Eurocurrency Market: Definition, History, and Types of Markets

What Is the Eurocurrency Market?

The eurocurrency market is a money market for currency outside the country where it's legal tender. The market is used by banks, multinational corporations, mutual funds, and hedge funds to circumvent the regulatory requirements, tax laws, and interest rate caps that are often present in domestic banking, particularly in the United States.

The term eurocurrency is a generalization of eurodollar and shouldn't be confused with the EU currency, the euro. The eurocurrency market functions in many financial centers around the world, not just in Europe.

Understanding the Eurocurrency Market

The eurocurrency market originated in the aftermath of World War II when the Marshall Plan to rebuild Europe sent a flood of dollars overseas. The market developed first in London when banks needed a market for dollar deposits outside the United States.

Dollars held outside the U.S. are referred to as eurodollars even if they're held in markets outside Europe such as Singapore or the Cayman Islands.

The eurocurrency market has expanded to include other currencies such as the Japanese yen and the British pound whenever they trade outside their home markets. The eurodollar market remains the largest, however.

Interest rates paid on deposits in the eurocurrency market are typically higher than those in the domestic market because the depositor isn't protected by the same national banking laws. It doesn't have governmental deposit insurance. Rates on eurocurrency loans are typically lower than those in the domestic market for the same reasons. Eurocurrency bank accounts aren't subject to the same reserve requirements as domestic accounts, either.

Types of Eurocurrency Markets

Eurodollar

Eurodollars were the first eurocurrency and they still have the most influence. U.S. banks can have overseas operations dealing in eurodollars. These subsidiaries are often registered in the Caribbean. The majority of actual trading takes place in the United States, however.

The eurodollar typically trades overnight but deposits and loans of up to 12 months are possible. Transactions are usually for a minimum of $25 million and can top $1 billion in a single deposit.

Euroyen

The offshore euroyen market was established in the 1980s and expanded with Japan's economic influence. The higher rates paid by euroyen accounts became more attractive as interest rates declined in Japan during the 1990s.

Eurobond

There's an active bond market for countries, companies, and financial institutions to borrow in currencies outside their domestic markets.

The first such eurobond was issued by the Italian company Autostrade in 1963. It borrowed $15 million for 15 years in a deal arranged in London and listed on the Luxembourg stock exchange.

The Bottom Line

The main benefit of eurocurrency markets is that they're more competitive. They can simultaneously offer lower interest rates for borrowers and higher interest rates for lenders because they're less regulated. Eurocurrency markets face higher risks, however, particularly during a run on the banks.