What Are Eurodollars?
Eurodollars are U.S. dollar-denominated deposits at foreign banks or at the overseas branches of American banks. Since these deposits are held outside the United States, they are not subject to regulation by the Federal Reserve Board, including reserve requirements. Historically, dollar-denominated deposits not governed by U.S. banking regulations were held primarily in Europe, hence the name ’eurodollar’. Today, they are also prevalent in locations like the Bahamas and the Cayman Islands.
Key Takeaways
- Eurodollars refer to dollar-denominated accounts at foreign banks or the overseas branches of U.S. banks.
- The eurodollar market is among the world’s most significant capital markets, leveraging sophisticated financial instruments.
Understanding Eurodollars
The largely unregulated nature of the eurodollar market enables these deposits to pay higher interest rates. However, their offshore placement poses political and economic risks relevant to the country in which they are domiciled. Predominantly, these deposits are housed in extremely stable locations.
Ranked as a leading player in international capital markets, the eurodollar market taps a constant flow of depositors channeling funds into foreign banks. These institutions may experience liquidity challenges if deposit inflows diminish.
Short-term eurodollar deposits, encompassing terms from overnight to a week, are priced depending on the fed funds rate. Longer-term maturities use the London Interbank Offered Rate (LIBOR) for pricing. Typically large, eurodollar deposits are made by professional counterparties starting at a minimum of $100,000, often scaling beyond $5 million. Occasionally, a bank might receive a single overnight deposit as considerable as $500 million or more. In 2014, a Federal Reserve Bank study estimated the market’s average daily volume at $140 billion.
Most eurodollar market transactions are conducted overnight, maturing the next business day. Amid weekends and holidays, an overnight transaction can extend up to four days. Such transactions generally begin on the same day they are carried out, with interbank money transfers via the Fedwire or CHIPS systems. Eurodollar agreements exceeding six months’ maturity mostly occur as certificates of deposit (CDs), which feature a limited secondary market.
The Inspiring History of Eurodollars
The eurodollar market’s origins trace back to the post-World War II era. Europe faced extensive devastation, prompting the United States to deploy Marshall Plan funds to aid continental recovery. These funds propelled widespread dollar circulation overseas, fostering a distinct, lightly regulated market for these deposits. Unlike U.S.-domestic deposits, eurodollar funds fall outside Federal Reserve’s reserve requirements and lack FDIC insurance coverage, allowing for elevated interest rates.
Numerous U.S. banks operate offshore branches, particularly in the Caribbean, accepting eurodollar deposits actively in the market. European and other international banks also participate extensively. Transactions for Caribbean branches of American banks are primarily managed by traders stationed in the U.S., lending finances to support both domestic and global operations.
Related Terms: Federal Reserve Board, Fed funds rate, London Interbank Offered Rate (LIBOR), certificates of deposit (CDs), Marshall Plan.
