Financial Regulatory Forum

Major central banks to end emergency dollar lending

By Reuters Staff
January 28, 2010

By Kristina Cooke and Marc Jones

NEW YORK/FRANKFURT, Jan 27 (Reuters) – Major central banks on Wednesday said they will stop the emergency U.S. dollar lending introduced during the financial crisis, a significant milestone indicating growing confidence that the financial system is returning to health.

The decision, announced in coordinated statements, marked the first unified retraction of central banks’ extraordinary support for financial markets.

The European Central Bank, the Bank of England, the Bank of Japan and the Swiss National Bank, as well as the central banks of Canada, Australia, New Zealand, Mexico, Brazil and Sweden said they will let their dollar “swap” arrangements with the U.S. Federal Reserve expire on Feb. 1.

Demand for the dollar swap lines, through which the U.S. Federal Reserve provided billions of dollars to overseas financial firms via foreign central banks, has fallen dramatically as market conditions improve around the world.

“These lines, which were established to counter pressures in global funding markets, are no longer needed given the improvements seen in the functioning of financial markets over the past year,” the European Central Bank said in a statement. “Central banks will continue to cooperate as needed.”

Analysts said the coordinated statement provided a boost to the dollar in afternoon trading in New York, with the dollar rising to a six-month high against the euro. [ID:nN27119978]

“That takes away dollars in circulation and that should be dollar-supportive simply because of supply and demand,” said Greg Salvaggio, senior vice president at Tempus Consulting in Washington.

The central banks’ statements coincided with the Fed’s policy statement following the close of its two-day January meeting, in which it said swap lines will end as planned on Feb 1.

The Fed’s policy-setting panel opened swap lines with the European Central Bank and the Swiss National Bank in December 2007. As the financial crisis worsened, the Fed also set swap lines with the central banks of Japan, Britain, Canada, Australia, Sweden, Norway, Denmark, Brazil, Mexico, South Korea and Singapore to ease dollar funding shortages.

With confidence in financial markets in short supply at the height of the crisis, short-term money markets froze.

Many foreign banks and investors depended on money markets to borrow dollars to cheaply fund their dollar-denominated longer-term investments. After the collapse of Lehman Brothers, many found themselves scrambling for dollars to fund these obligations, driving up the dollar against local currencies and raising the specter of wide-spread defaults.

Through the currency “swaps,” the U.S. Fed offered dollars to foreign central banks, in exchange for their currencies. The foreign central banks then lent the dollars to banks in their domestic markets, enabling firms to access dollars at a time when normal financing channels had shut down.

The Fed dollar swap agreements, after hitting a high of $583 billion in late December 2008, fell to $1.25 billion as of Jan. 20.

The trend has been seen across the central banks involved. European banks took just $75 million at last week’s ECB handout of dollar funds, compared with almost $170 billion at their peak in October 2008. (Additional reporting by Gertrude Chavez-Dreyfuss, Louise Egan, Elzio Barreto; Editing by Leslie Adler and Kenneth Barry) ((kristina.cooke@thomsonreuters.com; Tel: +1 646 223 6154; Reuters Messaging:rm://kristina.cooke.reuters.com@reuters.net))

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