Another important aspect of the international financial system is the Eurocurrency market. It was originally called Eurodollar market and can be traced back as early 1950s when the communist-controlled governments of Central Europe and Eastern Europe needed dollars to finance their international trade but feared that the U.S government would confiscate their holdings of dollars in U.S banks for political reasons. They solve this problem by using European banks that were willing to maintain dollar accounts for them. Thus, Eurodollars were born which refer to U.S dollars deposited in European bank accounts.
As other banks worldwide particularly in Canada and Japan began offering dollar-denominated deposit accounts thus the term Eurodollar evolved to mean U.S dollars deposited in any bank account outside the United States. As other currencies particularly Yen and Pound Sterling became stronger after the WWII era, the Eurocurrency market broadened to include Euroyen, Europounds and other currencies. Today, Eurocurrency was defined as a currency deposited outside its country of issue.
The Euroloan market has grown up with the Eurocurrency market. The market is extremely competitive and lenders operate on a razor-thin margins. It often quoted on the basis of the London Interbank Offer Rate (LIBOR), The interest rate that london banks charge each other for short-term Eurocurrency loans. The market was often the low-cost source of loans for large, creditworthy borrowers such as governments and large multinational corporations (MNCs) for three reasons;
- Euroloans are free of costly government banking regulations, such as reserve requirements
- Euroloans involve large transactions, so that the average cost of making the loans is lower
- Only creditworthy borrowers use the Euroloan market so that the risk premium that lenders charge is low
During the 1970s, U.S banks complained that reserve requirements and other expensive regulations imposed by the Federal Reserve Board (FRB) prevented them from competing with European and Asian Banks in issuing dollar-denominated international loans but it doesn't effect foreign banks lending in Eurodollar. To counter this problem, FRB authorised the creation of International Banking Facility (IBF) in 1981.
IBF is an entity of a U.S bank that is legally distinct from the bank's domestic operations and that may offer only international banking services. It do not need to observe the numerous U.S domestic banking regulations and FRB has issued various regulations to ensure that IBF do not engage in domestic banking services. Nonetheless, IBF enable U.S banks to compete with other international bankers on a more equal footing in the critical Euroloan market