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BIS Bulletin No 34 Summary: Central Bank Swap Lines and Cross-Border Bank Flows

Core Content

This BIS Bulletin examines the role of central bank swap lines, particularly those involving the Federal Reserve, in the context of the global financial system's response to the stress caused by the Covid-19 pandemic in the first half of 2020. It highlights how these swap lines influenced cross-border banking flows, especially the increase in US dollar claims on banks operating in the United States.

Key Takeaways

• Swap Line Usage Surge: In the first half of 2020, central banks heavily utilized US dollar swap lines with the Federal Reserve, contributing to a significant increase in cross-border banking flows.
• Impact on US Dollar Claims: The rise in cross-border claims on US-based banks was largely driven by a surge in global demand for dollar liquidity, rather than increased funding needs specific to US banks.
• Elasticity of the System: The global financial system, particularly the dollar-based system, relies on the "elastic" nature of central bank and commercial bank balance sheets. The Fed's swap lines acted as a critical backstop for this liquidity.
• Balance Sheet Mechanics: The use of swap lines expands the balance sheets of both central banks and commercial banks, as they transfer reserves through a network of affiliates and correspondent banks.

Main Points

1. Global Banking Flows and Dollar Liquidity Scarcity

• In Q1 2020, there was an extraordinary increase in global cross-border banking flows, especially in intragroup and interbank positions.
• The rise in US dollar claims on US-based bank affiliates (light red bars in Graph 1) was more than a third of the total increase in cross-border claims.
• These flows largely reversed by Q2 2020 as financial conditions improved.

2. The Role of Swap Lines in Liquidity Provision

• Central bank swap lines, such as those with the Fed, allow recipient central banks to obtain dollar liquidity in exchange for their own currency as collateral.
• This liquidity is then distributed to local financial institutions, easing dollar funding conditions.
• The process is illustrated using the Bank of Japan (BoJ) as an example, showing how the BoJ transfers dollar reserves to Japanese banks via its US-based affiliates or correspondent banks.

3. Balance Sheet Impacts

• Intragroup and Interbank Positions: The use of swap lines increases intragroup liabilities (claims on US-based affiliates) and reserves at the Fed for foreign banks.
• FX Swap vs. Swap Line: FX swaps between central banks expand their balance sheets by creating new reserves, while commercial banks using FX swaps typically do not expand their balance sheets as they use existing reserves as collateral.

4. US-Based Operations of Non-US Banks

• Graph 3 shows the relationship between swap line usage and changes in intragroup positions and reserves held at the Fed for foreign banks in the US.
• The data indicates that movements in these balance sheet items closely align with swap line activity, even though not all transactions are captured due to the complexity of cross-border flows.

Conclusion

The Federal Reserve's swap lines played a crucial role in stabilizing the global dollar financial system during the early stages of the pandemic. By providing liquidity, these lines helped to meet the sudden increase in demand for US dollars, which was reflected in the expansion of cross-border banking claims. The balance sheet mechanics of the swap lines demonstrate the interconnectedness of central banks and commercial banks in managing liquidity across borders, highlighting the importance of the Fed's role as a backstop in times of crisis.

References

• Aldasoro, I, T Ehlers, P McGuire and G von Peter (2020): "Global banks' dollar funding needs and central bank swap lines", BIS Bulletin, no 27, July.
• Bahaj, S and R Reis (2020): "Central bank swap lines: evidence on the effects of the lender of last resort", unpublished manuscript.
• Bank for International Settlements (2020): Annual Economic Report 2020, June, Chapter II.
• Borio, C and P Disyatat (2011): "Global imbalances and the financial crisis: link or no link?", BIS Working Papers, no 346, June.
• Cetorelli, N, L Goldberg and F Ravazzolo (2020a): "Have the Fed swap lines reduced dollar funding strains during the Covid-19 outbreak?", Liberty Street Economics, 22 May.
• Frost, J, H S Shin and P Wierts (2020): "An early stablecoin? The Bank of Amsterdam and the governance of money", BIS Working Papers, no 902, November.
• Mehrling, P (2015): "Elasticity and discipline in the global swap network", International Journal of Political Economy, vol 44.

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