What it means
The label describes where the money sits, not what the money is. Any freely traded currency becomes a eurocurrency the moment it is deposited with a bank outside its home jurisdiction, because the deposit then falls outside that country's domestic banking rules.
That regulatory gap is the whole point. Domestic deposits carry costs for the bank: reserve requirements, deposit insurance levies and local lending restrictions.
A bank booking the same deposit offshore avoids some of those costs, so it can pay slightly more to the depositor and charge slightly less to the borrower. In practice these are wholesale instruments rather than anything a retail saver would meet.
Deposits are usually in round amounts of $1,000,000 or more, with terms running from overnight to twelve months, and interest is quoted as a simple annual rate on a 360-day year. The nuance worth recognising is risk.
A eurocurrency deposit sits outside the depositor's home safety net, so there is no domestic deposit insurance standing behind it and the saver is relying on the bank's own strength plus the rules of the host country. That extra risk is the price of the better rate.
Naming follows the currency: dollars held offshore are eurodollars, yen held offshore are euroyen, and sterling held offshore is eurosterling. Confusingly, dollars deposited in a Tokyo bank are still called eurodollars, because the prefix now simply means "offshore" rather than "in Europe".
In practice
Real-world examples.
Example
A software company in Texas closes a funding round and holds $40,000,000 it will not need for four months. Its treasurer places $25,000,000 as a eurodollar time deposit with a bank in the Cayman Islands at a rate 15 basis points above the best onshore offer, and keeps the rest in an operating account for payroll.
Example
A German machinery exporter is paid in yen by a Japanese customer and does not want to convert immediately. It parks the yen as a euroyen deposit with its bank in Frankfurt for 60 days, earning interest in yen while its hedging desk decides when to sell the currency.
Example
A commodity trading house in Geneva needs dollars for three months to finance a cargo. Rather than borrowing onshore in New York, it borrows eurodollars from a London bank, which funds the loan out of its own pool of offshore dollar deposits.
Formula
Calculation
Interest on a eurocurrency deposit = principal x annual rate x (days / 360).
A corporate treasurer places $10,000,000 with a London bank for 90 days at a quoted rate of 5%.
Day count fraction = 90 / 360 = 0.25.
Interest = $10,000,000 x 5% x 0.25 = $10,000,000 x 0.0125 = $125,000.
At maturity the bank repays $10,000,000 + $125,000 = $10,125,000. Note that using a 360-day year rather than 365 flatters the quoted rate slightly: the same $125,000 over 90 actual days out of 365 is an effective annual simple rate of about 5.07%.Case study
Seen in the real world.
This is an illustrative, fictional example. Calderwood Instruments, an invented medical devices manufacturer, sold a division and found itself holding $60,000,000 of cash that would be spent on a new factory in nine months. Its finance director was told by the company's onshore bank that a nine-month domestic deposit would pay 4.60%.
The treasury team asked the same bank for a eurodollar quote through its offshore branch and was offered 4.85%, worth roughly $112,500 more over nine months on $60,000,000. Before accepting, the team checked what it was giving up: the offshore deposit carried no domestic deposit protection, could not be broken early without a fee, and exposed Calderwood to the rules of the host jurisdiction if the bank failed.
The board approved a compromise. Calderwood placed $40,000,000 offshore and kept $20,000,000 onshore in instantly accessible form, deciding that the extra yield was worth having but not worth concentrating the whole construction budget in one unprotected deposit.
Watch out
Common mistakes.
- Assuming eurocurrency means euros. The prefix refers to offshore deposits generally, and eurocurrency deposits are most commonly denominated in US dollars.
- Believing the money physically travels abroad. The deposit is a bookkeeping entry at an offshore branch or bank, and dollar balances still ultimately settle through the US payment system.
- Treating a eurocurrency deposit as being as safe as an insured domestic deposit. There is no domestic deposit insurance and recovery in a bank failure depends on the host country's law.
Questions
People also ask.
Why do banks pay more on eurocurrency deposits?
Offshore deposits escape some reserve requirements and insurance levies, so the bank's cost of holding them is lower and it can share part of that saving with the depositor.
Is eurocurrency lending legal?
Yes, it is a long-established part of wholesale banking, regulated by the host jurisdiction and by the home supervisor of the parent bank.
Can a small business use this market?
Rarely in a direct sense, because minimum sizes usually start around $1,000,000, but smaller borrowers feel its influence through the benchmark rates that price their own loans.
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