Acta Oeconomica Pragensia 2016, 24(4):3-23 | DOI: 10.18267/j.aop.548

Federal Reserve Swap Lines - International Lender of the Last Resort

Miroslav Titze

Vysoká škola ekonomická v Praze, Národohospodářská fakulta (xtitm02@vse.cz).

After 2007, financial market turmoil began and shortage of dollar funding liquidity disrupted not only the US dollar funding market but also overseas. To address the shortage of dollar liquidity, the FED introduced swap lines with systematic important central banks, including emerging markets. The paper discusses the main feature of the FED's swap lines in the context of the funding pressures on the FX swap market. The main objective of the paper is to reveal technical aspects and effectiveness of the swap lines. The paper explains connectivity between un/secured money markets and the FX swap market during the financial and debt crises. The FX swap market was hit significantly. During the liquidity crisis of 2007-2010, the main driver of the deviation from covered interest parity was a shortage of dollar liquidity jointly with counterparty risk. During the debt crisis, the main driver was counterparty risk of the euro zone banks and sovereigns. The FED swap lines were used as a liquidity backstop. The paper concludes that the swap lines were an effective tool of cooperation between central banks and significantly alleviated the pressure on the FX swap market. In addition, the swap lines were flexible, supported financial stability, no losses were recorded, the problem of adverse selection was avoided and exit was successful. Finally, the swap lines have become a permanent tool for solving temporary shortages of foreign currency liquidity in national banking systems.

Keywords: Federal Reserve System, swap lines, covered interest parity, FX swap market, basis, international lender of the last resort

JEL classification: E43, E50, E52

Published: August 1, 2016  Show citation