Eurocurrency markets, specifically the Eurodollar market, is said to have originated, ironically enough, with the Russian authorities seeking dollar-denominated deposits with banks in Britain and France. During the 1950s, the erstwhile USSR was earning dollars from the sale of gold and other commodities and wanted to use them to buy grain and other products from the West, mainly from the US. However, they did not want to keep these dollars on deposit with banks in New York as they were apprehensive that the US government might freeze the deposits if the cold war intensified. They approached banks in Britain and France who accepted these dollar deposits and invested them partly in US.
The subsequent enormous growth of the eurodollar market was however due to a number of other factors.
On the supply side, the impetus for growth derived from the various restrictions imposed by the US authorities on domestic banks and capital markets. Throughout the 60s and 70s American banks and other depository institutions had to observe ceilings on the rate of interest they could pay on deposits. 6 These restrictions did not apply to branches of American banks located outside the US, and a number of American banks began accepting dollar deposits in their foreign branches. The dollars so obtained were often reinvested in the US. Most of these restrictions had been lifted by mid seventies.
Secondly, domestic banks in US (as in many other countries) were subjected to reserve requirements which meant that a part of their deposits were locked up in relatively low yielding assets.
The requirement did not apply to dollar deposits held in foreign branches of American banks (except between 1969 and 1978). The result was banks outside US could offer better rates to depositors (slightly higher) and to borrowers (slightly lower) than their domestic counterparts. Absence of deposit insurance on deposits held outside was also an added factor. This absence of regulation continues to be a factor in favour of Euromarkets.
A third reason is that due to the importance of the dollar as a vehicle currency in international trade and finance, many European corporations have cash flows in dollars and hence temporary dollar surpluses. Due to distance and time zone problems, as well as their greater familiarity with European banks, these companies preferred to keep their surplus dollars in European banks, a choice made more attractive by the higher rates offered by Eurobanks.
These supply side the factors were reinforced by demand for Eurodollar loan by non-US entities and by US multinationals to finance their foreign operations. During the sixties as the US
balance of payments dlfl1culties started _rowing, the US government imposed a series of restrictions which made it difficult and / or more expensive for foreign entities to borrow in the US. The voluntary foreign credit restraints of 1963. followed by mandatory controls on foreign lending, and the interest equalization tax (a tax on interest QI\I’n4ld by US residents from foreigners) induced channeling of funds through the Eurodollar markets where these regulations did not apply.