Dollar Swap Lines - EconReads

How the U.S. Federal Reserve lends dollars to other central banks during crises, why the world needs dollars in emergencies, and who gets access.

Many banks and companies outside the United States borrow and lend in U.S. dollars. When crises strike, they can face a sudden shortage of dollars. Central bank swap lines help prevent this from turning into a global panic.

How a swap line works

A swap line is an agreement between two central banks to exchange currencies:

The U.S. Federal Reserve gives dollars to another central bank, such as the European Central Bank.
In return, it receives an equivalent amount of euros as collateral.
The ECB lends the dollars to banks in its area that need them.
Later, the swap is reversed, with interest.

The Fed takes little risk, since it deals with another central bank and holds its currency as collateral.

Why dollars run short

The dollar dominates global finance. Foreign banks hold large dollar assets and fund them with short-term dollar borrowing. In a panic, lenders stop rolling over these loans, and banks scramble for dollars. Without help, they might sell assets in a fire sale, spreading the crisis.

Use in crises

In the 2008 financial crisis, the Fed extended swap lines to many central banks, with large amounts drawn.
In March 2020, as COVID-19 hit, the Fed again expanded swap lines and set up a facility allowing other central banks to borrow dollars against U.S. Treasury bonds.

The Fed has standing swap lines with five major central banks: the ECB, Bank of Japan, Bank of England, Swiss National Bank and Bank of Canada.

Who gets access

Access is limited. Many emerging-market central banks, including the Reserve Bank of India, do not have permanent Fed swap lines, so they rely on their own reserves or on other arrangements. India has swap arrangements with other countries, such as Japan, and offers swap lines to neighbouring South Asian central banks.

A European bank's dollar crunch

A European bank has lent dollars to companies around the world, funding these loans by borrowing dollars short term. In a crisis, its lenders refuse to renew. Instead of dumping assets at fire-sale prices, the bank borrows dollars from the ECB, which obtained them through its swap line with the Fed. The crisis is contained.

Thinking only the United States needs dollars

Trillions of dollars of loans and deposits exist outside the United States. Dollar shortages abroad can spread back to U.S. markets, which is one reason the Fed provides swap lines.

Key takeaways

Swap lines let central banks exchange currencies to meet crisis funding needs.
The Fed lends dollars to other central banks against their currencies.
Swap lines were crucial in 2008 and March 2020.
The Fed has standing lines with five major central banks; many emerging markets rely on their own reserves.