where the volume of domestic financial transaction is small in relation to Eurocurrency transaction.  Another problem is that frequent and large flows of liquid Eurocurrency funds form one international monetary center to another can produce great instability in foreign exchange rates and domestic interest rates.

 Another problem is that Eurocurrency markets are largely uncontrolled. As a result, a deep worldwide recession could render some of the system’s bank insolvent. Domestic banks panic were more or less eliminated by the creation of national central banks to regulate domestic banking through domestic insurance and by setting themselves as lender of last resort for domestic banks in liquidity squeeze.

 In the Eurocurrency market,however,any attempt on the part of any one nation to regulate it would simply result in the market shifting its activities elsewhere.

Eurobond and Euro note Markets  Eurobonds are long term debts securities that are sold outside the borrowers country to raise long term capital in a currency other than the currency of the nation where the bonds are sold.  For example, A US corporation selling bonds in London denominated in Euros or US dollars.  The leading bond markets are London, New York,Tokyo,Frankfurt

Foreign Bond Foreign bond refers simply to bonds sold in a foreign currency but denominated in the currency of the country in which the bonds are being sold. For example, a US corporation selling bonds in England denominated in Pounds starlings.

Euro notes These are medium term financial instruments falling somewhat between short term Eurocurrency bank loans and long term international bands. Corporations, banks and countries make use of international notes to borrow medium term funds in a currency other the currency of the nation in which the notes are sold.

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