A Eurodollar deposit is a US dollar deposit placed with a bank outside the United States. This article discusses money market deposits generally with a focus on Eurodollar deposits and other related Eurocurrency deposits.
A deposit is a sum of money placed with a bank for safe keeping and possibly to earn interest. Individuals may be familiar with demand deposits, which they can place with a bank for no specific maturity. The money can be withdrawn at any time without penalty. A time deposit has a fixed maturity, and there is a penalty for early withdrawal.
Money market deposits are large-denomination time deposits. Terms range from overnight to one year. Interest accrues until maturity. Interest rates for most currencies are quoted as a simple interest rate with an actual/360 day count. The exception is British pound deposits, which are also quoted with simple interest but on an actual/365 basis. For major currencies, the rates banks are offering one another on new deposits are reported by the British Bankers Association as daily Libor rates, although the future of that arrangement is uncertain following a 2013 rate rigging scandal. For Euro deposits, Euribor has traditionally been a reference rate.
Money market deposits are non-negotiable. This means they cannot be traded or otherwise transferred to another party. This is what distinguishes a money market deposit from a certificate of deposit, which is negotiable. To compensate depositors for their relative lack of liquidity, money market deposits tend to offer slightly higher interest rates than certificates of deposit.
Historically, it was the convention that a bank branch would only accept deposits in the domestic currency where it was located. For example, a British bank would only accept British pound deposits at its branches in the UK. If it wanted to accept Japanese yen deposits, it would open a branch in Japan to accept those deposits. Prior to the 1950s, exceptions to this convention were rare. Then things started to change.
During the Cold War, Soviet-block nations often had to pay for imports with US dollars—or receive US dollars for their exports. They were loath to leave their dollar deposits with banks in the United States due to the risk of those deposits being frozen or seized. Instead, they started placing the deposits with European banks. Because they were US dollars held in Europe, the funds came to be known as Eurodollars, and the deposits were Eurodollar deposits. The banks started to lend those deposited dollars out. This was the beginning of the Eurodollar market.
As the US dollar increasingly became the currency for international trade, European banks expanded their Eurodollar operations, taking deposits and making loans in dollars to ensure themselves a continuing role in international finance. The market was further fueled by financial regulations in the United States, which drove dollar deposits offshore. Regulation Q capped the interest rates US banks could offer on domestic deposits, but Eurodollar deposits were not subject to those caps. When interest rates shot up in the early 1980s, dollar deposits migrated from the United States to Europe. Regulation Q was rescinded as of 1986. However, the United States was then requiring banks to hold capital against deposits. This was an expense European banks didn’t face. They were still able to offer higher rates on deposits, and the Eurodollar market continued to grow. Today, America’s persistent balance of payments deficit continues to ensure a ready supply of dollars available for Eurodollar deposits.
The Eurodollar market has become global, so its name is a bit of a misnomer. A bank in Japan or Singapore may accept dollar deposits, but these are still called Eurodollar deposits. The market also includes other currencies, so there are Eurosterling, Euroyen, Euroswiss, etc. To confuse matters, in 1999, the European Union embraced the euro as its new currency, so you can now hear of Euroeuro. Eurocurrency is the general term for any currency deposited in bank branches outside countries where it is the national currency.
Money market deposits tend to be spot. That is, they commence in two business days (or two “target” days for deposits of European euros). Other settlement is available. An overnight deposit must have cash (immediate) settlement, by definition. Forward deposits are also possible. A forward rate agreement (FRA) is a forward on a deposit structured as a cash-settled derivative. There are also cash-settled futures on money market deposits. These are called Eurodollar futures, Euroyen futures, etc.