Central banks move to ease pressure

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kevin carmichael
WASHINGTON— Globe and Mail Update
Published Wednesday, Nov. 30, 2011 8:11AM EST
Last updated Wednesday, Nov. 30, 2011 9:43AM EST

Central banks moved to ease the strain the European debt crisis is putting on the global financial system by lowering the rate they charge for emergency access to U.S. dollars.

In a joint announcement Wednesday, the Federal Reserve, the European Central Bank, the Bank of Japan, the Bank of England, the Bank of Canada and the Swiss National Bank said the move is necessary to “ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity.”

Starting next week, the central banks will drop the rate they charge to exchange U.S. dollars for other currencies by half a percentage point. The new charge for “swaps” will be half a percentage point above the U.S. dollar overnight index swap, or OIS. A swap is essentially a loan backed by collateral. The OIS market is where banks go to borrow dollars or other currencies on a short-term basis.

The co-ordinated action comes as European leaders struggle to contain a debt crisis that has seen the borrowing costs of countries such as Italy and Spain climb to crippling levels. The central banks’ moves are an attempt to instill some confidence in financial markets by assuring investors that banks will have easy access to cash for the foreseeable future. They pledged to keep the lower dollar swap rate in place until February, 2013.

While several central banks are participating, this is primarily a show of force by the Federal Reserve and the ECB. The cost for European banks to fund in U.S. dollars rose to the highest level in three years Wednesday as finance ministers from the continent ended a meeting without a definitive plan to backstop the heavily indebted members of the euro zone. To help the ECB deal with the situation, the Fed is agreeing to give its Frankfurt-based counterpart access to all the dollars in needs in exchange for euros.

In addition, the central banks said they will expand their emergency provisions beyond U.S. dollars by opening swap lines in other currencies. This is a precautionary move to ready for the worst-case scenario: a spreading of the European debt crisis to the rest of the world. For now, banks and other financial institutions need U.S. dollars because that is the main unit of exchange for global business.

But if conditions worsened, lenders could struggle to access, say, Swiss francs to settle any accounts in that currency.

“At present, there is no need to offer liquidity in non-domestic currencies other than the U.S. dollar, but the central banks judge it prudent to make the necessary arrangements so that liquidity support operations could be put into place quickly should the need arise.”

The six central banks made the announcement Wednesday in separate statements issued jointly before the start of trading in North America. The Bank of Canada said it would extend an existing $30-billion swap arrangement with the Fed that was scheduled to expire in August, 2012 to February 2013.

“The Bank of Canada judges that it is not necessary for it to draw or offer operations on any of these swap facilities at this time, but that it is prudent to have these agreements in place,” the central bank said. “The Bank of Canada continues to closely monitor developments in global financial markets and remains committed to providing liquidity as required to support the stability of the Canadian financial system and the functioning of financial markets.”