Central Bank Liquidity Swap Lines are among several facilities established by the Federal Reserve to support the economy during the Coronavirus Pandemic. They were first used during the 2008 financial crisis, and were recently enhanced and expanded to a larger set of countries → nyfed.org/swap-lines
But what are swap lines? How do they function? And why are these liquidity arrangements with foreign central banks important to households and businesses in the United States?
In today’s global economy, bank funding markets extend across borders, and developments in any one area can have a far reaching impact. When these funding markets break down, the provision of credit to businesses and households in the United States and other countries can be disrupted.
As our nation’s central bank, it’s the Federal Reserve’s responsibility to do what it can to support the functioning of U.S. dollar funding markets, both at home and abroad, to shield the U.S. economy from financial strain.
One way the Fed does this is by entering into U.S. dollar liquidity arrangements, or swap lines, with foreign central banks.
Acting on behalf of the Federal Reserve System, the New York Fed and a foreign central bank agree to exchange-or swap-currency of equal value for a set period of time. The Fed supplies dollars and receives an equivalent value of foreign currency.
At the time of the agreement, a market-based exchange rate is applied to exchange foreign currency for U.S. dollars. That same exchange rate is then applied when the transaction matures. In addition to a fee paid by the foreign central bank, the Fed receives back the same amount of dollars it initially provided, meaning it bears no foreign exchange risk. And, it is the foreign central bank-not the Fed-that bears the risk of lending to financial institutions located within its jurisdiction.
When U.S. dollars are made available to foreign central banks during times of market stress, it provides certainty and stable pricing to financial institutions in their jurisdictions. The financial institutions are then able to extend credit to households and businesses that rely on U.S. dollar funding markets for trading and investing, and U.S. dollar funding markets around the world continue to function normally. As a result, funding markets in the United States remain stable.
Developments in one part of today’s global economy can have significant impacts for everyone. Entering into U.S. dollar liquidity arrangements with foreign central banks ensures that financial institutions around the world can provide credit to households and businesses when they need it - and shields the U.S. economy from financial strain.
For more information, visit nyfed.org/swap-lines.
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