The Eurodollar Market and Offshore Dollar Funding
Dollars held in bank accounts outside the United States are still dollars, still lent and borrowed like any deposit, but they sit entirely outside the reach of US domestic banking regulation — a huge, largely invisible funding market with its own rules.
Prerequisites: The Money Market and the Short End of the Curve
A dollar deposited at a bank branch in London is still a dollar — it can be lent, borrowed, and used to settle payments just like a dollar in New York. But because that deposit sits outside the United States, it isn't subject to US domestic bank reserve requirements or deposit insurance rules. This distinction — same currency, different regulatory jurisdiction — created the Eurodollar market, a huge pool of dollar deposits and loans held entirely outside US borders, and it has nothing to do with the euro currency (the market predates the euro by decades; "Euro-" here just means "offshore").
Eurodollars are ordinary US dollar deposits held at banks outside the United States, free of domestic reserve requirements — that regulatory gap made offshore dollar deposits and loans cheaper and more flexible to create than onshore ones, which is why the market grew to be one of the largest funding pools in the world.
How offshore dollars are created
No physical dollars ever leave the country — a Eurodollar deposit is created the moment a bank outside the US accepts a dollar-denominated deposit and books it on its own balance sheet, ultimately still settling through the US payments system when dollars actually move. Once created, that deposit can be re-lent to another bank, another offshore branch, or a corporate borrower, all in dollars, all outside US domestic banking rules. Because these deposits historically weren't subject to the same reserve requirements as US domestic deposits, offshore banks could sometimes offer better deposit rates or cheaper loans, pulling dollar activity offshore.
Worked example
A US corporation's European subsidiary needs $50 million in short-term dollar financing. Two options:
- Borrow onshore from a US bank at a rate reflecting domestic funding costs, say 5.40%.
- Borrow offshore (Eurodollar loan) from a London branch of an international bank, quoted at 5.25%, cheaper because the lending bank's offshore dollar deposits (its funding source for the loan) aren't subject to the same domestic reserve costs.
- The subsidiary borrows offshore, saving 15 basis points, roughly $18,750 annually on $50 million — small on this size, but multiplied across the trillions in offshore dollar funding activity, this regulatory-cost differential is a persistent structural reason so much dollar lending happens offshore rather than through US domestic banks.
The interest rate benchmark historically built directly on this market — LIBOR ("London Interbank Offered Rate") — was literally the rate at which banks reported lending Eurodollars to each other, before benchmark reform moved most markets toward transaction-based rates like SOFR.
What this means in practice
The Eurodollar market is the reason a huge share of global trade, loans, and derivatives are priced off dollar rates set outside the US regulatory perimeter, and it's why dollar funding stress can originate offshore and still ripple straight back into the US financial system — foreign banks that fund themselves partly in Eurodollars are exposed to swings in offshore dollar availability, which is precisely why central bank dollar swap lines exist, to backstop offshore dollar funding when it seizes up.
"Eurodollar" has nothing to do with the euro currency or the eurozone — the name is a historical accident from the market's origins in postwar Europe, and Eurodollar deposits and loans exist in dollar-funding centers worldwide, not just in Europe; conflating the term with the euro is a common and avoidable mistake.
Further reading
- Stigum's Money Market (ch. on the Eurodollar market)