The effectiveness of the ECB’s euro liquidity lines
Silvia Albrizio, Ivan Kataryniuk, Luis Molina Sánchez, Jan Schaefer September 29, 2021
Central bank swap and repo lines have been used extensively over the past decade to provide liquidity in foreign exchange markets during times of distress (e.g. McCauley and Schenk 2020, Aizenman et al. 2021). During the Covid-19 pandemic, central bank coordination played a key role in temporarily preventing financial market turmoil from turning into global financial instability (IMF 2020).
The operation of the liquidity lines is simple. When a liquidity line is active between a home central bank and a recipient bank, the latter can access the currency of the home central bank in exchange for its domestic currency at the spot exchange rate and at a rate fixed interest, lower than the market rate. At maturity, the same amount of money is exchanged between the two counterparties at the same fixed spot exchange rate. In this ‘do uOn the one hand, the recipient central bank can inject liquidity into the domestic market, preventing market pressure on its own currency in times of financial stress or to avoid depleting its own reserves. On the other hand, by reducing the foreign liquidity shortage, the home central bank prevents negative spillovers in the form of financial instability (McCauley and Schenk 2020, ECB 2021).
In this context, previous contributions have largely focused on the Fed’s liquidity lines and its role as international lender of last resort, but what do we know about those of the ECB? What is the scope and effectiveness of these lines? In this column, we present descriptive and empirical evidence (based on Albrizio et al. 2021) on ECB arrangements providing liquidity in euros.
Since the terrorist attack of September 11, 2001, the ECB has participated in the G10 network of central banks helping to provide liquidity in dollars on a global scale.1 In addition, between October 2008 and August 2020, it established and / or extended a total of 28 swap and repo lines with 16 foreign counterparties to provide liquidity in euros.
Figure 1 Timeline of announcements of ECB swap and repo lines providing euros and liquidity in other currencies
Source: Albrizio et al. (2021). Database based on ECB press releases available online here.
To note: The figure reflects the announcements of liquidity facilities from the ECB. Above the timeline, line settlements between the ECB and other central banks for the supply of foreign currencies (such as US dollar, British pound, Swiss franc, Chinese yuan) are reported. Below the timeline, the ECB’s euro liquidity facilities are recorded.
Historically, central bank liquidity lines have been used for three main purposes: (1) to defend a parity system like that of Bretton Woods (Bordo et al. 2015, McCauley and Schenk 2020); (2) offer a global liquidity backstop, which is the case with the Fed (Auer and Kraenzlin 2009, Bahaj and Reis 2018); or (3) improving the international use of the national currency, in particular the case of the People’s Bank of China (Bahaj and Reis 2020). As Figure 1 clearly shows, the main purpose of the ECB’s euro liquidity lines so far has been to provide liquidity in times of distress, as the number of such announcements has increased during crisis episodes. .
With the exception of agreements within the G10 network, the counterparties to the liquidity facilities in euros were mainly from EU countries outside the euro area (Bulgaria, Croatia, Czech Republic, Denmark, Hungary, Poland, Romania and Sweden). In addition, since March 20, 2020, the ECB has extended the network to third countries (Serbia, San Marino, Albania and the Republic of North Macedonia). Consequently, unlike the Fed, the role of the ECB has been more of a regional lender of last resort than a global lender (Chart 2).2
Figure 2 Geographical breakdown of the ECB’s liquidity facilities in euros: repo and swap lines
Source: Albrizio et al. 2021.
To note: Countries whose central bank has established euro swap lines with the ECB are highlighted in red while countries with euro repo lines are highlighted in blue.
Direct effects of the ECB’s liquidity lines: Reduction in foreign currency borrowing costs
As pointed out in Auer and Kraenzlin (2009), during market turmoil, interbank money markets may not function properly. In times of financial stress, it becomes increasingly expensive for agents to borrow in riskier foreign exchange markets, making it more difficult for banks and businesses to fulfill their contracts and commitments denominated in foreign currencies. Previous empirical research shows that the Fed’s swap lines have been effective in lowering dollar borrowing costs (Bahaj and Reis 2018), limiting fire sales of assets, and helping contain the risk of market contagion. . In addition, the mere announcement of the Fed’s facilities gave market participants confidence without the need to activate them (Panetta and Schnabel 2020), the so-called signaling effect (Aizenman et al. 2021).
Likewise, we compare the variations in the cost of financing in euros on the foreign exchange markets of the targeted currencies with those of the currencies of similar non-target countries.3 To isolate the signaling effect, we estimate these developments in a narrow window around the public announcement of each liquidity line.4 Figure 3 compares the density of these changes for targeted and untargeted currencies. The breakdown of target countries suggests a shift to the left towards lower euro borrowing costs. In contrast, we do not observe such a change in the non-target group. This suggests that the ECB’s liquidity line announcements have effectively reduced euro funding costs in the targeted economies.
figure 3 Base currency density before and after announcement
Source: Albrizio et al. 2021.
To note: Baseline density changes within a four-day window around the ad. For any ad, the currency (ies) processed is / will be the currency (s) targeted by the ad, while non-target currencies in the sample are not processed. Post-treatment is defined as the day of treatment and the day after (Post), while pre-treatment is the two days before treatment (Pre).
In a more formal assessment, relying on a difference-in-differences approach as in Bahaj and Reis (2018), we believe that announcing a swap line reduces the cost of financing in euros in the equity markets. changes significantly and up to 76 basis points (Figure 4).
Figure 4 Estimated reduction in the cost of financing in euros in foreign currencies: signal effect
Sources: Albrizio et al. (2021).
To note: The blue bars represent the estimated effect on the exchange swap basis of the currencies traded against a group of currencies not targeted by the row announcements. Sample I includes countries whose currencies were targeted at least once during the period considered (Bulgaria, Denmark, Croatia, Hungary, Poland, Serbia, Sweden). Sample II adds currencies from geographically contiguous countries that have never been targeted (Norway, Iceland). Sample III expands Sample II by considering the targeted G10 countries (United States, Switzerland, Canada, United Kingdom, Japan) and other control countries such as New Zealand and Singapore.
Indirect effects: spillover effects for euro zone banks
The liquidity shortage in foreign exchange markets can spill over into the domestic market in different forms: turning into global financial instability, increasing funding costs for domestic companies (McCauley and Schenk 2020), or negatively affecting the valuation of the market. market of the national banks most exposed to the crisis. markets. Central bank liquidity line announcements can prevent these negative spillovers from materializing by building confidence in recipient economies and reducing the risk of contagion. In addition, the Fed lines have generated a positive fallout, as the cheaper swap lines increase purchases of dollar-denominated assets at banks located in the targeted jurisdictions, relative to other banks and banks. other names (Bahaj and Reis 2018).
To assess the potential spillover effects for the euro area, we compare the stock prices of banks in euro area countries with close banking ties to the target countries versus banks in less exposed euro area countries. Therefore, we expect that an announcement by the ECB of a repo line with Romania will benefit Italian banks more than Belgian banks, since the latter do not have strong banking ties with Romania. Our results indicate an increase of around 7% in the prices of bank shares of the euro area countries most exposed to beneficiary economies at the time of the announcement.
Conclusions: the lines of the ECB are working
Swap and repo lines are becoming an integral part of the ECB’s stabilization toolbox. As indicated in our work, their use makes the ECB a regional lender of last resort since the ECB increasingly relies on these instruments in times of crisis. An unanswered question then is whether these arrangements can also stimulate the use of the euro as an international currency, at least at the regional level (see Panetta and Schnabel 2020). Going forward, a larger and more permanent network could strengthen the global safety net and help mitigate the negative effect of capital flow reversals.
Albrizio, S, I Kataryniuk, L Molina and JL Schaefer (2021), “ECB Euro Liquidity Lines”, Banco de Espana Working Paper n ° 2125.
Aizenman, J, H Ito and GK Pasricha (2021), “Central bank swaps in the age of Covid-19”, VoxEU.org, April 08.
Auer, R and S Kraenzlin (2009), “Money Market Strain and International Liquidity Provision During the Crisis,” VoxEU.org, October 14.
Bahaj, S and R Reis (2018), “Central bank swap lines”, VoxEU.org, September 25.
Bahaj, S and R Reis (2020), “Jumpstarting an international currency”, VoxEU.org, September 21.
Bordo, MD, OF Humpage and AJ Schwartz (2015), “The Evolution of Federal Reserve Swap Lines Since 1962”, IMF Economic Review 63 (2): 353-372.
ECB (2021), “Central Bank Liquidity Lines”, European Central Bank Web Article.
IMF (2020), Financial Stability Report, April 2020.
McCauley, R and CR Schenk (2020), “Swap innovation, then and now,” VoxEU.org, April 12.
Panetta, F and I Schnabel (2020), “The provision of euro liquid through the ECB’s swap and repo operations”, ECB blog, August 19.