The Euro currency markets serve three basic functions.
- They are extensively used for foreign exchange hedging purposes as the banks seek to balance out their foreign assets and liabilities. The banks, therefore, take positions in the Euro-currency markets to cover the forward commitments they have made with their customers.
- Euro currency markets can at times bypass domestic channels of financial ‘intermediation’ especially when governments impose tight credit policies. For example, US Corporation can acquire Eurodollars in London. These deposits may be US domestic dollar deposits that have been transferred abroad during a US domestic credit squeeze.
- Function of the market is the full international intermediation role of channellizing surplus liquid resources from, say, OPEC countries or corporations who need to borrow.
The most important Euro currency markets are Eurodollar, Euro mark and Euro-sterlling. Euro-currency market operates only in currencies that are freely convertible into other currencies, such as the US dollar and the German mark, and only outside that currencies-Country of Origin. Euro banks are, therefore, located in countries which do not regulate their foreign currency banking activities.
The Euro-currency markets are money markets rather than foreign exchange markets. Their importance in the context of international financial management is that they provide an alternative source of funds to domestic banks. A wide range of participants make use of the Euro-currency markets.
Types of Euro-currency Loans – The following types of Euro-currency loans are available in the Euro-currency markets
- Fixed interest loans are usually over a medium term of up to five years, and the borrower knows in advance what the interest payments will be.
- Stand-by credits are overdraft facilities offered by banks to customers in Euro-currency.
- Most Euro-currency loans are roll-over loans, where the bank agrees to make funds available over a given period of time, say five years, but the interest rate is open to renegotiation every three or six months.
- A number of banks may form themselves into a syndicate in order to provide a large loan to a single customer over a period that is longer than usual. Such loans are called’ syndicated loans:
The advantages to the borrower of using Euro-markets are that lenders on the domestic market may discriminate, or larger sums may be required than are available in the home markets, or it may be deemed necessary to avoid the possibility of exchange control barriers.
Due to the considerable competitive advantages compared with the domestic banking systems, Euro-currency market has its tremendous economic significance nowadays. The most important role is that through the Euro-currency market the total volume of the world credit will be increased. While the domestic banks cannot involve in such business since the imposed regulation and strict reserve requirement from the central bank. Moreover, it adds the arbitrage opportunities and widens the definition of arbitrage. Finally, as their economies of scale and other competitive position against the domestic banks, the Euro-banks can contribute more to the efficient international allocation of credit than those in domestic markets and in the mean while promote economic growth.