Introduction

Foreign-currency depositsthose denominated in a currency other than that of the host

countryhave risen spectacularly in recent years. As of December 1976, the Bank for
International Settlements estimated the stock of Eurocurrency deposits to be about $310
billionbigger than the domestic banking systems of major European countries and more
than nine times the size of Eurocurrency deposits outstanding back in 1968 The
Eurocurrency system is now the focal point of the international market for short-term capital
( deposits and loans of a year or less), and intermediate-term credits of three to seven years
are increasingly common. Why then was this incredible growth virtually unforeseen by
practical bankers or by academic observers? In principle, the Eurocurrency market is
unnecessary. The clearing of international payments, hedging forward against exchange risk,
and short- term credits for trade finance can all be provided by a system in which
commercial banks in each country accept deposit liabilities from foreigners and domestic
nationals that are denominated exclusively in the currency of that countryone in which
only Dutch banks accept guilder deposits and make guilder loans, only American banks
accept dollar deposits and make dollar loans, and so on. To finance foreign trade for their
customers, these commercial banks can easily obtain spot or for- ward foreign exchange in
the interbank market that operates internationally or draw on balances of foreign currency
held with correspondent banks abroad. Let us define traditional foreign-exchange banking
( TFEB ) to be this conceptually simple system of " - onshore" banking supported by foreign
correspondents. Traditional foreign-exchange banking arises naturally from the role of
domestic commercial banks as custodians of the national money supply and intracountry
payments mechanism. Historically, TFEB has dominated international finance, including the
twenty years of rapid growth in trade following the Second World War. For understanding
the causes of exchange-rate fluctuations at the present time or the invoicing and hedging
strategies of nonbank merchants and manufacturers engaged in foreign trade, the implicit
assumption of TFEB is sufficient. In a Eurocurrency market, by contrast, banks resident in
country A accept deposits and make loans in the currencies of countries B, C, D, and so on,
and depositors and borrowers are often nonresidents. Despite the semantic connotations, a
Eurocurrency system is not necessarily located in Europe. Major Eurocurrency markets
1

exist in Canada, Singapore, Japan, and the Caribbean, Because the U.S. dollar is usually the
principal currency traded abroad ( see Table 1), the expression "Eurodollar market" often
connotes trading in many convertible currencies. Here, however, the term "Eurodollar" is
used narrowly to refer only to deposits of U.S. dollars held outside the United States. The
term "Euroguilders" refers to deposits of guilders in banks not resident in the Netherlands:
"offshore" markets exist in many convertible currencies other than U.S. dollars. The rapid
emergence in the 1960s of a worldwide Eurocurrency market that coexists and competes
with TFEB resulted from the peculiarly stringent and detailed official regulations governing
residents operating with their own national currencies. These regulations contrast sharply
with the relatively great freedom of nonresidents to make deposits or borrow foreign
currencies from these same constrained national banking systems. On an international scale,
offshore unregulated financial markets compete with onshore regulated ones. Gurley and
Shaw's ( 1960 ) standard analysis of unregulated versus regulated financial intermediaries'
shows why it is not surprising that the former grow rapidly at the expense of the latter.

History
The Euromarket is conventionally assumed to have been founded in 1927, although strictly
medieval bankers were Eurobankers, but its period of phenomenal growth started with the
changes in the world financial system in 1957-8 especially the end of the dollar shortage and
the introduction of convertibility for European currencies. The nature of the market is such
that it is almost totally beyond the control of any central bank, or any other official body. A
transaction can be booked in any country, so, for example, a German lending dollars to a
Spaniard in London might record the transaction (book it) in Singapore; effectively all he
would do is make the loan by giving the Spaniard a cheque drawn on a Singapore bank.
Thus, attempts by any one country to control the market would merely push the market to
another centre. No international body can, or is likely to, exercise con- trol over banking, so
the banks in the market are totally free of any prudential requirement. Moreover, banks in
this market borrow short and lend long on a grand scale; in June 1982 only 15 per cent of
deposits were for more than one year against 87 per cent of loans. All banks borrow short
and lend long but rarely in so spectacular a fashion. Domestic banks are subject to various
forms of control to minimise the risks they (and their depositors) run: licensing, ratios or
deposit insurance. In addition, central banks in practice accept a responsibility to cover the
deficiency of any default- ing bank by one means or another. No such protection is available
when a Eurobank crashes, e,g. the Bank Ambrosiano group collapse in 1982. The Italian
authorities accepted a responsibility to protect the customers of its domestic banking
business but not of its Eurobanking subsidiary (a Luxemburg company). Eurobanks have
lent heavily to some sovereign borrowers whose repayment prospects are doubtful (Poland,
Argentina). In practice, such debts have usually been resched- uled, i.e. the borrower is
given longer to pay but the banks balance sheet shows the asset as if it were beyond
reproach. Many Eurobanks have been imprudent, but it may be that such risks are an
inevitable byproduct of banking. The Eurobanks, like the domes- tic US banks, have proved
very flexible and rendered the world great service in such activities as recycling OPEC
surpluses, i.e. in accepting deposits from OPEC members and their citizens and on-lending
them to those purchasing oil. The dangers arise from the absence of a central bank rather
than the behaviour of the Eurobanks per se. Rather similar considerations apply as do to the
3

analysis of US banks in the nineteenth century and Temin (1976) has argued that the costs
imposed by unreg- ulated banks and the occasional failure may not be as great as is conventionally assumed. Finally, the Eurocurrency market is a very capitalistic institution, whether
for good or ill. The Eurobanks normally put their responsi- bility to depositors and
borrowers and the opportunity to earn profits far above adherence to the spirit of (national)
government regulations. Often this means that the banks shelter the (rich) victims of
oppression, as with the Jewish victims of Hitler in the markets early days. Some- times
criminals are sheltered but, much more importantly, facilities are provided to enable large
companies to minimise tax or to evade exchange control. The market has probably been
highly beneficial despite its drawbacks, but any analysis of it must acknowledge that it is
capitalism, red in tooth and claw, with all its faces acceptable and otherwise.

Characteristics of Euro Currency Market

4

The rise of the Petro Dollars market shifted the focus of Euro-Currency operations away
from Europe. With the Globalization of the Euro-Currency market, it was now referred to as
the Offshore-Currency market and the prefix Euro was replaced by the prefix Offshore
to denote the particular brand of banking transactions which these markets represented.
OFCS act as channels for global trade and facilitate international capital flows.
International joint ventures are often structured as companies in an offshore location when
neither party in the joint venture wishes to form the company in the other partys home
jurisdiction for fear of unnecessary tax consequences.
1. Transactions in each currency take place outside the country of origin of that
currency.
2. Even though the transactions are recorded outside the country of issue, it continues
to be held in the country of issue. This is because a currency cannot be used for
settlement of commercial liability outside its domestic area. (The existence of the
foreign exchange market is based on this feature.)
3. Euro-Currency deposits and loans fall outside the regulatory and supervisory control
of the monitoring authority in the country of origin.
4. Euro-Currency market is distinct from the foreign exchange market. It is a market for
deposits and for loans between banks and between banks and their customers. It is a
market in which foreign currencies are lent and borrowed whereas in the foreign
exchange market, foreign currencies are bought and sold. This market therefore
converts short term deposit resources into short and medium term loans for financing
projects. While the Euro- Currency market operates on interest rates, the foreign
exchange market operates on exchange rates.
5. Due to absence of regulation, deposits in this market are unsecured. Due to this
deposits are received only on short term basis (max: one year) whereas loans are
demanded on medium to long term basis. This creates an asset-liability mismatch
which results in Euro-banks being exposed to both liquidity and interest rate risks.
6. To eliminate interest rate risk Euro-banks developed the credit roll-over concept
which involves resetting the interest rates on loans at fixed pre-decided intervals. To
achieve this loans/credits are provided on floating rates of interest. To ensure that

the Interest rates are reset on a fair and equitable basis the concept of reference rates
called LIBOR. (LIBOR London Interbank Offered Rate) was developed.
7. Each Euro-Currency credit (loan) specifies the periodicity of the roll-over and the
LIBOR to which it is referenced. To provide a uniform profit margin for the lender a
MARKUP is specified over and above the LIBOR. The interest cost to the borrower
is therefore the applicable LIBOR + Mark-up. The mark-up normally remains
constant through the life-span of the loan.
8. Financial assets and liabilities in a currency by way of deposits, loans and
instruments can be traded only in the domestic market of that currency. Such markets
are called the Domestic or Onshore markets. However in the case of freely
convertible currencies, it is possible to trade in assets and liabilities in such
currencies outside their home country. Such markets are called Euro-Currency or
Offshore markets. Consequently such markets deal only in freely convertible
currencies such as USD, GBP, EUR, JPY, CHF, CAD, AUD etc. The predominant
currency is USD.
9. It is essentially a wholesale market dealing only is standardised deposit amounts and
large volume Euro-credits involving substantial credit risk. Lending in this market is
therefore done on a Consortium basis, i.e. a syndicate of banks collectively finance
a project on uniform terms and conditions thereby distributing the risk among the
syndicate members.
10. The Euro-Currency market can be broadly divided into 4 components:
a) Euro-Currency deposit market involving short term deposits.
b) Euro-Currency loan market (Euro-credits) involving syndicated loans.
c) Euro-Bond market in which Corporate entities issue debt instruments to raise
resources from investors through banks operating as underwriters.
d) Euro-Notes market in which international borrowers raise resources directly from
the investors without using banks as intermediaries or any underwriting support.

Features of The Euro-Currency Market

1. International Market: The Euro-Dollar market is an International market. The Euro
currency market emerged as the most important channel of mobilizing funds on an
International scale.

2. Under no national control: By its very nature, the Euro-Dollar market is outside the
direct control of any national monetary policy. The dollar deposits in London are
outside the control of United States because they are in London . They are also
outside the control of the British because they are in dollar. The growth of the EuroDollar market is due to the fact that it is outside the control of any national authority.
3. Short tern money market: It is a short term money market. The deposits in this
market rage from one day up to one year. Euro dollar deposits are predominantly a
short term investment. The Euro dollar market is a credit market. It is a market in
dollar bank loans. The Euro dollar loans are employed for long term loans.
4. It is a whole sales market: The Euro-dollar market is a wholesale market in the
sense that the Euro dollar is a currency which is dealt only in large units. The size of
an individual transactions is usually above $ 1 million.
5. A highly competitive and sensitive market: It is a highly competitive and sensitive
market. It's growth and expansion tells us that it is highly competitive market. It is
reflected in the responsiveness of the supply of and demand for funds to changes in
the interest rates and vice-versa.
6.

Functions of the Eurocurrency Markets

The Eurocurrency market serves several important functions:
Its very nature allows market forces a fuller play than the counterpart domestic
market constrained with regulations and laws. Thus, it gives a more accurate reading
of market forces. Indeed, the more opaque the domestic market due to distortions,
the more critical the role of the Eurocurrency market as a barometer of market
forces. A paradox should be noted here. Since this market owes its existence to
7

impediments in the domestic markets, it stands to reason that any reduction (if not
removal) in regulations in the domestic markets in recent years should decrease the
relevance of the Eurocurrency market. However, its significance has increased rather
than diminished over time. It is likely that taxes and transaction costs have assumed
a much more pivotal role than ever before because of pressures on bank profits
created by intensified competition.
The Eurocurrency markets are well connected and efficient. As a result, the market
can be used for hedging purposes. Banks can buy and sell foreign currency
denominated assets and liabilities of different maturities and amounts for managing
their exposure to interest rate and currency risk.
The Eurocurrency markets are well funded, and thus are convenient sources for
funding a banks domestic and international loans.
Finally, new products are needed by the banks clientele to contain exposure
resulting from globalization, and such products may have legal, regulatory, or tax
implications that make them unsuitable for introduction in the domestic market.

Countries Responsible for the Growth of the

Eurocurrency Market

China, Korea And Russia:

Since 1949, China feared that its dollar earnings would be blocked by USA. So China
shifted its dollar earnings to Paris in the Russian Banks. Korean war broke in 1950. So USA
indeed blocked Chinese indentifiable dollar deposits in USA. Russian banks in Paris and
London started disguising their balances by placing them in western European banks rather

than in New York. So the communist countries had dollar claim on the western European
banks and western European banks had similar claim on USA.
United Kingdom
British Government in 1957, decided not to grant sterling pound loans outside
sterling area.
During the same period, however, Western European banks were permitted to foreign
currency deposits (say bank in London will accept dollar deposit).
So the banks in London offered loans to their non-sterling area customers.

United States Of America (USA)

Federal Reserve Act: Regulation Q
This act was about restriction on payment of interest on dollar deposits as well as
other currency deposits.
No interest was payable on deposits having maturity of 30 days or less. There were
restrictions and ceilings on interest payments on deposits having maturity above 30
days.
Therefore, the dollar deposits of Non Resident US citizens got shifted to Europe as
the banks in Europe offered higher rates of interest on dollar deposits
Foreign (for US) investors also shifted their dollar deposits from US to centres
outside US, mostly to banks in London.
London Banks used these deposits for lending to its customers in non-sterling areas.
Thus London got the prominence in borrowing and lending Euro-dollar.

Federal Reserve Act: Regulation M

This act was about reserve requirement of the banks on their deposits.
The act required US banks to block more money in reserves, than European banks.
US banking regulation was not very tight then (and it is not so even now)
American banks found it beneficial to move the deposits of Non Resident US citizens
as well as those of resident citizens to banks in Europe.

Eurocurrency Centers
A Eurocurrency or international banking center is a place where a number of banks are
concentrated to conduct transactions related to deposits and loans denominated in various
Eurocurrencies. Although Eurocurrency markets are global in nature, the deposit and loan
rates in each location are somewhat different, reflecting the local risk and impediments.
1. Different time zones thrust different locations into the limelight during a typical day.
2. Differing regulatory (e.g., disclosure or report filing) or tax (e.g., annual registration fees)
requirements may lead to development of new locations.

10

3. Locations that meet the infrastructure needs (e.g., communications network and
availability of skilled personnel) have always been a major drawing card for wellestablished centers, such as London and New York.
There are five major Eurocurrency centers: Western Europe (represented by London as the
headquarters), the Caribbean and Central America, the Middle East, Asia, and the USA.
London is the oldest and foremost Eurocurrency center. Its prominent position is the result
of its history of financial expertise and lack of government regulations for Eurocurrencies.
The Bank of England does not have reserve requirements on Eurocurrency deposits or
capital requirements for the branches of foreign banks. During the 1980s, Japanese and US
banks dominated the London market. Now banks from other European countries have a
respectable representation.
In the Caribbean and Central American currency center, the Cayman Island is one of the
most attractive locations for setting up shell branches for US banks where transactions are
booked or routed to for a variety of reasons such as lenient disclosure requirements and low
or no profit taxes. It is not difficult for a large multinational bank to open a branch in the
Cayman Islands. The minimum capital requirement can be met by using the capital of the
parent bank. Furthermore, there are no reserve requirements for Eurocurrency operations.
Bahrain is the center of the Middle East market in terms of the foreign exchange and
Eurocurrency trading. Its close proximity to Saudi Arabia and Kuwait is important for
currency trading and lending activities in the region.
Tokyo, Singapore, and Hong Kong are three major Asian currency centers. The Japanese
government has been widely known to have a stronghold on its financial markets. Because
of intense pressure from the USA and other governments, the Japanese government has
gradually deregulated its financial markets. In late 1986, the Japanese government set up the
Japan Offshore Market (JOM) in Tokyo for booking accounts exclusively for non-resident
transactions

(including

transactions

of

foreign

subsidiaries

of

Japanese

corporations).Transactions in JOM are exempt from reserve requirements, withholding tax,

and interest rate controls that apply to domestic banking. The major beneficiaries of JOM
are Japanese regional banks that do not have overseas branches. Although Japan was
11

attracting more attention through the 1980s in the Asian currency market because of
liberalization of the Japanese financial market and the prominent position of the Japanese
banks globally, several recessions in the 1990s coupled with political indecision has at least
temporarily removed the bloom of the JOM. Two major reasons for the existence of
Singapore and Hong Kong are:
(a) the abundance of the US dollar circulating among Far Eastern residents during the
Vietnam War; and
(b) the differences in time zones vis--vis the USA and Europe that create inconvenience
for conducting business transactions dealing in the US dollar.

Thus, the combination of the Asian dollar market, European centers, and the US market
provides 24-hour service to customers all over the world.
Singapore is now the headquarters for the Asian dollar market. The Singapore
government, in an attempt to compete with Hong Kong for leadership in the Asian dollar
market, eliminated its 40 percent withholding tax on interest income earned by nonresidents in 1968, and reduced its tax on bank profits on offshore loans in 1973. In addition,
other taxes have also been reduced or eliminated while the exchange control measures for
promoting growth in the Asian dollar market have been liberalized.
Since December 1981, the Federal Reserve System has permitted US banks and branches of
foreign banks in the USA to establish IBFs, which are exempt from reserve requirements,
federal taxes, and deposit insurance. The intent of setting up IBFs was to attract offshore
banking business to the USA. Many shell bank branches in places like the Cayman
Islands or the Bahamas really amounted to nothing more than a small office and a telephone
for booking loans and deposits. The location of IBFs reflects the location of banking
activity in general. Thus it is not surprising that over 75 percent of the IBF deposits are in
New York State. IBFs do not require physically separate banking entities, as they are just the
booking facilities located in the USA and sharing basic characteristics of Eurobanks outside
the country. IBFs can do business with only non-bank foreign residents; thus IBF s cannot
lend to or accept deposits from US residents.
12

Although borrowing from a US bank is allowed, it is subject to reserve requirements. At the

same time, IBFs are not allowed to issue negotiable instruments such as CDs. Because of
these restrictions, IBFs are not a perfect substitute for offshore deposit facilities. Still, to
make them more competitive with offshore banking, the minimum deposit maturity is
overnight for interbank IBFs and two business days for nonbank foreign residents. The
minimum size of deposits is in excess of $100,000; hence they are not subject to deposit
insurance.

Factors Causing Development Of Euro Currency

Market
The Eurocurrency market has grown rapidly mainly due to the existence of various US
regulations that have raised costs and lowered returns on domestic banking transactions. In
other words, the Eurocurrency market has become popular because of the absence of
restrictions from the government which have led to attractive deposit rates for savers and
attractive loan rates for borrowers. This means that banks can offer higher interest rates on
Eurocurrency deposits than on deposits made in the home currency. Similarly, banks can
also charge lower interest rates to Eurocurrency borrowers than to those who borrow the
home currency. The spread between the Eurocurrency deposit and lending rates is less than
the spread between the domestic deposit and lending rates giving Eurocurrency banks a
competitive edge over domestic banks.
13

1. Regulation Q of the Federal Reserve Act which imposed a ceiling on interest rates
that could be given on deposits by banks in the US. This enabled European banks to
attract US Dollar deposits by offering better interest rates.
2.

Regulation M of the Federal Reserve Act which stipulated reserves to be

maintained against deposits accepted by banks in the US. This increased the cost on
deposits for banks in USA which widened the spread between deposit and lending
rates. This feature was exploited by European banks, since they were not subject to
reserve requirements on Euro-Dollar deposits.

3. The mandatory requirement on all banks in the US to insure deposits accepted by

them from the public. The Euro-Currency market is unregulated which means
Eurobanks were under no obligation to insure Euro-Currency deposits. This reduced
their cost on deposits.
4. The Interest Equalization Tax introduced by the US monetary authority in
1963resulted in increasing the effective cost of borrowing in the United States for
non residententities. They therefore approached the offshore market for their funding
needs since Euro-banks were not subject to the Interest Equalisation Tax.
5. The Voluntary Restraint Program was introduced in the US in 1965 in terms of
which,borrowing in the US for financing international projects was restricted. The
US banks were discouraged from making loans to international borrowers. The
guidelines were replaced by mandatory restrictions on outbound direct investments in
1968. Effectively, US Multinationals were also, now constrained to borrow in the
offshore market for their international projects.
6. Persons not resident in the US have unequal cash flows in USD. They acquire USD
by exporting to the US and need the same to pay for imports from the US. At both
times, conversion into/from domestic currency is involved. Such entities deposited
their export proceeds with Euro-banks and withdrew them when needed to pay for
imports. It became possible for such entities to maintain foreign currency resources,
without incurring conversion cost, without exchange rate risk, earn the higher deposit
14

rates available in the Euro-Currency market and have the convenience of dealing
with local banks.
7. The large and persistent deficit in the balance of payments of USA increased the flow
of US dollars in these countries having surplus balance of payments in relation to
USA. The USA has a deficit in the balance of payments since 1950 extent in 1957
and since 1956 the balance of payments deficits have assumed alarming proportion.
Hence it was one of the most important factors responsible for the rapid growth of
the Euro-dollar market.
8. Banking Regulation in USA: The Federal Reserve system of USA issued regulation
"Q" in USA which fixed the minimum rate of interest payable by the member banks
in USA. It also prohibited the payment of interest on deposit for less than 30 days.
These things significantly contributed to the growth of Euro-dollar market. The Eurodollar rates of interest were comparatively higher than the US interest rates which
attracted the Collar deposits from USA to European countries. The selective controls
in the United [States such as interest rate equalization and the voluntary restrictions
on lending and investing abroad by United States corporations and banks also led to
widening of the f Euro-Dollar market.
9. The advent of innovative banking, sphere headed by the American banks in Europe
and the willingness of the banks in Europe in the Euro-Dollar ketto operate on a
narrow spread, also encouraged the growth of Euro-Dollar market.
10. The supply and demand for funds in the Euro-currency market comes from the
participants in the Euro-currency business viz. the Governments, International
organizations,

central

banks,

commercial

banks,

corporation's

especially

multinational corporations, traders and individuals etc. Governments have emerged

as significant borrowers in the Euro-currency market. The frequent hike in price and
the consequent increase in the current account deficits of number of countries compel
then to increase their borrowings. The central banks of various countries constitute
the important supplying. The bank of the central banks funds are channeled through
BIS. The enormous oil revenue of OPEC countries has become an important source
of flow of funds to the Euro-Dollar market. Multinational corporations and trader, too
15

place their surplus funds in the market to obtain short term gains. The commercial
banks in need of additional funds for lending purposes may borrow from the Euro
market and relent it. At the end of the financial year, they some times resort to
borrowing for "window dressing" purposes.
11. The flow of Petro-dollars facilitated by the tremendous increase in OPEC oil
revenue following the frequent hikes in oil prices since 1973 has been a significant
factor in the growth of Euro-Dollar market. The Euro-Dollar market grew especially
rapidly after 1973 with the huge dollar deposits from OPEC arising from the
manifold increase in the price of petroleum.
12. The Suez crisis occurred in 1957. During the crisis the restrictions were place upon
the sterling credit facilities for financing trade provided a stimulus for the growth of
Euro-Dollar market. The British banks which could not meet the demand for credit
from traders found out a good alternative to meet the demand for credit in terms of
Euro-Dollar.
13. The relaxation of exchange control, the stability in the exchange market, and the
resumption of currency convertibility in Western Europe in 1958 provided a fresh
impetus to the growth of Euro-Dollar market. Due to resumption of currency
convertibility and the comparative higher rate of interest attracted the flow of US
dollars from USA to Europe. The US dollars could be converted into domestic
currency to finance domestic economic activity.
14. The cold war between the United States and the communist countries also
contributed to the growth of Euro-Dollar market. In the event of hostilities the
communist countries feared, that there would be blocking of their dollar deposits and
hence the communist countries deposited their dollar holdings with the East
European banks. This move led to the growth of the Euro-Dollar market.

16

Instruments of Eurocurrency Market

The following are the instruments of the Eurocurrency Market.
1. Time Deposits :
A large part of money in the Eurocurrency Market is held in fixed exchange rate time
deposits. The maturities of most of them ranges from one week to six months. The
bulk of Eurocurrency time deposits are interbank liabilities. They pay a fixed,
competitively determined rate of return.
2. Certificate of deposits :
Another important instrument is the Eurocurrency certificates of deposit (CD). A
Eurocurrency CD is a negotiable receipt for a dollar deposit at a bank located outside
the US. There also exists an active secondary market for Eurodollar CDs. This
allows investors to sell Eurodollar CDs before the deposits mature. Eurodollar CDs
are issued by banks to tap market for funds and are commonly issued in
denominations varying from $25,000 to $5 million.
3. Eurodollar floating rate CDs (FRCDs) and Eurodollar floating rate notes (FRNs):
Eurodollar floating rate CDs and Eurodollar floating rate notes came into use as a

means of protecting both borrower and lender against interest rate risk. By making
their coupons payment float with market rate of interest, they help to stabilise the
principal value of the paper. Eurodollar floating rate CDs are not very active now-adays.
4. Note issue facilities:
17

Note issue facilities became a significant Eurodollar instrument in the mid-1980s. It

is an arrangement between a borrower and an underwriting bank under which the
borrower can issue short term paper known as Euronotes in its own name. Under
such an arrangement, the under writing bank is committed either to purchase any
notes the borrower cannot sell or to provide standby credit. It is something like
commercial paper programmes, the only difference being that it is with underwriting
commitments.
5. Euro currency interest rate:
Interest rate paid to the depositors and charged for loans is based on London
Interbank Offered Rate (LIBOR). LIBOR is comparatively cheap as Euro banks
operate with a small spread that is, the difference between deposit and lending rate.
LIBOR rates are calculated as the averages of the lending rates in the respective
currencies of the leading London Banks. At present, eight leading banks are involved
in determining LIBOR rate. Since euro deposits and lending rates are not subject to
restrictions by the Central Banks, euro banks work with a smaller spread, that is,
deposits are paid higher rate and loans are charged lower rate of interest.

18

Economic Impact of Eurocurrency Market.

The emergence and the growth of Eurocurrency market and its ability to create multiple
expansion of credit without any apparent control mechanism have given rise to certain
problems and advantages.
Problem:
The important problems associated with it are:
1. The Eurocurrency market facilitates short term speculative capital flows. This
creates difficulties for central banks in their efforts to stabilise the exchange rates.
2. The national monetary authorities lose effective control over monetary policy since
domestic residents can make their effort less effective by borrowing or lending
abroad. Since Eurocurrency market contributes to increasing the degree of
international mobility of capital, it makes monetary policy less effective.
Eurocurrency market provides opportunities for avoiding many of the regulations
that the monetary authorities try to enforce on domestic money markets.
3. Since the Eurocurrency market can be a source of international liquidity it can
contribute to inflationary tendencies in the world economy.
4. The Eurocurrency market allows the central banks of deficit countries to borrow for
balance of payments purposes. This may make these countries to postpone the
needed balance of payments adjustment measure.

Advantages:
Despite these problems arising from the growth of Eurocurrency market, it has given
rise of many advantages.
1. It has helped to alleviate considerably the international liquidity problem.

19

2. It has provided credit to countries to finance the balance of payments deficit. In

other words, it has played an important role in recycling funds from surplus to
deficit countries.
3. It has helped to meet the short term credit requirements of business corporations.
4. It has provided a market for profitable investment of funds by commercial banks.
5. It has enabled the exporters and importers to obtain credit.
6. This Eurocurrency market has helped to accelerate the economic development of
some countries like South Korea, Taiwan & Brazil.
7. It has been largely responsible for the increased degree of financial integration
between economies.
The Eurocurrency market have become important sources of finance for governments and
private firms. The importance of Eurocurrency market is likely to grow with the growing
integration of the world economy and globalisation. Their competitive deposit and lending
rates prove to be attractive for both investors and borrowers of funds. At the same time, the
growth of Eurocurrency market has made monetary control more difficult for domestic
authorities.

Eurobonds
Since bonds issued by national governments from euro area countries share the same
currency but remain different, there is no unified bond market. This stands in sharp contrast
20

with the huge market for US treasuries, which underpins the supremacy of the dollar as the
single international currency. In the absence of federal debt, the euro is bound to remain a
currency of secondary international importance, which is likely to weigh on the
development of European financial markets. While political constraints currently prevent
the emergence of a federal government, which would issue its own public debt, there are
periodic suggestions that national governments could pool (some of) their debt instruments
and make them identical.
To be identical, Eurobonds must share the same currency, as they already do of course, but
they also must bear the exact same risk. To that effect, they must be guaranteed in the exact
same way. Indeed, a bond is as safe as those that issue it. Many solutions are possible. They
can be issued by a single agency, which is backed by member governments. The backing
can be total or limited to a portion of the debt; in the latter case, the debt would likely
command a premium over the debt issued by the government considered to be safest.
Alternatively, they can be issued by national governments, which however formally and
contractually commit to guarantee each others debts. In this case, the guarantee must be
complete and the contractual terms must be exactly identical; otherwise national debts will
remain different. An intermediate solution (blue and red bonds) is presented below.
Whatever solution is adopted, the key characteristic of Eurobonds is that they mutualise
national public debts. In other words, a group of countries, possibly all euro area Member
States, undertake to share responsibility for each one of them as far as debt service is
concerned. With each government retaining sovereignty on its fiscal policy, the explicit
guarantee creates a severe moral hazard problem unless it is appropriately dealt with. Why
should any government exercise restraint when it knows that others will pay for its own
excesses. That such proposals attract interest in the midst of the current crisis may seem
surprising. In fact, there is a clear logic, albeit one that is fraught with serious risks. The
intention is quite explicitly to rule out sovereign crises. If the Greek debt was guaranteed by
the other euro area Member States, there would be no crisis. That is true, but there must be a
price. One price is the moral hazard issue. The answer is to tighten up institutional
mechanisms apt to delivering fiscal discipline in the future. Indeed, we have seen a range of
proposals to harden the Stability and Growth Pact, including new sanctions that should act
21

as a powerful deterrent, for instance the suspension of voting rights for delinquent countries
and a range of fairly inquisitive surveillance procedures. Solidarity thus comes along with
some reduction in fiscal policy sovereignty. The other price is financial. Governments that
offer a guarantee must be ready to suffer occasionally some losses. The table below shows
the cost that all other countries would suffer if one of them would default on 25% of its debt
(this is a level frequently observed in sovereign debt restructurings). The losses are
measured as a percentage of the insuring countries, assuming that all 17 euro area countries
contribute in proportion to their GDP. For all but five countries, the losses are less than 1%,
with four others above 0.5%, the maximum penalty imposed by the Stability and Growth
Pact , which was meant to be a powerful deterrent, and was never levied for fear of a grave
political backlash. Of course, no one would expect Germany or the Netherlands to default,
but other countries that could be, or currently are, on the market watch list, could impose
losses that are quite enormous.
A Eurobond is an international bond that is denominated in a currency not native to the
country where it is issued. Also called external bond; "external bonds which, strictly, are
neither Eurobonds nor foreign bonds would also include: foreign currency denominated
domestic bonds. It can be categorised according to the currency in which it is issued.
London is one of the centres of the Eurobond market, with Luxembourg being the primary
listing centre for these instruments. Eurobonds may be traded throughout the world - for
example in Singapore or Tokyo.
Eurobonds

are

named

after

the

example, Euroyen and Eurodollar bonds

currency
are

they

are

denominated

denominated
in

in.

For

Japanese yen and

American dollarsrespectively. Eurobonds were originally in bearer bond form, payable to

the bearer and were also free of withholding tax. The bank paid the holder of the coupon the
interest payment due. Usually, no official records were kept. The word Eurobond was
originally created by Julius Strauss.
The first Eurobonds were issued in 1963 by Italian motorway network Autostrade, who
issued 60,000 bearer bonds at a value of USD250 each for a fifteen-year loan of USD15m,
paying an annual coupon of 5.5%. The issue was arranged by London bankers S. G.
22

Warburg and listed on the Luxembourg Stock Exchange. Their conception was largely a
reaction against the imposition of the Interest Equalization Tax in the United States. The
goal of the tax was to reduce the US balance-of-payment deficit by reducing American
demand for foreign securities. If foreign securities were denominated in dollars and not
foreign currency, however, then they would not affect the US balance-of-payment deficit
because Americans would not need to exchange dollars to acquire them. Clever financiers
(initially based in London) realized this and the Eurobond was born. Americans could
bypass the costly tax and Europeans could keep open access to US capital.
The majority of Eurobonds are now owned in 'electronic' rather than physical form. The
bonds are held and traded within one of the clearing systems (Euro clear and Clear
stream being the most common). Coupons are paid electronically via the clearing systems to
the holder of the Eurobond (or their nominee account).

Types of Eurobonds
1. Conventional or Straight Eurobonds:
23

A bond that pays interest at regular intervals, and at maturity pays back the principal
that was originally invested. Straight bonds are debt instruments because they are
essentially loaning money (creating debt) to an entity. The entity (government,
municipality, or organization) promises to pay the interest on the "debt" and at
maturity pay back the original loan.
2. Floating rate bond notes (FRN) :
Floating rate bonds are usually short to medium term bond issues, with a coupon
interest rate that floats, i.e. goes up or down in relation to a benchmark rate plus
some additional spread of basis points (each basis point being one hundredth of
one percent). The reference benchmark rate is usually LIBOR (London interbank
offered rate) or EURIBOR (Euro interbank offered rate). The spread added to that
reference rate is a function of the credit quality of the issuer. The floating rate notes
(FRNS) were issued in 1970 and now they occupy a prime position in the Euro-bond
market. The FRNS are similar to straight bonds in respect of maturity and
denomination. The difference is that it is payable in varying in accordance with the
market conditions unlike the fixed rate payable on a straight bond.
3. Convertible bonds:
Convertible bonds can be exchanged for another instrument, usually an ordinary
share or shares (fixed ahead of time with a predetermined price) of the issuing
organisation. The bondholder decides whether to convert the bond. In convertible
bonds, the coupon payable is usually lower than it otherwise would be. Because
convertible bonds can be viewed more as equity shares than bonds, the credit and
interest rate risks for investors are higher than with conventional bonds.

4. High-yield bonds :
High yield bonds are also part of the Eurobond markets, a class of bonds (rather than
a type of bond) which individual investors may encounter. High-yield bonds are
those that are rated to be below investment grade by credit rating agencies (i.e.
issuer has a credit rating below BBB).
24

5. Zero-coupon bonds:
Zero coupon bond do not have interest payments. The investor in this type of
Eurobond may be looking for some kind of tax advantage.

Advantages of Eurobonds
1. It would prevent repeated financial crisis that is creating a destabilising economic
and political environment.

25

2. Investors would have greater security in buying the bond because overall Eurozone
debt is manageable.
3. Interest rate costs would fall for several countries, this would give them much greater
ability to repay outstanding debt rather than just keeping up with interest payments.
4. It would mean secure countries wouldnt need to get involved in bailout packages.
5. Austerity measures to try and contain the debt crisis threaten to cause a double dip
recession. For example, Italy is facing prospect of second economic downturn
because of necessity to cut spending to deal with fears over rising debt costs (despite
having a primary budget surplus) Eurobonds which give greater security would give
countries more time in reducing long term deficits without sacrificing growth.
6. Logical conclusion of single currency. A common monetary policy and common
currency needs a single fiscal policy to ensure economic harmonisation.
7. Countries in Eurozone suffer from inability to print money and avoid liquidity
shortages. The experience of recent months suggests it is more difficult for countries
in the Eurozone to borrow. The lack of an independent Central bank to avoid
temporary liquidity shortages makes members of the Euro much more vulnerable to
panic selling of bonds.

Euro Equity
Business firms raise finance in domestic as well as foreign markets by marketing
bonds and equities. Among foreign markets, the Euro market is one of the important
financial market where firms raise finance through euroequities besides euro bonds.
Euro equity issue refers to a process whereby a company raises funds through the sale of
equities using Global Depository Receipts (GDRs) as a financial instrument, in more

26

than one foreign market, except in the domestic market of the issuing company. GDRs
are denominated in a currency other than the home currency of the issuing company.
Euro equities are sold through Global Depository Receipts (GDRs) in international
markets specially Eurocurrency market. Global Depository Receipts (GDRs) tradable
securities issued by the depository bank against the domestic shares of the issuing
company.
A Global Depository Receipts (GDR) represents one or more shares of a sponsored or
issuing company. The issuing company deposits the shares with the depository bank.
With the help of brokers, the depository banks sell shares through depository receipts.
Global Depository Receipts (GDRs) holders have no voting rights unless GDRs are
converted to shares.

Euro-Currency Deposits
Euro-currency is the funds to collect in large quantities by the banks on behalf of
International borrowers. The Euro currency deposits represent the funds accepted by the
banks themselves. The Euro-currency market consists of all deposits of currencies
placed with banks outside their home currency. The deposits are accepted in
Eurocurrency. The Euro-currency time deposits are the most important investment in the
27

Euro-Dollar market. The deposits may be placed at call or for fixed period on time
deposits.
Call deposits may be made for overnight, two days or seven day notice for US dollars.
Canadian dollar, Sterling and Japanese Yen and a minimum notice of two days for other
currencies. Time deposits are accepted for a period of 1, 3, 6 and 12 months for all
currencies. There is a close link in the functioning of the Euro-currency deposit market
and foreign exchange market. Deposits in US dollar and Pound Sterling can be placed
for periods up to five years. In general, the minimum size of deposit in Euro-currency
market is $ 50,000 or its equivalent.
The interest rates in Euro-currency market are determined by the factors which affect
the demand and supply conditions of the currency concerned viz.
i) Volume of world trade transacted in the currency,
ii) Domestic interest rates,
iii) Domestic monetary policy and reserve requirements,
iv) Domestic Government regulations,
v) Relative strength of the currency in the foreign exchange market.
In practice domestic interest rates act as a floor to Euro-currency rates because
the funds flow into Euro-currency market seeking higher interest. Although the
Eurocurrency market operates in number of centres around the world, interest rates for a
particular currency are consistent. Any temporary variations at different market are
quickly eliminated by the International arbitrage.

Euro Credits
Most of the lending in Euro currency market takes the form of Euro credit. Euro credits are
medium and long term loans. Euro-credits belong to wholesales sector of the International
Capital market and normally involve large amounts.
Euro-credits are provided mostly without any collateral security from the borrower.
28

Here emphasis is laid on credit rating i.e. credits worthiness of the borrower rather than
on only tangible security.
Euro-credits are normally provided in either of the two forms:a) Revolving credit and
b) Term Credit,
A) Revolving Credit is similar to a cash credit facility. It is a stand by facility to meet
temporary but recurring financial requirements of the borrower. Interest is charged on the
actual amount utilized, a commitment fee may be changed on unutilized portion.
B) Term Credit is similar to medium term loans provided by banks. At the beginning both
the lenders and borrowers agree on the schedule of changing the facility. The repayment
schedule is fixed taking into account the expected revenue flow from the investment. Many
loan agreements provide for pre-payment of the full amount without any penalty at 30 days
or 60 days notice. This provision helps the borrowing companies to repay the loan and avail
of better conditions that may prevail in the market at a later date.
The period of Euro-credit extends up to 15 years. But most of the credits are for 5 to 8 years.
Interest is fixed at a certain percentage, generally the inter banks rate for Eurocurrency
deposits. For dollar loans the reference rate is LIBOR i.e. London Inter Bank Offered Rate.
Generally, interest for dollar loan .is fixed at a percentage over LIBOR i.e. 1 % over
LIBOR. Technically the credit is rolled over or renewed every six months. The variations
are allowed from the method of rolling over the interest every six months at a fix percentage
over LIBOR.
Many of the loans raised are in dollars. The borrower is given the option to roll over the
loan in different currencies according to his requirements. The multi currency option helps
the borrower in avoiding exchange risk and also doesn't involve the lending bank in any
risk. Since it is not possible for single bank to meet all the demand for loan the banks form
the syndicate to provide funds to the borrower.

29

Current Scenario of Eurocurrency Market

In every economic crisis there comes a moment of clarity. In Europe soon, millions of
people will wake up to realize that the euro as we know it is gone. Economic chaos is
awaited. Europes crisis to date is a series odd supposedly decisive turning points that
each turned out to be just another step down a steep hill. It is already nearly impossible to
30

save Greek membership in the euro area: depositors flee banks, tax payments, and
companies postpone paying their suppliers either because they cant pay or because they
expect soon to be able to pay in cheap drachma.
The troika of the European Commission (EC), European Central Bank (ECB), and
International Monetary Fund (IMF) has proved unable to restore the prospect of recovery in
Greece and any new lending program would run into the same difficulties. Particularly as
the Greek failure mostly demonstrates how wrong a single currency is for Europe. The
Greek backlash reflects the enormous pain and difficulty that comes with trying to arrange
internal devaluations (a euphemism for big wage and spending cuts) in order to restore
competitiveness and repay an excessive debt level. Faced with five years of recession, more
than 20 percent unemployment, further cuts to come and a stream of failed promises from
politicians inside and outside the country, a political backlash seems only natural. With IMF
leaders, EC officials and financial journalists floating the idea of a Greek exit from the
euro, Greeces economy can only get worse. Greeces exit is simply another step in a chain
of events that leads towards a chaotic dissolution of the euro zone.
During the next stage of the crisis, Europes electorate will be rudely awakened to the large
financial risks which have been foisted upon them in failed attempts keep the single
currency alive. If Greece quits the euro later this year, its government will default on
approximately 300 billion euros of external public debt, including roughly 187 billion euros
owed to the IMF and European Financial Stability Facility (EFSF).
More importantly and currently less obvious to German taxpayers, Greece will likely default
on 155 billion euros directly owed to the euro system (comprised of the ECB and the 17
national central banks in the euro zone). This includes 110 billion euros provided
automatically to Greece through the Target2 payment system which handles settlements
between central banks for countries using the euro. As depositors and lenders flee Greek
banks, someone needs to finance that capital flight, otherwise Greek banks would fail. This
role is taken on by other euro area central banks, which have quietly leant large funds, with
the balances reported in the Target2 account. The vast bulk of this lending is, in practice,
31

done by the Bundesbank since capital flight mostly goes to Germany, although all members
of the euro system share the losses if there are defaults.
The ECB has always vehemently denied that it has taken an excessive amount of risk
despite its increasingly relaxed lending policies. But between Target2 and direct bond
purchases alone, the euro system claims on troubled periphery countries are now
approximately 1.1 trillion euros. This amounts to over 200 percent of the capital of the euro
system. No responsible bank would claim these sums are minor risks to its capital or to
taxpayers. These claims also amount to 43 percent of German Gross Domestic Product,
which is now around 2.57 trillion euros. With Greece proving that all this financing is
deeply risky, the euro system will appear far more fragile and dangerous to taxpayers and
investors.
The calamity of a Greek default is likely to result in a flight from banks and sovereign debt
across the periphery, and that to avoid a greater calamity all remaining member nations
need to be provided with unlimited funding for at least 18 months. The ECB is not prepared
to provide such a firewall, and no other entity has the capacity, legitimacy, or will to do so.
The most likely scenario is that the ECB will reluctantly and haltingly provide funds to
other nations an on-again, off-again pattern of support and that simply wont be enough
to stabilize the situation. Having seen the destruction of a Greek exit, and knowing that
both the ECB and German taxpayers will not tolerate unlimited additional losses, investors
and depositors will respond by fleeing banks in other peripheral countries and holding off
on investment and spending.

Conclusion
The creation and growth of the Eurocurrency market has been an important side effect of the
increase of international economic activity over the past few decades. The market has
expanded largely as a means of avoiding the regulatory costs involved in dollardenominated financial. Due to the size and importance of the foreign exchange market, it
remains largely unregulated. There is no international organization to look over it or any
32

institutions that sets rules. The name Eurocurrency market is given to any bank deposits in
any country held in a different countrys currency. An example of this is United States dollar
depositing in a British bank. These banks are called Euro banks. The emergence of
eurobanks has facilitated trade and investment between countries. A Eurocurrency is any
currency that is deposited outside of the home country. Since approximately two thirds of
Eurocurrency is U.S. dollars, central banks and regulators are concerned about
Eurocurrency because they are stateless money. Eurocurrency market has very little
regulation, such as taxes, restrictions on capital movements and exchange controls. Thus,
the market attracts more investors. It is easier for banks around the world to use the
Eurocurrency market to move and store funds more profitably than they could in many
countries. Since the market is relatively free of regulation, Eurodollar market must operate
on narrower margins than banks in the United States. The Eurocurrency market gives
investors the opportunity to hold short-term claims on commercial banks, which also act as
intermediaries to transform these deposits into long-term claims on final borrowers. Not
only does Eurocurrency market allow for more convenient borrowing, it also improves the
international flow of capital for trade between countries and companies. This market also
attracts domestic deposits because it offers a higher interest rate. The largest Eurocurrency
markets are located in London, New York, and Tokyo.
This report discussed various issues related to the Eurocurrency market. Specifically, it
explained development as well as the features of the Eurocurrency market. The growth of
the Eurocurrency results from government-induced impediments and it requires sustenance
from benign indifference on the part of the government issuing the currency. Institutional
setting of various geographic centres was described to highlight the requisite ingredients for
development of such centres. The traits of interest rates were discussed with respect to time
(term structure), space (other currencies), and impediments (domestic versus offshore).
Interrelationships among the three were brought out through arbitrage activities facilitated
by new tools based on conventional concepts of term structure and interest parity theories.
Finally, the role of the Eurocurrency market in the development of new products was
discussed with illustrations of NIFs, Euro-CP, asset securitization, and Eurobonds. It was

33

suggested that it is not the far-reaching novelty of these products that is important, but what
they symbolize: a change in the bank attitude that marks a break with the past.
The main problem for the Euro crash was not sub-optimal currency areas nor profligate
government spending but fatal flaws in monetary design and an appalling series of policy
mistakes by the European Central Bank (ECB). The inflation-targeting regime established
by the ECB right at the start, coupled with the reckless dismantling of the old Bundesbank's
monetary framework, contributed decisively to the ensuing gross failures. Further factors in
the fatal cocktail included long-term French monetary nationalism, empowered by a French
President at the head of the ECB, and the succumbing of euro officials to the same deflation
phobia which had gripped the Federal Reserve. There is only one way which has any real
prospect of salvaging European monetary integration - that is to start again.

Bibliography
BOOKS:
1. International Bank Management by Dileep Mehta and Hung Gay Fung.
2. The Eurocurrency Interbank Market: Potential for International Crises? Federal
Reserve Bank of Philadelphia, Business Review.
34

3. A Note to Euroyen and Domestic Yen Interest Rates Journal of Banking and
Finance.
.
WEBSITES:
1.
2.
3.
4.
5.
6.

www.investopedia.com
www.scribd.com
www.managementparadise.com
www.baseinscenario.com
www.wisegeek.com
www.tradecurrencies.com

Acknowledgement
I owe a great many thanks to many people who helped and supported me during this Project.
My deepest thanks to Lecturer, Ms. Afroz , the Guide of the project for guiding and correcting
various documents of mine with attention and care. She has taken pain to go through the project and
make necessary correction as and when needed.
I would also thank my Institution and my faculty members without whom this project would have
been a distant reality. I also extend my heartfelt thanks to my family and well wishers.
35

Methodology
The data used in this project has been collected from secondary sources. There are those data which
have already been collected by someone else and have panel through statistical power. When the
researcher utilizes secondary data, he has to look into various sources from where he can obtain
data usually published data is available in:

Technical and trade journals.

Books, Magazines & newspapers.

Public records & statistics.

Historical Documents and other resources.

Website journals, etc.

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37