The Development of the Eurodollar Market

Euro Markets are unregulated Money and Capital markets. These markets are spread over Europe, Middle East and Asia. Short-term Euro markets are called as “Euro- currency Markets”. Any currency held outside to home country is referred to as Euro-currency. For example when a Dollar is held as a deposit outside the U.S. is referred to as Euro-Dollar, Similarly a deposit in Marks, outside Germany is called as a Euro-Mark deposit.

The Dollar was and still is widely used to settle the international payments. Although there is an increase in European Deposits, denominated in Euro, Pound sterling, Yen etc., by far the U.S. Dollar still remains the most popular Euro-currency. The preference for Dollars can be attributed to the relative political stability and the absence of severe restrictions in the U.S. It thus facilitates high liquidity to Dollar—denominated deposits.

There are many reasons which have helped to popularize Euro Dollar deposits. Some of these are discussed in detail here.

Americans could prefer to hold their Dollars outside the U.S. This may be attributed sometimes to the numerous financial services provided by foreign banks as compared to American Banks. Further, at regulations and restrictions are capital outflow by the U.S. Similarly, at times the U.S. may lay restrictions and the Americans restraining them from depositing in foreign securities. In such cases it would be advantageous for the Americans to have Dollar Deposits outside the U.S. as they can use their Euro Dollar deposit whenever they require it, without fear of any restrictions being laid.

During the 1960s, the U.S. banks and financial institutions had to abide by the restrictions placed an the maximum rate of interest that they could pay an the deposits placed with them of particular interest are the “Q” and “M” regulations placed by the U.S. Federal Reserve Board. The Q regulations restricted the interest rates on deposits. The U.S. Banks, inside the U.S. were subject to such restrictions. Many U.S. Banks outside the U.S. were not subject to such restrictions. This fact has attracted large volumes of Dollar Deposits outside the U.S. A large part of dollar deposits had flown out of the Country prior to deregulation and continued to remain there through the tenure of the deposit, some of these deposits on maturity, were reinvested in the U.S. since interest differentials ceased to exist.

Another contributory to the movement of dollar deposits outside the U.S. was the “M” regulations. It stipulated holding of reserves against deposits. These regulations were not applicable to deposits with overseas branches of U.S. Banks. On account of reserves, which are idle funds, the cost of operation in U.S. was naturally much higher than abroad. The U.S. Banks preferred to shift some of their dollar deposits outside the U.S. to less regulated or unregulated markets.

Yet another reason for the dollar deposits outside the U.S. being more attractive was the absence of the need to pay for Deposit Insurance. The Dollar deposits inside the U.S. were required to be covered by deposit insurance.

Euro Dollar markets also grew as a measure to avoid interest equalization tax levied on U.S. lenders earnings abroad. Foreigners in U.S. have also in U.S. Have also shown greater interest in Euro—markets, since 1979 when Iranian assets were frozen by the U.S. Between 1975 and 1988, the Euro Dollar market had recorded an annual average growth of 17% Euro deposits had steadily increased over the years, in spite of the removal of restrictions initially placed by the Federal Reserve.

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