What Is the Eurodollar?
Let me explain what a eurodollar is: it's an unsecured deposit denominated in U.S. dollars, held at a foreign bank or an overseas branch of an American bank. Since these deposits are outside the United States, they're not regulated by the Federal Reserve Board, including rules on reserve requirements.
These dollar-denominated deposits, free from U.S. banking regulations, started mostly in Europe—that's where the name comes from—but you can find them anywhere outside the U.S. Places like the Bahamas and Cayman Islands hold huge amounts of them.
Key Takeaways
Here's what you need to know: eurodollars are unsecured, dollar-based accounts at foreign or overseas U.S. bank branches. The market isn't regulated by the Federal Reserve. These accounts can give you higher interest rates than domestic banks, but they come with more risks. Overall, the eurodollar market is one of the biggest capital markets globally, dealing in sophisticated financial instruments.
Understanding the Eurodollar
The eurodollar market's lack of regulation means lower costs, so these deposits can pay higher interest. That same lack of protections adds to the rates as compensation for potential risks. Being offshore, they're exposed to political and economic risks in the host country, though most are in stable locations.
This market is a key international capital source, offering short-term unsecured funding for corporations and institutions. Borrowing here can be cheaper than elsewhere. Companies with foreign exchange exposure also use eurodollar funds for hedging.
Liquidity in the Eurodollar Market
The market relies on a steady flow of depositors into foreign banks. If deposits drop, these banks could face liquidity issues. Deposits are large—starting at $100,000, often over $5 million, and it's common to see $500 million or more in overnight deals.
From 2019 to 2024, the New York Federal Reserve reports an average daily volume of $150 billion for overnight eurodollar and selected deposit transactions. Most are overnight, maturing the next business day, which could stretch to four days with weekends or holidays. Transactions start the same day, using systems like Fedwire and CHIPS. Longer maturities over six months often use certificates of deposit, with a limited secondary market.
Example of Eurodollars
Suppose a U.S. company has extra cash it doesn't need right away. It could deposit it in dollars at a bank outside the U.S. That deposit stays in dollars and might earn higher interest than at a U.S. bank.
Many U.S. banks have branches in the Caribbean accepting these deposits. European banks are active too. For Caribbean branches, traders in U.S. dealing rooms handle the transactions, and the funds support domestic and international operations.
History of the Eurodollar
The eurodollar market began after World War II, when Europe was rebuilding with U.S. Marshall Plan funds. This spread dollars overseas, creating a less regulated market for those deposits. Unlike U.S. deposits, they're not under Federal Reserve reserve rules or FDIC-insured, leading to higher interest rates.
Can Americans Invest in Eurodollars?
Yes, you can invest in eurodollars through mutual funds focused on eurodollar futures. If you have access to overseas banks, set up a dollar-denominated account or CD abroad. But these are usually for millions, out of reach for most individuals. They're not under U.S. rules but follow the host country's laws.
Who Are the Primary Borrowers in Eurodollars?
The main borrowers are U.S. branches and agencies of foreign banks, borrowing $50 billion to $200 billion daily on average. They also borrow a lot in the fed funds market.
How Risky Are Eurodollars?
Eurodollars lack the reserve requirements and FDIC protections of U.S. accounts, adding significant risk. The federal government won't bail out these overseas institutions if they fail.
The Bottom Line
Despite the name, eurodollars aren't tied to the euro or EU—they're just dollar deposits at overseas banks. You get higher interest than domestic options, but with greater risks.
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