Eurocurrency Explained: What It Is & How It Works

Eurocurrency is a currency that is deposited at a foreign bank outside of its home country. Contrary to its name, the term does not refer to euros that are deposited outside of Europe. It is a general term that applies to all currencies that are deposited anywhere outside of its local country. For example, if you deposit Japanese yen at a bank in the United States, it is considered to be Eurocurrency.

History of Eurocurrency

The Eurodollar is considered to be the initial origin of Eurocurrency. The Eurodollar was initially a term that refers to how USD was deposited in banks in Europe, especially London. European banks held a lot of USD after World War II, as the United States provided financial aid to Europe.

The fixed exchange rate system at that time also created an opportunity for more countries to invest in USD. Eventually, the Eurodollar transitioned to become Eurocurrency due to globalizationGlobalizationGlobalization is the unification and interaction of the world's individuals, governments, companies, and countries. It has been accomplished through the. More individuals around the world began to deposit local currency at a foreign bank outside of Europe.

Although it is used all around the world, London remains the center of the Eurocurrency market at present. It’s been able to maintain a competitive advantageCompetitive AdvantageA competitive advantage is an attribute that enables a company to outperform its competitors. It allows a company to achieve superior margins in the market because of the freedom in regulations in the commercial banking sector.

Therefore, banks in London are able to provide interest rates that pertain to the class of the borrower and lender, increasing the use of Eurocurrencies in London, while the rest of Europe adhere to tighter banking restrictions.

Uses of Eurocurrency

Eurocurrency is commonly used by corporations and financial institutions, such as mutual fundsMutual FundsA mutual fund is a pool of money collected from many investors for the purpose of investing in stocks, bonds, or other securities. Mutual funds are owned by a group of investors and managed by professionals. Learn about the various types of fund, how they work, and benefits and tradeoffs of investing in them and hedge funds, in order to receive financing. It is often seen as an advantageous source of capital and a beneficial way to receive international funding because of its ability to switch to other foreign currencies.

It is also an attractive choice as a financial instrument because local interest rates can be avoided due to relaxed restrictions in comparison to local banking regulations. Therefore, many individuals and businesses use foreign currencies as a way to protect themselves against risks in foreign exchange and international tradeInternational TradeInternational trade is an exchange involving a good or service conducted between at least two different countries. The exchanges can be.

Eurobanks

A Eurobank is a financial institution that allows the deposits and loans of foreign currency. In other words, a Eurobank is a bank that accepts the use of Eurocurrency as a financial instrument. A Eurobank can be located anywhere in the world – it does not need to be located in Europe only. For example, a bank located in Canada that holds South Korean won is considered to be a Eurobank.

Eurobanks enjoy restrictions and regulations that are more relaxed in comparison to typical banks, which allows them to reduce their operating costs. In turn, they are able to offer clients a lower cost of banking. For example, Eurobanks are able to offer foreign currency at low interest rates to the borrower and high interest rates to the lender. They can do so because the Eurocurrency market does not have restrictions for interest rate ceilings.

Eurobanks often make transactions with foreign currency in large amounts, as $1 million is often considered to be one unit. It is because the clients are usually businesses or large corporations that use Eurocurrencies to reduce financial risks.

Additional Resources

CFI offers the Financial Modeling & Valuation Analyst (FMVA)®Become a Certified Financial Modeling & Valuation Analyst (FMVA)®CFI's Financial Modeling and Valuation Analyst (FMVA)® certification will help you gain the confidence you need in your finance career. Enroll today! certification program for those who want to gain essential skills to become a world-class financial analyst. To keep learning and developing your career, the following CFI resources will be helpful:

• Currency RiskCurrency RiskCurrency risk, or exchange rate risk, refers to the exposure faced by investors or companies that operate across different countries, in regard to unpredictable gains or losses due to changes in the value of one currency in relation to another currency.
• Foreign Exchange Gain/LossForeign Exchange Gain/LossA foreign exchange gain/loss occurs when a company buys and/or sells goods and services in a foreign currency, and that currency fluctuates
• Virtual CurrencyVirtual CurrencyVirtual currency is a type of unregulated digital currency. It is not issued or controlled by a central bank. Examples of virtual currencies include Bitcoin
• Fixed vs Pegged Exchange RatesFixed vs. Pegged Exchange RatesForeign currency exchange rates measure one currency's strength relative to another. The strength of a currency depends on a number of factors such as its inflation rate, prevailing interest rates in its home country, or the stability of the government, to name a few.