Eurocurrency refers to any currency deposited in banks anywhere outside the country that issued it. These currencies belong to non-residents of a nation. Foreign-based banks lend these to anyone who wants to use them in the country where they are legal tender.
Despite having “euro” as a prefix, the term has nothing to do with Europe, the Eurozone, or the monetary unit Euro. For example, euros or Indian rupees deposited in a U.S.-based bank would be eurocurrency or non-local currency. It acts as a primary source of global financing for financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. , banks, corporations, governments, and mutual and hedge fundsHedge FundsA Hedge Fund is an investment vehicle that pools money from investors & uses a fund manager to operate it and gain maximum returns for them. It utilizes different trading techniques & might specialize in real estate, trade junk bonds, & “long-only” equities etc. .
- Eurocurrency applies to any currency deposited in banks outside the country of its issuance.
- Despite the prefix “euro,” it has nothing to do with Europe or the Eurozone or euro currency. Even a British pound deposit in a U.S.-based bank will still be eurocurrency.
- Eurodollar refers to US-dollar deposits in foreign banks. Eurobonds, which are bonds denominated in a non-local currency, are also part of the eurocurrency market.
- Individuals and businesses use the non-local currency to mitigate the risks of international trade and foreign exchange.
History And Explanation
Eurocurrency came into prominence when foreign nations and businesses started depositing U.S. dollars in European banks in mid-1955. The post-World War II events like the fixed exchange rate system, increased imports into the U.S., the American governments’ financial aid to Europe, and the 1957 Suez Crisis were responsible for this. Gradually, many non-European countries, including the Soviet Union and China, followed this trend in the early 1960s.
The prefix “euro” in eurocurrency signifies the role of the United States in helping European nations financially post-World War II. In 1948, the American government introduced Marshall Plan – the European Recovery Program. It provided financial resources worth over $13 billion to the Western European economies to rebuild and regain financial stability.
While supporting Europe in improving its market economy, the United States discovered ways to create two separate markets for trade and transactions. These were the domestic market and the eurocurrency market. The Federal Reserve supervises, controls, and manages the former, while the latter is exempt from its governance.
Thus, the first form of non-local currency that came into existence was the eurodollar. It represented funds deposited in US-dollar in banks outside the United States. The name Eurodollar might sound misleading, indicating U.S. dollars deposited only in the European banks. But the term applies to all currencies deposited anywhere outside their home markets. So, if someone deposits U.S. dollars in an Asian bank, it would still be Eurodollars.
Globalization, easy currency conversion, and much less regulation in international markets drive the demand for eurocurrencies in the global financial system. Increasing cross-border transactions requiring banks to exchange foreign currencies also contribute to an active eurocurrency market. Also, this facilitates instant lending and access to short-term financing for financial institutions.
How Does the Eurocurrency Work?
- Eurocurrency transactions occur in two ways – receiving deposits in non-local currencies and lending those currencies.
- Non-local currency comes from private and high-net-worth individuals, multinational corporations, governments, financial and non-financial institutions, central banks, commercial banksCommercial BanksA commercial bank refers to a financial institution that provides various financial solutions to the individual customers or small business clients. It facilitates bank deposits, locker service, loans, checking accounts, and different financial products like savings accounts, bank overdrafts, and certificates of deposits., and other statutory bodies.
- These are generally short-term interbank deposits having maturities ranging from one day to one year.
- The non-local currency remains free from the intervention or restrictions imposed by any regulatory or financial entity.
- The eurocurrency deposits are not bound to any reserve requirementsReserve RequirementsReserve Requirement is the minimum liquid cash amount in a proportion of its total deposit that is required to be kept either in the bank or deposited in the central bank, in such a way that the bank cannot access it for any business or economic activity..
Let us look at examples below to understand how eurocurrencies circulate and work in the global financial system:
Katsuro, a Japanese software developer, relocated to the United States for a three-year onshore project. He could not resist his hunger as he landed and walked to a local shop to have a hamburger. When he tried to pay for it, the Yen was rejected because it was not an American currency. He asked his companion, who came to pick him up from the airport, to pay for the same.
The first thing Katsuro did was to deposit the money he had in a U.S.-based bank and exchange it for U.S. dollars to avoid such a problem again. Yen, in this case, is a non-local currency deposited in a bank outside the nation to which it belonged. Also, while visiting his native country, Katsuro can exchange his U.S. dollars for Yen from the U.S.-based bank and use it there.
The COVID-19 pandemic has affected the global financial system adversely. In 2020, several eurozone countries, including France, Italy, and Spain, proposed Coronabonds, the novel form of Eurobonds, to stabilize the European economy.
Eurobonds are bondsBondsA bond is financial instrument that denotes the debt owed by the issuer to the bondholder. Issuer is liable to pay the coupon (an interest) on the same. These are also negotiable and the interest can be paid monthly, quarterly, half-yearly or even annually whichever is agreed mutually. denominated in a currency that does not belong to the nation which issues them. They are exclusively available in the eurocurrency market. Also, they are exempt from domestic interest rate and reserve requirements.
However, the Netherlands rejected the proposal of Coronabonds to provide financial aid to Italy, Spain, and other nations. In the first week of April 2020, the Dutch government opposed any federal-level financing by European countries. This decision came following a 2017 episode when Dutch Economic Minister alleged Spain, Italy, and other southern European nations of spending the European Union budget on drinks and women.
Individuals and corporations alike utilize eurocurrency to receive overseas funds. It also reduces the risk associated with international trade and foreign exchange. Other users of non-local currencies are:
- Central and commercial banks
- Financial institutions (mutual fundsMutual FundsA mutual fund is an investment fund that investors professionally manage by pooling money from multiple investors to initiate investment in securities individually held to provide greater diversification, long term gains and lower level of risks. and hedge funds)
- Individuals and non-financial institutions
- International agencies and other statutory bodies
- Multinational corporations
The eurocurrency rate of interest is often higher than that in domestic markets. Furthermore, eurobanks’ rates on eurocurrency loans are lower than those in the home market.
Frequently Asked Questions (FAQs)
Eurocurrency represents any currency deposited in banks outside of its home country. Even though the term has a “euro” prefix, it has nothing specific to do with Europe or the Eurozone, or the currency euro.
The term eurocurrency refers to any currency deposited in banks of nations other than the country of its issuance. Eurodollar, however, is an example of it that signifies US-dollar deposits in foreign banks.
In a post-World War II world, many foreign governments and corporations started depositing U.S. dollars in European banks. In mid-1955, events like the fixed exchange rate system, increased imports into the U.S., the American governments’ financial aid to Europe, and the 1957 Suez Crisis led to the emergence of eurocurrency.
This has been a guide to What is Eurocurrency and its Definition. Here we discuss history, an explanation of eurocurrency and how it works, along with examples and uses. You may also have a look at the following articles to learn more –
- European Central Bank
- Fiscal PolicyFiscal PolicyFiscal policy is a government policy that is used to control a country's finances and revenue, and it includes various taxes on goods, services, and individuals, i.e., revenue collection. It has an impact on spending levels, so it is referred to as monetary policy's sister policy.
- Quantitative EasingQuantitative EasingQuantitative easing (QE) refers to that non-standard monetary policy whereby the central bank makes an open market purchase of the long-term securities such as government bonds to induce additional money in the economy.