With the exception of the smuggler, international capital transactions generally are not realized through paper or metal money. Instead, most international payments are settled by drawing on depoisits with a bank. Thus, banks are the main conduit for international transfer of funds and the principal private institutions providing liquidity to the international monetary system.
Although they are closely interlinked, there are two different banking systems through which the international transfer of funds can be accomplished. One system is the traditional correspondent banking system, in which the banks maintain deposits in the home currency of the country in whic they are located and are subject to local banking regulations affecting deposits. In the other system, banks' deposits can be denominated in any currency ( regardless of the country in which the banks are located), but these deposits are not subject to local regulations affecting the cost and nature of deposits. This is so - called Eurocurrency market in which Eurodollars, Eurosterling, and other Eurocurrencies are traded.
Given the factors that differentiate domestic from Eurocurrency deposits, we can see that the term "Eurocurrency" is a misnomer. One should talk instead of currencies outside the control of domestic banking regulations, or external currencies. Although the bulk of these external transactions intially took place in Europe, a sizable amount of the market is now transacted in other parts of the would, particularly Asia, the Middle East, and the Caribbean. Since 1981, Eurocurrencies (including Eurodollars ) are also traded in the Unied States in the international banking facilities approved that year by the Federal Reserve. These facilities are exempt from reserve requirements and interest ceiling imposed on domestic bank's deposits; that is, they are not subject to the banking regulations on deposits applicable to. regular domestic banks. However, these international banking facilities must restrict their business in the United States to traditional Eurocurrency transactions, which exclude loans to U. S. companies for domestic purposes.
As an illustration of how payments can be settled internationally under the alternative banking systems we will use an example. Assume that U. S. Corporation imports cars for a total of US $ I million equivalent. The exporter is the ABC Corporation in England. U.S. Corporation's bank in the United States is Chase Manhattan and ABC Corporation's bank in England is Barclays.
