FACTORS CONTRIBUTING TO THE GROWTH OF EURO-CURRENCY (OFFSHORE)
The factors which contributed to the growth of this market were:
1. Regulation ‘Q’ of the Federal Reserve Act which imposed a ceiling on interest rates
that could be given on deposits by banks in the US. This enabled European banks to
attract US Dollar deposits by offering better interest rates.
2. Regulation ‘M’ of the Federal Reserve Act which stipulated reserves to be maintained
against deposits accepted by banks in the US. This increased the cost on deposits
for banks in USA which widened the spread between deposit and lending rates. This
feature was exploited by European banks, since they were not subject to reserve
requirements on Euro-Dollar deposits.
3. The mandatory requirement on all banks in the US to insure deposits accepted by
them from the public. The Euro-Currency market is unregulated which means Eurobanks
were under no obligation to insure Euro-Currency deposits. This reduced their
cost on deposits.
4. The Interest Equalization Tax introduced by the US monetary authority in 1963
resulted in increasing the effective cost of borrowing in the United States for nonresident
entities. They therefore approached the offshore market for their funding
needs since Euro-banks were not subject to the ‘Interest Equalisation Tax’.
5. The Voluntary Restraint Program was introduced in the US in 1965 in terms of which,
borrowing in the US for financing international projects was restricted. The US banks
were discouraged from making loans to international borrowers. The guidelines were
replaced by mandatory restrictions on outbound direct investments in 1968.
Effectively, US Multinationals were also, now constrained to borrow in the offshore
market for their international projects.
6. Persons not resident in the US have unequal cash flows in USD. They acquire USD
by exporting to the US and need the same to pay for imports from the US. At both
times, conversion into/from domestic currency is involved. Such entities deposited
their export proceeds with Euro-banks and withdrew them when needed to pay for
imports. It became possible for such entities to maintain foreign currency resources,
without incurring conversion cost, without exchange rate risk, earn the higher deposit
rates available in the Euro-Currency market and have the convenience of dealing
with local banks.