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The Origin of The Eurocurrency Market

joeleebassy | Jan 18, 2010 |

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The origin of the Eurocurrency market-that is, the market in currency trading outside their respective domestic economy. Several factors were behind their birth.

(1). The centrally planned economies were reluctant to hold bank deposits in the United States, so they put their dollar earnings on deposit in London. Gradually other European dollar holders did the same, a tendency that was particularly marked when the United States ran large balance of payments deficits.

(2). Balance of payments pressures made the United Kingdom government limit British banks' external use of sterling, so they had a strong incentive to develop business in foreign currencies.

(3). By the end of 1958 the main industrial countries had restored full convertibility of their currencies. The new freedom produced a surge of international banking business.

The growth of the Eurocurrency market was also stimulated by certain monetary regulations in the United States. For instance, Regulation Q put a ceiling on the interest rates that banks operating in the United States could offer to domestic depositors were naturally attracted to Eurobanks that were not bound by Regulation Q. In addition, banks in the United States were required to hold non-interest-bearing reserves. By diverting dollar deposits to their offshore branches or subsidiaries, U.S. banks were able to avoid tying up so much of their funds in reserve requirements at a zero rate.

General controls on the movement of capital also helped to boost the Eurocurrency markets. One example was the introduction, in 1965, of the Voluntary Foreign Credit Restraint Program (VFCR) in the United States. The specific goal of the VFCR was to limit the growth of foreign lending by U.S. banks. Instead, their foreign branches-which were not subject to the VFCR- took deposits and onlent them outside the ceiling. Between 1964 and 1973 the number of U.S. banks with overseas branches increased from 11 to 125. The number of branches increased from 181 to 699 over the same period.

At the end of the 1960s and during the early 1970s the Eurocurrency markets, which had been located in Western Europe (and centered in London), expanded to a number of other "offshore" banking centers. These were typically small territories that had tax, exchange control, and banking laws favorable to international banks. The business was entrepot in nature, with foreign currency funds deposited by one foreign source and then onlent to another. Offshore centers have been set up in the Caribbean area, Latin America, the Middle East, and establishment of international banking facilities (IBFs) in the United States designed to bring the locus of American banking business back "onshore".

With the recent strong growth of domestic currency lending abroad, total international lending is now the most meaningful lending aggregate, and it encompasses Eurocurrency market activity.