COVID-19: Federal Reserve Support for Foreign Central Banks
April 7, 2020
COVID-19: Federal Reserve Support for Foreign Central Banks
As part of the U.S. response to COVID-19, the U.S. Federal
Figure 1. Trade-Weighted U.S. Dollar Index
Reserve (Fed) has taken steps to ensure that foreign central
banks have uninterrupted access to U.S. dollars. First, the
Fed established emergency swap lines, or temporary
reciprocal currency arrangements, with a broader group of
central banks and lowered the interest rate it charges on the
swap lines. Swap lines allow foreign central banks to
temporarily exchange their currency for dollars with the
Fed. When the swap is concluded, the foreign central bank
returns the dollars, with interest, to the Fed and the Fed
returns the foreign currency. Second, the Fed created a
foreign central bank (FIMA) repo facility. The facility,
which also charges interest, allows foreign central banks to
temporarily exchange their U.S. Treasury securities for U.S.
dollars.
Background
In the U.S. banking system, the Fed serves as the lender of
Source: Federal Reserve
last resort to domestic banks in a financial crisis. In periods
of economic turmoil, such as now, during the financial
What is the Purpose of These Facilities?
crisis of 2007-2009, and after the September 11, 2001
Swap lines and the FIMA repo facility are intended to
terrorist attacks, the Fed has provided emergency liquidity
provide liquidity to private banks in non-domestic
to banks to keep them from failing. According to a recent
denominations. Because banks lend long-term and borrow
survey by the Bank for International Settlements (BIS), the
short-term, a solvent bank can become illiquid in a panic,
dollar accounts for 88% of global foreign exchange market
meaning it cannot borrow in private markets to meet short-
turnover and is key in funding an array of financial
term cash flow needs. For example, many European banks
transactions, including serving as an invoicing currency to
have borrowed in dollars to finance dollar-denominated
facilitate international trade. The dollar also accounts for
transactions. Typically, banks can only borrow from their
two-thirds of central bank foreign exchange holdings, half
home central bank, and central banks can only provide
of non-U.S. banks foreign currency deposits, and two-thirds
liquidity in their own currency. (The U.S. affiliate of a
of non-U.S. corporate borrowings from banks and the
foreign bank can borrow from the Fed, but not the parent.)
corporate bond market. As a result, disruptions to
The Fed’s swap lines and repo facility allow foreign central
international dollar lending markets can have wide-ranging
banks to provide needed liquidity to their country’s banks
repercussions on international trade and financial
in dollars.
transactions. The BIS also estimates that banks outside the
United States have over $13 trillion in dollar denominated
Central Bank Swap Lines
assets. In a global economic crisis, banks all over the world
The Fed’s first swap lines, which were created in the 1960s,
are reliant on the Fed to make sufficient liquidity available
played a prominent role during the 2007-2009 financial
to prevent their collapse.
crisis. Overall, ten central banks drew on the swap lines at
some point during the crisis, and four more were eligible
In the current crisis, a massive economic shutdown due to
to—but did not—use the swap lines. In October 2008, the
plant closures and national lockdowns has interrupted
Fed made the swap lines with certain countries unlimited in
global supply chains, which are largely funded privately
size. These swap lines expired in February 2010, but were
with dollar-denominated credit. As supply chains break
subsequently reopened in May 2010 with the Bank of
down, businesses with insufficient dollars will seek to
Canada, the Bank of England, the European Central Bank
quickly draw down pre-existing loan facilities and hoard
(ECB), the Bank of Japan, and the Swiss National Bank in
dollars. In addition to disrupted supply chains, recent
response to the eurozone crisis. Although initially
volatility in the stock and bond markets spurred a rush to
temporary, the Fed converted them to permanent standing
dollar-denominated assets as a safe haven during the crisis.
arrangements in October 2013. On March 19, 2020, the Fed
As a result of this surge for dollars, the value of the dollar
announced a major expansion of the swap lines to nine
has soared (see Figure 1). The availability of dollar access
additional central banks, all of whom also had access to Fed
has since eased pressure in some countries.
liquidity following the 2007-2009 crisis. These new
facilities will support the provision of U.S. dollar liquidity
in amounts up to $60 billion each to the central banks of
Australia, Brazil, Mexico, Singapore, South Korea and
Sweden, and up to $30 billion each for Denmark, Norway,
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COVID-19: Federal Reserve Support for Foreign Central Banks
and New Zealand. These dollar liquidity arrangements will
meantime (although the Fed also does not enjoy upside gain
be in place for at least six months. The swaps were created
if the dollar depreciates). Because the swaps are only with
under the section of the Federal Reserve Act (12 U.S.C.
other central banks with the most widely used currencies,
§ 226) providing authority for open market operations
there is essentially no credit risk involved (the foreign
(Section 14); they did not require the emergency authority
central bank bears losses if the private bank it lends the
found in Section 13(3).
dollars to defaults). The Fed has reported no losses under
the program. Initially, the swap lines were designed only to
Data on Usage
provide major foreign central banks with access to U.S.
During the 2007-2009 financial crisis, swap lines were used
dollars. In April 2009, the swap lines were modified so that
expansively by the Fed, peaking at $583 billion in
the Fed could draw on foreign currency as well; to date, the
December 2008 (see Figure 2), and accounting for a
Fed has not done so.
quarter of Fed assets at the time. They subsequently fell to
zero by March 2010. During the eurozone crisis, swaps
FIMA Repo Facility
outstanding increased suddenly in late 2011, averaging
The Fed offers certain services, including the foreign repo
more than $100 billion from late December 2011 to
pool, to foreign central banks and other official
February 2012. Their use declined after the eurozone crisis,
international institutions which maintain accounts with it.
and less than $1 billion was outstanding after August 2013.
The foreign repo pool allows these institutions to engage in
Before March 2020, most of the swaps were with the
reverse repos with the Fed, in which the Fed temporarily
European Central Bank; the Bank of Japan was the second-
invests foreign central bank dollar balances held at the Fed
largest counterparty. In March 2020, there has been a
in securities owned by the Fed. The foreign repo pool has
sudden surge in usage as a result of COVID-19. As some
always drained liquidity from the U.S. financial system
banks have become reluctant to lend to each other, central
since its creation in the 1970s, but the effect has increased
banks have taken a much larger role in providing banks
in recent years because balances have grown much larger,
with liquidity directly. During the week ending March 25,
averaging over $200 billion outstanding daily since 2016.
2020, the European Central Bank, Bank of England, Bank
Despite the overall dollar scarcity, balances have remained
of Japan, and the Swiss National Bank cumulatively drew
large since the pandemic.
$206 billion from the Fed.
On March 31, the Fed announced the Foreign and
Figure 2. Fed Central Bank Swap Usage
International Monetary Authorities (FIMA) Repo Facility,
which works like the foreign repo pool in reverse. This
facility allows foreign central banks to convert their U.S.
Treasury holdings into U.S. dollars on an overnight basis.
The Fed will charge an (typically) above-market interest
rate of 0.25 percentage points above the interest rate paid
on bank reserves. The facility is available to a broader
group of central banks than the swap lines.
Issues for Congress
Congress has oversight responsibility for the Fed and is
formally briefed semi-annually on its operations and policy
decisions. The expanded Fed swap lines and new FIMA
repo facility raise a range of issues for Congress:
What are the overall costs and benefits of the Fed’s
Source: Federal Reserve
expanded global lender of last reserve function? Should
Notes: As of April 1, 2020
swap lines be extended to more countries, such as
China?
How do Central Banks Swaps Work?
As standing facilities, central banks can draw on the swap
Should Congress establish new oversight functions to
lines as needed. Under a swap with the ECB (for example),
oversee the Fed’s expanded role?
the ECB temporarily receives U.S. dollars and the Fed
temporarily receives euros. After a fixed period of time (up
More broadly, does Congress think it is appropriate for
to three months), the transaction is reversed. Until March
the Fed to be providing this support bilaterally or should
2020, interest on swaps was paid to the Fed at 0.5
swap line facilities be coordinated through a multilateral
percentage points above the U.S. dollar overnight index
institution, such as the IMF?
swap rate (OIS), a private borrowing rate. This was reduced
to 0.25 for the new arrangements. Another change is the
Martin A. Weiss, Specialist in International Trade and
duration of the arrangements. Funding can now be accessed
Finance
not only for 7 days, but also for 84 days (approx. 3 months).
Marc Labonte, Specialist in Macroeconomic Policy
James K. Jackson, Specialist in International Trade and
The swaps are repaid at the exchange rate prevailing at the
time of the original swap, meaning that there is no
Finance
downside risk for the Fed if the dollar appreciates in the
IF11498
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COVID-19: Federal Reserve Support for Foreign Central Banks
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