Central banks take coordinated action to keep dollars flowing

Investors continue to reel from turmoil in the banking sector

FRANKFURT: The US Federal Reserve and other top central banks on Monday kicked off a coordinated effort to keep dollars flowing through the financial system and shore up confidence, as investors reel from turmoil in the banking sector. In a move reminiscent of emergency action taken during the 2008 financial crisis, the Fed and five other central banks announced they were stepping up their so-called swap-line operations, giving foreign banks greater access to safe-haven US dollars.

What are swap lines?

A swap line is a temporary agreement between two central banks to exchange currencies, usually because one of the parties needs to pass the foreign currency liquidity on to their domestic commercial banks. The Fed, the European Central Bank, Bank of England, Bank of Japan, Bank of Canada and the Swiss National Bank said in a statement late Sunday that they would switch from weekly to daily swap lines, ensuring quick access to US dollars.

The “coordinated action” will last until at least the end of April. The domestic banks must place collateral with their central banks in return for the dollars, but are then sure of getting as much of the US currency as needed. The central banks said their network of swap lines “serve as an important liquidity backstop to ease strains in global funding markets”.

Why now?

The initiative was announced just hours after Switzerland said its largest bank UBS would take over troubled rival Credit Suisse-the first rescue of a major bank since the global financial crisis 15 years ago. Markets have already been riled by the recent collapse of three US regional lenders, which has fuelled concern about the health of the global financial sector.

Analysts saw the expanded swap line action as a precautionary move. “It is important to signal to the public and the markets that whatever happens, the central banks will be there to ward off any crisis,” Baader Bank analyst Robert Halver told AFP. There is no sign yet of “outsized demand” for US dollars, added ING economist Padhraic Garvey.

But fears that the banking turmoil could turn into a full-blown crisis have called into question whether the Fed, ECB and other central banks will continue to aggressively raise interest rates to combat inflation. Higher rates make it harder for businesses and households to get credit, and there’s a risk that the recent banking tensions could see the supply of loans dry up further-with damaging consequences for the economy. It is therefore “reasonable” for central banks to boost US dollar liquidity while tightening monetary policy, said UBS Global Wealth Management chief economist Paul Donovan. But “if the existing tightening of lending standards accelerates, economic policy will have to change,” he said.

Lifeline in past crises

The network of swap lines was set up during the 2008 financial crisis, when credit dried up and non-US banks struggled to access US dollars. Swap lines have since become a key part of the central bank toolkit during challenging times. Daily dollar auctions were last used in the early days of the pandemic in 2020, when COVID-related restrictions battered the global economy and sent investors scrambling for the safety of the dollar. That central banks are once again reaching for the tool now shows “that the dollar faces no credible rival as a global reserve currency”, said Donovan. – AFP

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