World Bank Document

Box 8.3 The origins of the Eurocurrency markets
The origins of the Eurocurrency markets-that is, the The growth of the Eurocurrency market was also stimmarkets
in currencies traded outside their respective ulated by certain monetary regulations in the United
domestic economies-go back to the late 1950s and early States. For instance, Regulation Q put a ceiling on the
1960s. Several factors were behind their birth. interest rates that banks operating in the United States
* The centrally planned economies were reluctant to could offer to domestic depositors. Since market rates
hold bank deposits in the United States, so they put their often went above the ceiling, depositors were naturally
dollar earnings on deposit in London. Gradually other attracted to Eurobanks that were not bound by Regula-
European dollar holders did the same, a tendency that tion Q. In addition, banks in the United States were
was particularly marked when the United States ran required to hold non-interest-bearing reserves. By
large balance of payments deficits. diverting dollar deposits to their offshore branches or
* Balance of payments pressures made the United subsidiaries, U.S. banks were able to avoid tying up so
Kingdom government limit British banks' external use of much of their funds in reserve requirements at a zero
sterling, so they had a strong incentive to develop busi- rate.
ness in foreign currencies. General controls on the movement of capital also
* By the end of 1958 the main industrial countries had helped to boost the Eurocurrency markets. One example
restored full convertibility of their currencies. The new was the introduction, in 1965, of the Voluntary Foreign
freedom produced a surge of international banking busi- Credit Restraint Program (VFCR) in the United States.
ness.
The specific goal of the VFCR was to limit the growth of
foreign lending by U.S. banks. Instead, their foreign
Box figure 8.3A Stock of international and branches-which were not subject to the VFCR-took
Eurocurrency loans, 1973-84
deposits and onlent them outside the ceiling. Between
1964 and 1973 the number of U.S. banks with overseas
Billions of dollars branches increased from 11 to 125. The number of
2,800 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 Westem
Europe (and centered in London), expanded to a
International loans number of other "offshore" banking centers. These
2,000 / _ were typically small territories that had tax, exchange
control, and banking laws favorable to international
banks. The business was entrep6t in nature, with foreign
currency funds deposited by one foreign source and then
1,000 onlent to another. Offshore centers have been set up in
the Caribbean area, Latin America, the Middle East, and
Southeast Asia. A recent development has been the
Eurocurrency loans establishment of international banking facilities (IBFs) in
the United States designed to bring the locus of Ameri-
O1
can banking business back "onshore."
1973 1976 1979 1982
With the recent strong growth of domestic currency
lending abroad, total international lending is now the
Note: Data indicate stock at the end of the last quarter of each year, most meaningful lending aggregate, and it encompasses
except data for 1984 are as of the end of the third quarter.
Eurocurrency market activity. Box figure 8.3A shows the
Source: BIS Quarterly Report 1974-85.
growing stock of total bank lending alongside that of the
Eurocurrency market.
the returns on lending to these countries would be default clause specifies that the loan will be considhigh
compared with the risks involved. Aside from ered to be in default if the borrower defaults on
the direct returns they expected on loans, banks any other loan. It strengthened the guarantee on
wanted to develop a wider and more profitable sovereign loans and blurred the differences in risk
business relationship with developing countries. between individual borrowers or projects within a
* The development of mechanisms for dealing with developing country. Hence, bankers paid less
sovereign risk. One important development that attention to the viability of the particular projects
helped banks overcome their concern about sover- they financed, and more to macroeconomic condieign
risk was the introduction of a cross-default tions in borrowing countries. Furthermore, if a
clause covering publicly guaranteed debt. A cross- developing-country borrower defaulted, cross-
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