Swap Line Agreement

Since 1994, the Federal Reserve has entered into bilateral swat-exchange agreements with the Bank of Canada and the Bank of Mexico under the North American Framework Agreement (NAFA). As part of a currency swap agreement, the lending central bank, such as the Bank of England (BoE), is demanding US dollars from the Fed. In return, the Fed receives a pound counter-value, calculated at the market exchange rate. The BoE then lends the dollars to UK banks and collects interest. For the duration of the swap, the BoE has a dollar liability that takes the form of an account with the Fed, and the Fed has a pound liability which is an account at the BoE. Once the swap is over, the BoE returns the dollars to the Fed and the Fed returns the books to the BoE. The BoE also pays the Fed the interest it earns on borrowed funds. In May 2010, the FOMC announced that it had approved dollar liquidity swaps with the Bank of Canada, the Bank of England, the European Central Bank, the Bank of Japan and the Swiss National Bank in response to the resumption of tensions in the short-term dollar financing markets. In October 2013, the Federal Reserve and these central banks announced that their existing temporary liquidity exchange agreements, including dollar liquidity exchange lines, will be converted into permanent agreements that will be maintained until further notice. Both the State Department and the Treasury were consulted on countries that meet the Fed`s criteria that „increased pressure in [these countries] could trigger unwelcome radiation for both the U.S.

economy and the international economy in general.“ The minutes of the FOMC meeting at which the final decision was made show that members had very specific concerns, such as whether countries with large mortgage-backed securitizations issued by Fannie Mae and Freddie Mac could be tempted to eliminate them all at the same time if they did not have access to the dollar. , which would increase mortgage rates and hinder the recovery in the United States. In his book International Liquidity and the Financial Crisis, William Allen gives estimates for a number of countries on the gap between the level of bank liabilities in a given currency, which was to be refinanced, and the funds available for that purpose. Among emerging countries, brazil`s banking system had the largest dollar deficit and the Korean banking system was the largest dollar deficit among Asian banking systems. The Fed traded lines to emerging markets, such as developed economies, helped close those dollar spreads and lowered the dollar`s interest rates. In order to improve financial stability and economic cooperation in the Saarc region, the RBI last November put in place a revised framework for the foreign exchange agreement for the SAARC countries for 2019-22. These swap transactions do not involve exchange rates or other market risks, as trading conditions are set in advance. The absence of foreign exchange risk is the main advantage of such a facility. The Fed is selective in accessing swap lines. It is not surprising that countries like Russia, Iran and China do not get them. And only four emerging markets – South Korea, Mexico, Singapore and Brazil – get them. Swapd loans are very short and almost risk-free, not the type of longer-term development assistance loans normally provided by the IMF and the World Bank.

The Fed has terminated its GFC swap lines due to improved market conditions. However, lines with the largest banks were temporarily restored in 2010 and converted into permanent permanent facilities in October 2013 to provide a „prudent liquidity backstop“ for problems that could arise if a currency is available. (Federal Reserve, Oct 2013). Permanent agreements allow the Fed to quickly allocate U.S. dollars to market financing if necessary. Since 2009, China has signed bilateral currency exchange agreements with 32 counterparties. The stated intention of these swaps is to support trade and investment and to promote the international use of the renminbi.