Reserves on Eurodollar rate loans: Overview, definition, and example
What are reserves on Eurodollar rate loans?
Reserves on Eurodollar rate loans refer to additional costs that lenders may pass on to borrowers to account for regulatory reserve requirements imposed on certain types of deposits or loans. When a lender makes a Eurodollar loan—typically a U.S. dollar-denominated loan funded outside the U.S.—it may be required by central banks or regulators to maintain a portion of that amount as a reserve, which doesn’t earn interest. The reserve cost is often reflected in the loan’s interest rate through a reserve adjustment.
Why are reserves on Eurodollar rate loans important?
These reserves are important because they can increase the lender’s cost of providing the loan, and that cost is often shared with the borrower. To ensure the lender is compensated fairly, loan agreements frequently include language allowing the interest rate on Eurodollar loans to be adjusted to reflect these reserve requirements. Without this adjustment, lenders might be discouraged from making certain types of loans due to uneconomical regulatory burdens.
Understanding reserves on Eurodollar rate loans through an example
A borrower takes out a Eurodollar loan with an interest rate set at LIBOR + 2.00%. If the central bank imposes a 10% reserve requirement on similar deposits, the lender may not be able to lend the full amount profitably. Under the loan agreement, the LIBOR rate may be adjusted upward to reflect the reserve cost—effectively passing part of that burden to the borrower through a slightly higher rate.
Example of how a reserves on Eurodollar rate loans clause may appear in a contract
Here’s how a reserves on Eurodollar rate loans clause may appear in a credit agreement:
"The Eurodollar Rate shall be adjusted for any reserves required to be maintained by the Lender with respect to Eurocurrency liabilities under Regulation D or any other applicable requirement, and the Borrower shall be responsible for any increased cost resulting from such reserve requirements."
Conclusion
Reserves on Eurodollar rate loans account for the regulatory costs lenders incur when providing offshore U.S. dollar loans. By allowing interest rate adjustments for these reserves, contracts ensure that lenders remain economically whole while maintaining transparency for borrowers. Borrowers entering into such loans should be aware of these potential rate adjustments, as they can affect overall loan pricing.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.