Status: 03/20/2023 11:32 a.m
Because of the acute banking crisis, the major central banks are improving the supply of dollars to the financial markets. The aim is to calm the markets and ensure the stability of the financial system.
Several large central banks are working together to stabilize the financial sector. The European Central Bank (ECB), the US Federal Reserve, the Bank of England and the central banks of Japan, Great Britain, Switzerland and Canada want to use a “coordinated measure” to secure banking transactions in dollars.
The central banks involved announced yesterday that so-called swap transactions will be expanded as of today, with which the central banks exchange currencies with each other. The central banks outside the USA are to be better supplied with dollars and the financial markets are to be calmed down.
Specifically, the central banks agreed to increase the frequency of seven-day dollar currency swaps from weekly to daily. Initially, these daily operations are expected to last until the end of April. The move now allows participating central banks to offer seven-day dollar loans every day to financial institutions in their currency zone.
Much of the financial system depends on the dollar
The above-mentioned swap transactions between the central banks are measures intended to ensure that the financial markets always have a sufficient quantity of foreign currencies available if they are in demand from commercial banks. Since a large part of the global financial system is processed in dollars and, for example, many bonds from other currency areas are also quoted in dollars, there is a constant need for the US currency between banks.
The swap agreement with the US Federal Reserve System will allow the ECB and all Eurosystem national central banks to receive dollars from the Fed in exchange for a corresponding euro amount made available to the Federal Reserve, the European Central Bank said so-called swap lines.
These swap transactions ultimately serve to provide the banks with liquidity among themselves and are a kind of active confidence-building: Swap transactions are an important “liquidity hedge in order to reduce tensions on the global financing markets and thus contribute to reducing the effects of such tensions on the credit supply of households and companies,” according to the ECB.
Learned from experience?
The background is also the experience of central banks, commercial banks, economists and investors during the 2008 financial crisis. When the US investment bank Lehman Brothers collapsed, the consequences brought the financial system to the brink of collapse.
At the height of the crisis, interbank trading almost came to a standstill. Financial institutions could no longer be certain of the liquidity of their competitors. The permanent trade between the banks in money, bonds, stocks and foreign exchange became drastically more expensive and almost came to a standstill because market participants feared the bankruptcy of other institutes.
At that time, it was difficult for euro area banks to obtain US currency to fund their dollar-denominated assets, the ECB said. To prevent disruptions and extreme price movements, the euro central bank and the Federal Reserve would have established a currency swap line, allowing the ECB and the Eurosystem to provide dollars to banks in the euro area. This long-established system has now been temporarily extended to protect the markets.
Markets strained but stable
Can this surprising move calm the financial markets? The DAX is currently staying close to its Friday level, and there is currently no sign of another crash. However, Derek Tang, an economist at LH Meyer, believes that the firmness of the announced central bank action betrays greater concerns about the risk of contagion in financial markets.
“If central banks rush to take action to ensure that everything is in order, then things are actually not in order,” quoted the “Handelsblatt” Jeroen Blokland from the analysis house True Insights, who takes a similar view. Market participants are afraid of the next aftershock and are wondering which bank could be in trouble, comments Christian Henke, market observer at IG Markets.
Central banks in “whatever-it-takes mode”?
Holger Schmieding, chief economist at Berenberg Bank, is more optimistic. According to the economist, central banks such as the Fed or the ECB are capable of containing any financial crisis.
“Their financial toolbox goes beyond targeted liquidity injections, accepting depreciated assets at face value and a temporary relaxation of regulatory requirements,” emphasizes Schmieding.
Alluding to a quote from former ECB President Mario Draghi, Schmieding said central banks are now back in “whatever-it-takes” mode to stop the contagion. In 2012, during the financial crisis that mutated into a debt crisis, Draghi made it clear with these words that the central bank would do everything necessary to secure the common currency, the euro.