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Definition and Origin of Euro-currency
Evolution and Growth of Eurocurrency Markets, Although the words Eurocurrency or Eurodollar don’t make any sense in the literal perspective, a dive into the history solves this dilemma for us. Prior to 1950s, the English pounds (£) were used as the currency for the transaction of the international trade. The English banks used to lend the £ and accept the deposits. However, the Suez Canal crisis during 1956 put downward pressure on the £.
As a result the English banks were prohibited to lend £’s to the international borrowers. The reason for this strategy was simple. If the foreigners didn’t have any £’s, they will not be able to put pressure on the £’s by selling them. This made the banks unhappy because a very profitable business opportunity was taken away from them (MacKinnon, R. I. 1977, p. 6). The international trade however could not stop amid this crisis. The English banks hence started accepting the deposits in US$ to finance the trade. This was the inception of Eurocurrency market.
Eurocurrency is the word for the deposit of a currency in any country other than the country of its origin. For instance, Japanese Yen in a bank in US is Eurocurrency and US$ in a bank in Japan is also an example of Eurocurrency. It has nothing to do with the Euros (€). It is only due to the historic nature of the concept since the markets were initially located mainly in Europe.
Besides the restriction from the Bank of England at the use of sterling as the currency for international transactions and lending to the foreigners, the interest rate ceiling in United States also encouraged the depositors to move their funds to the banks offshore to facilitate from the better market interest rates.
Since the beginning of Eurocurrency in the 1950s, several regulations were introduced to shape the international financing the way we see it now. During the oil crisis of 1973, the international lending became very common and frequent by the oil importing countries (MacKinnon, R. I. 1977, p. 6). Although the Eurocurrency market has a huge share in the international financial markets and has a greater worth than the orthodox commercial banking.
McKinnon, however believes that the Eurocurrency markets are unnecessary (1977, p. 1). The participants in this market today use it to hedge their foreign exchange risk and other risks associated with the international trade while it was originally created to finance the trade only. This is mainly due to the profit seeking greed which is a common by product of the banking system. According to McKinnon, R. I. the commercial banks can easily facilitate the traders for the payments where a bank in US will only accept the deposits in US$ and will lend in terms of US$.
The Eurobanks are those banks which provide the Eurocurrency for the transaction or are involved in other financial activities related to the Eurocurrency. These banks are able to offer lower rates to the borrowers and higher rates to the lenders than other domestic banks. The reason for this difference is mainly due to the relaxation in the regulations for the Eurobanks by the central bank. These banks mainly deal in huge amount, and generally consider US$ one million as one unit. The clients are also huge firms which automatically reduces the default risk. This not only allows the Eurobanks to get an exemption from the rigorous terms and conditions and reserve ratios from the central banks, but also allows to transfer this lower cost of banking on to its customers.
Financial Instruments related to Eurocurrency
The financial markets have been extremely adaptive in last few decades. The customization in the financial securities keeps happening and the market keeps adopting them instead of resenting such changes which not only complicate the daily transactions but also pose a threat to the viability of the market and increase the probability of incurring huge losses. This is a reason for the prevalent opinion which regards the use of derivatives, a major tool of customization of the financial securities, being the ultimate weapon of mass destruction.
The Eurocurrency market is no different. The concept of Eurocurrency was initially introduced as an alternative to the payment methods for international trading but conveniently extended itself to profit seeking by those who transferred their money from the US banks to the international or European banks. This was the beginning of the financial instruments being incorporated in the Eurocurrency market. Today, several other instruments have established themselves in this market which are mentioned and briefly discussed in the following section.
Eurocurrency Depository Receipts:
The eurocurrency depository receipts are were first introduced in the US in order to provide the US investors an opportunity to invest in the companies that choose not to register on the American exchanges for the trade of their stocks and other financial securities. They are called ADRs or American Depository Securities.
American depository securities are the easiest way to buy the stocks of the companies which are not based in the US. The mechanism of the ADRs is simple if the concept of Eurocurrency is kept in mind. The brokers buy the shares of the foreign company and delivers them to the custodian bank which is based in the foreign country. The broker then deals with another bank called the depository bank which then issues the receipts based on the purchased shares. These receipts can then be regarded …
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