Banking crisis and Fed’s credit line: how does it work and how concerned should we be?
Central banks around the world announced last night that they were taking steps to improve access to liquidity in the financial system.
In a coordinated move reminiscent of Covid in 2020 and the financial crisis in 2008, central banks in the US, the eurozone, Britain, Japan and Canada announced new measures to calm financial markets.
Why make the statement?
Financial markets have been in turmoil since the collapse of Silicon Valley Bank two weeks ago. The crisis at Credit Suisse, which has now been bought by UBS, only added to market fears.
This was particularly true as both Credit Suisse’s shareholders and bondholders faced significant losses in the deal.
Banks looking for funding could find it more difficult if there are concerns that similar measures could be put in place elsewhere. They may also be more wary of lending out of concerns that they would expose themselves to risks elsewhere in the financial system. This could lead to a credit crunch
As the central banks themselves said, the credit lines will serve as “an important liquidity backstop to ease strains in global funding markets, thereby helping to mitigate the effects of such strains on the supply of credit to households and businesses.”
How does it work?
The Fed set up a swap line network in 2008 to provide a funding backstop for banks during times of peak market instability.
Banks around the world used the swap lines to access dollars in exchange for local currencies by pledging collateral at their domestic central bank.
Until Sunday’s announcement, the Fed paid dollars to other major central banks each week in exchange for local currency.
Starting today, the Fed will now conduct daily auctions to ensure that banks have the liquidity they need to operate. These daily auctions will run “at least until the end of April”.
How concerned should we be?
Looking at the level of borrowing from central banks using the existing swap lines, there is little sign of crisis.
Foreign central banks held outstanding swaps with the Fed for only $472m at 15 March. This compared to $446bn at the beginning of the pandemic and a peak of $583bn in 2008.
However, the coordinated intervention signals that central banks are deeply concerned about the potential risks to financial stability following SVB’s collapse and UBS’s purchase of Credit Suisse.
According to Reuters, at least two major banks in Europe are examining scenarios of contagion potentially spreading in the region’s banking sector. They are hoping the Fed and the European Central Bank will step in with stronger signals of support.