Plans to reopen swap line arrangements between central banks are being stripped back due to shrinking demands for USD funding.
Previously in March, the European Central Bank (ECB), the Bank of England (BoE), the Bank of Japan (BoJ) and the Swiss National Bank (SNB) had all struck an agreement with the US Federal Reserve (Fed) to reopen prior arrangements. The agreement was made in order to combat market distress as a result of the global coronavirus pandemic by helping to maintain the flow of credit to overseas homes and businesses.
By and large, the decision to scale back liquidity operations is being perceived as an indicator that markets are finally starting to make a recovery after the initial shock caused by coronavirus.
According to Stephanie Segal, a senior fellow at the Center for Strategic and International Studies, the move shouldn’t have a negative impact on corporates.
“Provided US dollar funding markets continue to function smoothly, the reduction and eventual termination of temporary dollar swap lines should not impact creditworthy corporates” she said in an email.
“At the same time, a recent IMF working paper (WP/20/113) highlights that reliance by non-US banks on wholesale dollar funding can be a source of potential risk should dollar funding markets come under stress. Under such a scenario, and absent support such as dollar swap lines, dollar scarcity can result in financial stress and the reduction in dollar loans.”
As part of their arrangement with the Fed, the ECB, BoE, BoJ and SNB agreed to lower the price on existing USD swap lines by 25 basis points. In order to make these liquidity measures more effective, the banks then offered USD with an 84-day maturity at auction three times per week in addition to the one-week maturity that was already on offer.
But starting September 1, the three weekly auctions on offer from the ECB, BoE, BoJ and SNB have been reduced to just once per week.
Swap lines are a tool that central banks use to try and improve liquidity conditions.
Under ordinary circumstances, if a bank needed access to USD it would turn to the market. But if USD funding was too expensive or the market were in distress, the bank would then need to go to its central bank.
Thanks to swap line agreements, select central banks are able to have direct access to USD in exchange for access to their own respective domestic currencies. Those central banks are then free to offer USD to commercial banks within their own respective jurisdictions, which can then be passed on to corporate borrowers and customers.
The Fed has five standing swap arrangements that enable foreign central banks to access USD – including the ECB, BoE, BoJ, SNB and Bank of Canada (BoC). But when governments started to impose restrictive health and safety measures on businesses that limited economic activity earlier in 2020, the Fed decided to bolster existing operations and reopened a number of other temporary swap lines with central banks in Australia, Brazil, Singapore, Mexico, New Zealand and more.
Although the BoE confirmed that USD liquidity operations would be slowing down from September, the bank did say in a statement that all four “central banks stand ready to re-adjust the provision of US dollar liquidity as warranted by market conditions.”