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Why Eurodollar Funding Is Not a Close Substitute for Fed Funds

Article Quant Q&A · Author: Kun
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Summary

The document considers whether US banks can replace domestic Fed funds borrowing with eurodollar borrowing when they need reserves. The response agrees that dollar transfers ultimately affect reserve accounts at the Federal Reserve, while distinguishing that settlement mechanism from the practical availability of funding through different markets.

It argues that term eurodollar markets have limited volume and therefore may lack the capacity to replace Fed funds borrowing, particularly in a severe funding squeeze when overnight Fed funds loans are unavailable. The answer also notes that abundant excess reserves associated with quantitative easing made the question less pressing in the circumstances it describes. These are qualitative claims rather than a detailed account of market structure or supporting volume data, and the discussion is context-dependent: funding conditions and institutional arrangements can change over time.

Key ideas

  • Dollar payments ultimately settle through reserve accounts at the Federal Reserve.
  • Settlement links eurodollar borrowing to US bank reserves but does not make the markets interchangeable.
  • The response characterizes term eurodollar market capacity as too limited to replace Fed funds in a crisis.
  • Abundant excess reserves can reduce the immediate importance of this funding distinction.
  • The market assessment is qualitative and tied to the conditions described.

Tags

Fixed incomeUS marketsMarket microstructure
Full text
# Is Eurodollar borrowing close substitute for Fed funds borrowing?


# Is Eurodollar borrowing close substitute for Fed funds borrowing?












It is often stated that eurodollar borrowing is clost substitute for Fed funds borrowing. In other words, when US banks cannot fund themselves domestically, they might go to the eurodollar market and borrow some money to satisfy thier reserve requirment. Although it seems intuitive that in eurodollar borrowing you are borrowing from banks in other countries, I believe it implicitly involve a loss of reserve in a US bank. This is because since foreign banks cannot hold reserve at Fed and the borrower wish to borrow reserve, the only way this can happen is for the foreign bank to demand its US correspondant (the US bank where it deposits its dollar) to transfer the amount of reserve to the borrower. So implicity, a US bank is losing its reserve. Am I correct?

## Answer by dm63 (score 1)

https://quant.stackexchange.com/a/22341

I think you are right that ultimately all dollar movements are reflected in reserve accounts at the Federal Reserve.

May I make a couple of additional points: Eurodollar borrowing is really not a close substitute for Fed Funds. First of all, not much volume goes through the term eurodollar markets, so it doesn't have the capacity to replace Fed Funds borrowing. In a dire situation where a bank cannot obtain overnight loans in the Fed Funds market, I would think there's no chance it could borrow in the eurodollar market.

I would add that right now all this is moot, because we are in a situation of massive excess reserves due to Quantitative Easing.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.