Explain the features and growth of euro-currency market.
Answers
Features of Euro Market
(1) Whole sale market:- Euro currency market is wholesale market. Size of
transactions is large. Transactions are rarely for less than $ 1 million and sometimes
they are for $ 100 million.
(2) Inter-Bank operations :- The vast bulk of Euro currency market is confined to inter
bank operations.
(3) Unsecured credits:- No doubt Euro currency borrowers are big corporate who have
status and name in the market and thus credit risk is comparatively low . As, Euro
currency loans are unsecured credits, special attention is required to judge credit
worthiness of borrower before providing any loan.
(4) Concentrated :- Euro currency market is focused upon London who is almost 1/3 of
Euro currency market.
(5) Telephone linked :- Euro currency market is linked through Tele communication
which has facilitated Euro currency transaction.
(6) Commercial banks :- Commercial banks play dominant role in Euro currency
market. They act as both depositors and lenders . They accept primary deposits &
enter into inter bank transactions with Euro banks. These features led investors to
move their funds more freely. It gives gave lenders and borrowers more options .
(7) Maturity Transformation :- Euro banks are also engaged in maturity transformation
by borrowing short and lending long .
The following factors led to its growth:
1. Flow of US Aid:
The United States emerged as the most powerful nation in the post-war period which spent huge sums of money on the rehabilitation of Europe both in terms of economic and military aid. This led to the transfer of a large number of dollars in Euro-banks.
2. Cold War:
The cold war which started in the 1950s led the Soviet Union and the East European government to transfer their dollar deposits from America to Euro-banks for fear that they might be blocked by the American Government.
3. Decline in the Importance of Sterling:
In the post-war period Britain emerged as a debtor country. Consequently, the British sterling which had dominated the international financial market in the pre-war era gave place to the dollar in the post-war period. The importance of sterling further fell when the British Government placed severe restrictions on the grant of sterling to central banks outside the sterling area under the British Exchange Control Act in the early post-war period.
4. Regulation-Q:
Regulation-Q of the US Federal Reserve System had been a major factor which gave rise to the Euro-currency market in the late 1960s. Under Regulation-Q, a ceiling was imposed on the interest rate payable on time deposits with the US banks and it prohibited the payment of any interest at all on deposits up to 30 days.
This encouraged the US banks to open branches in Europe and attract dollar deposits to be used for financing international trade. In particular, this happened in 1968 and 1969 and again from 1979 onwards when the Regulation-Q ceiling kept low interest rates on time deposits.
Consequently, both the US citizens and foreigners having dollars in excess of their transactions requirements transferred them in Euro-banks because they paid higher interest rate than the US banks. This also encouraged European lenders and borrowers to trade in dollars and their currencies in London and other European financial markets rather than in New York.
5. Other US Measures:
There were some other measures which hampered the capacity of US banks to compete for international business including curbs on the release of taxes on profits earned by foreigners in the United States, the introduction of the Interest Equalisation Tax in 1964, controls over the US direct investment abroad, and tight monetary policy to control inflationary pressures. These led to heavy borrowing by US banks from the Euro-currency market to meet the demand for dollars in the US.
6. BOP Deficits in US:
There have been large and persistent BOP deficits in the US thereby leading to the outflow of the US dollars to the Euro-banks in countries having surplus with it.
7. Petro-dollars:
The increase in the oil prices since 1973 has resulted in the tremendous increase in the incomes of the oil producing countries of the world which are known as petro-dollars. These are deposited in Euro-banks. These have further expanded the Euro-currency market.
petro dollar and cold War is the main reason