FED EXTENDS CENTRAL BANKS SWAP LINES / THE FINANCIAL TIMES ( RECOMMENDED READING )

Fed extends central bank swap lines


By Robin Harding in Washington

Published: December 21 2010 17:11

The Federal Reserve has extended its currency swap lines with other central banks until the end of August 2011 in a move that shows the continued uncertainty caused by Europe’s sovereign debt problems.


Whenever risk aversion hits global markets – especially if it involves doubts about the solvency of European banks – it tends to lead to a shortage of dollar liquidity in Europe. The Fed has extended its swap lines with the Bank of Canada, the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss National Bank.


The swap lines allow foreign central banks to exchange their own currency for dollars from the Fed for an agreed period and exchange rate. A foreign central bank such as the ECB can then lend dollars on to its local financial institutions.


The swap lines were first set up in December 2007 but were allowed to expire in early 2010. However, central banks were forced to revive them shortly afterwards when Greece’s sovereign debt crisis began, and are keeping them in place as a precaution.


At present only $60m of the swap lines are in use but as much as $9.2bn was drawn down in May this year when stress on the European banking system was at a peak. Overall usage of the central bank swap lines peaked at the height of the financial crisis in December 2008 when foreign central banks drew on $583bn in dollar funding.


The Fed’s Open Market Committee authorised the extension at its last meeting on December 14 but legal agreements with other central banks had to be completed before it was announced. The swap lines were not due to expire until the end of January, but the FOMC’s next meeting is not until January 26-27, which would have left little time to complete the paperwork.


Currency swaps have never caused much controversy within the Fed, which sees them as part of its responsibility to provide short-term dollar liquidity in times of financial stress. As it lends via foreign central banks, rather than directly to foreign commercial banks, there is almost no risk that it will suffer losses.


But the swap lines have come under attack from critics such as Ron Paul, the Texas congressman, who argue that the Fed should not be lending such large sums overseas without greater scrutiny.


Copyright The Financial Times Limited 2010.