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Introduction

  • The euro currency market is the money market for currency outside of the country where it is legal tender. The euro currency market is utilized by banks, multinational corporations, mutual funds, and hedge funds. The euro currency market functions in many financial centers around the world, not just Europe.
  • Euro currency refers to commercial bank deposits outside the country of their issue. For example, a deposit denominated in U.S. dollars in a British commercial bank (or even in a British branch of a U.S. bank) is called a Eurodollar. Similarly, a pound sterling deposit in a French commercial bank or in a French branch of a British bank is a Euro sterling, a deposit in Euros (the new European currency) in a Swiss bank is simply a Euro deposit (to avoid the awkward “Euro euro”), and so on.
  • These balances are usually borrowed or loaned by major international banks, international corporations, and governments when they need to acquire or invest additional funds. The market in which this borrowing and lending takes place is called the Euro currency market.
  • Initially, only the dollar was used in this fashion, and the market was therefore called the Eurodollar market. Subsequently, the other leading currencies (the German mark, the Japanese yen, the British pound sterling, the French franc, and the Swiss franc) began also to be used in this way, and so the market is now called the Euro currency market.
  • The practice of keeping bank deposits denominated in a currency other than that of the nation in which the deposit is held has also spread to such non-European international monetary centers as Tokyo, Hong Kong, Singapore, and Kuwait, as well as to the Bahamas and the Cayman Islands in the Caribbean, and is appropriately called offshore deposits.
  • Often, however, the name Euro deposits is also used for such deposits outside Europe. With these geographical extensions, the Euro currency market has become an essentially 24-hour-a-day operation.
  • Indeed, any foreign deposit made in a nation’s bank (even if in the nation’s currency) is Euro currency if the deposit is exempted from the regulations that the nation imposes on domestic deposits.

Growth of Euro-Currency Market

During 1960’s and 1970’s, the Euro­currency markets experienced a very rapid growth. It was on account of the following factors:

  1. Advantage of London Market: Although New York money market was larger from the viewpoint of volume of transactions, the London money market enjoyed the location advantage on account of greater proximity to some prominent customers.
  2. Flow of Economic and Military Aid: During 1950’s and 1960’s, the U.S. economic and military assistance continued to flow on a large scale to the West European countries. This resulted in large transfers of dollars to the banks in the European countries.
  3. Decline in the Importance of Pound Sterling: In the post-war decades, Britain became a debtor country. The dominant position that sterling had enjoyed in the world financial markets before the Second World War had been assumed by the U.S. dollar. The British Exchange Control Act enacted in the early post-war period continued to restrain the grant of sterling to central banks outside the sterling area. As a result, the position of dollar got reinforced in the European financial centers.
  4. Regulation Q: An important factor responsible for the rapid expansion of Euro-dollar market in 1960’s was the Regulation Q of the U.S. Federal Reserve System. Under this regulation, a ceiling was imposed on the interest rate payable on time deposits with the U.S. banks. The banks had been restrained from paying any interest at all on the deposits upto 30 days. This resulted in the U.S. banks opening their branches in Europe. Consequent upon it, there was a large scale flow of dollars from the United States to the European countries in the late 1960’s.

The main features of the Euro-currency or EURODOLLAR market

  1. Wholesale Market: The Euro-currency market is essentially a wholesale market. The transactions include, on the one hand, large banks extensive international operations and, on the other hand, governments, large government agencies or private corporations. The average size of transactions, lending or borrowing, is quite large. On account of the extensive scale of operations, the overhead expenses of Euro-banks are quite low.
  2. Inter-Bank Transactions: An outstanding feature of the Euro-currency market is that the inter-­bank transactions constitute the largest proportion of its transactions. In this context, it may be pointed out that Euro-banks are against other banks. As the inter-bank transactions are generally concerned with a short period, the lending and borrowing operations of Euro-banks are essentially short term in nature.
  3. Highly Competitive Market: The Euro-currency market is a highly competitive market. The new banking institutions have almost unrestricted entry. As a result of greater extent of competition, the margin between interest rates on deposits has sometimes made the Euro-banks to take greater risk in the matters of choice of borrowers, security of loan and the maturity of loan. In the recent years, however, the Euro-banks have become more cautious about the element of risk.
  4. Distinct from Domestic Money Market: Although in many respects the Euro-currency market is similar to the domestic money market, yet it is distinct from the latter in a significant respect. The Euro-banks have no central monetary authority and they are free from central monetary and exchange restrictions.
  5. Greater Extent of Risk: The transactions in the Euro-currency market involve a greater degree of risk than that existing in the case of domestic banking. Apart from the normal risk associated with a given transaction in a given currency, there is additional risk on account of possibility of imposition of new banking regulations or exchange controls by the government of the country in which the transactions are affected.
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