Maintaining steady access to dollars a challenge during coronavirus crisis - BIS
April 2, 2020 |
Preserving the flow of payments is "essential" to avoid further economic meltdown
Since the outbreak of the coronavirus pandemic, demand for US dollars has surged, putting a strain on corners of the financial markets that do not have as readily available access to greenbacks, while also lifting funding costs, according to a study released by the Bank for International Settlements (BIS) on Wednesday.
The study, titled "Dollar funding costs during the Covid-19 crisis through the lens of the FX swap market," examines how the US Federal Reserve's recent measures to open up additional lines of credit with central banks around the world has helped ease some of the strain, but it says that more needs to be done.
Highlighting the difference between the current crisis and that of the prior global financial crisis in 2008, the BIS said policies that reach beyond the banking sector to final users is required.
"These businesses, particularly those enmeshed in global supply chains, are in constant need of working capital, much of it in dollars. Preserving the flow of payments along these chains is essential if we are to avoid further economic meltdown," the BIS said in the report.
As the global economy suffers a sudden stop, with governments layering on more and more stringent rules for social distancing, leading to lower production, businesses are drawing down on their bank credit lines where they can. The study contends this is resulting in a sharp increase in the cost of obtaining dollars, and can be seen in what is known as the so-called FX swap basis.
This measure is the "difference between the dollar interest rate in the money market and the implied dollar interest rate from the FX swap market where someone borrows dollars by pledging another currency as collateral. A negative basis means that borrowing dollars through FX swaps is more expensive than borrowing in the dollar money market," the BIS said.
While the basis is usually close to zero in less turbulent times, current conditions have blown out this figure, only to have it reeled back in by the central bank actions. According to the BIS, aggregate data on the use of currency swaps and currency forward transactions show the total amount outstanding at the end of June last ear neared $86 trillion, of which the US dollar was 89% of the time one of the two currencies exchanged.
Against this backdrop, the financial turbulence of recent weeks has led to a sharp decline in the supply of hedging services by banks as they retrench in the face of the shock. In addition, banks have experienced drawdowns of credit lines from corporate borrowers, which have crowded out other forms of lending by banks. Prime money market funds that traditionally supply dollar funding have experienced redemptions, leading to thinner supply. Together, the pullback in the supply of dollars from banks and market-based intermediaries (even as dollar demand has remained high) has resulted in the sharp increase in indicators of dollar funding costs
We show in particular that the dollar exchange rate takes on the attributes of a risk capacity indicator for the banking sector. This reflects the tendency for an appreciating US dollar to dampen dealer banks’ intermediation capacity. For this reason, the dollar exchange rate and dollar funding costs tend to move in lock-step, as they did during the recent bout of turbulence.
the growing foreign currency portfolios of Asian institutional investors (mostly dollardenominated) have been an important component of the growth in the demand for dollar funding.