US Dollar shortage and global policy response

BIS Working Paper No 291 titled 'The US dollar shortage in global banking and the international policy response' by Patrick McGuire and Goetz von Peter deals with the international policy response to the stresses in the banks balance sheets last year. 

An important point noted by the paper:

Beyond addressing the immediate exigencies, however, the international swap arrangements are of broader interest from an institutional perspective. The structure of the arrangements appears to overcome two challenges commonly associated with international lending of last resort. First, the Federal Reserve and its foreign counterparts have the power, in principle, to create any amount of money, in contrast with international financial institutions administering limited resources. Demands in other currencies can similarly be met by including the respective currency-issuing central banks in the network of swap lines. Second, the swap network does not compound the informational problems that can give rise to moral hazard. By lending against collateral to foreign central banks that intermediate those funds to banks in their jurisdictions, the Federal Reserve assumes no credit risk vis-à-vis the ultimate borrowers, and delegates the task of monitoring the banks (or collateralising the loans) to the national authorities closer to the bank supervision process.

Conclusion of the paper:

The recent financial crisis has highlighted just how little is known about the structure of banks’ international balance sheets and their interconnectedness. The globalisation of banking over the past decade and the increasing complexity of banks’ international positions have made it harder to construct measures of funding vulnerabilities that take into account currency and maturity mismatches. This paper partially fills this void, investigating how banks funded their international positions across currencies and counterparties. The analysis shows that between 2000 and mid-2007, the major European banking systems built up long US dollar positions vis-à-vis non-banks and funded them by interbank borrowing, borrowing from central banks and FX swaps. We argue that this greater transformation across counterparties in fact reflected greater maturity transformation across these banks’ balance sheets, exposing them to considerable funding risk. When heightened credit risk compromised sources of short-term funding during the crisis, the chronic US dollar funding needs became acute, particularly in the wake of the Lehman Brothers bankruptcy.


In contrast to many previous international financial crises, it was banks’ international exposures to other industrialised countries that deteriorated, and the global interbank and FX swap funding structure which seized up. The build-up of such stresses at the global level can only be identified by tracking the extent of cross-currency funding, and by implication, banks’ reliance on short-term interbank and FX swap positions. What pushed the system to the brink was not cross-currency funding per se, but rather too many large banks employing funding strategies in the same direction, the funding equivalent of a “crowded trade”. Only
when examined at the aggregate level can such vulnerabilities be identified. By quantifying the US dollar overhang on non-US banks’ global balance sheets, this paper contributes to a better understanding of why the extraordinary international policy response was necessary, and why it took the form of a global network of central bank swap lines. A broader message of this paper is that vulnerabilities in the international financial system are best measured along the contours of banks’ consolidated balance sheets, rather than along national borders. ....
The macroprudential perspective afforded by these data shows that (i) stresses can build up in a national banking system that cannot be identified with the home country’s residencybased statistics alone, and (ii) banks’ cross-border positions are large relative to countries’ external positions, clouding the interpretation of what the “national balance sheet” implies for domestic residents.