December 13, 2012 / 2:38 PM / in 8 years

Top central banks renew currency swaps as precaution

WASHINGTON (Reuters) - Top central banks around the world on Thursday renewed a series of currency swap lines set up during the 2007-2009 financial crisis, providing a precaution against future market strains.

The U.S. Federal Reserve said it had extended for another year the dollar swaps with the European Central Bank, Bank of Canada, Bank of England and Swiss National Bank. The announcement was released at the same time by the other central banks.

These provisions were an important part of the powerful response launched by monetary authorities during the crisis to keep global financial markets open, curbing lofty dollar funding costs which had spiraled due to fear over counter-party risk.

Swap arrangements were revised and extended in November, 2011 as the euro zone debt crisis intensified, to ease the dollar funding pressure being experienced by some European banks.

Washington views the problems in Europe as a direct threat to the U.S. economy’s own tepid recovery owing to deep trade links, and sanctioning the dollar swaps is one direct way U.S. authorities can help out their European counterparts.

Use of the swap lines peaked at $583 billion in December, 2008 but has since steadily declined, and stood at around $12 billion earlier this month.

The Fed said the central banks had also renewed until February 1, 2014, bilateral currency swap arrangements that would also provide liquidity “should market conditions so warrant.”

The Bank of Japan separately said that it will decide on joining the extension of central bank liquidity swap arrangements at its next policy meeting, on December 19-20.

The Fed’s dollar swaps have led some political foes of the U.S. central bank to claim that it was putting American taxpayer money at risk. The Fed robustly denied this accusation.

It only conducts swaps with other central banks. These central banks may lend to proceeds on to private banks in their own countries, but they take on the credit risk from those transactions themselves and it is not borne by the Fed.

In addition, because the transactions are indeed “swaps”, the Fed receives foreign currency in exchange for providing dollars, giving it with collateral in the event of non-repayment. It also earns interest on the dollars it provides.

Furthermore, all foreign exchange risk is hedged out in each swap, so there is no risk of the Fed suffering a loss from any change in currency values during the duration of the deal.

Additional reporting by David Milliken and Olesya Dmitracova in London, Paul Carrel in Frankfurt and Leika Kihara in Tokyo; Editing by Chizu Nomiyama

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