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IMF: FX Swaps -- March 2010

IMF: FX Swaps -- March 2010

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FX Swaps: Implications for Financial andEconomic Stability
 Bergljot B. Barkbu and Li Lian Ong 
WP/10/55
 
 
© 2010 International Monetary Fund WP/
10/55
 
IMF Working Paper
Strategy, Policy and Review Department and Monetary and Capital Markets Department
FX Swaps: Implications for Financial and Economic StabilityPrepared by Bergljot B. Barkbu and Li Lian Ong
1
 
Authorized for distribution by Lorenzo Giorgianni and Cheng Hoon LimMarch 2010
Abstract
 
This Working Paper should not be reported as representing the views of the IMF.
 
The views expressed in this Working Paper are those of the author(s) and do not necessarily representthose of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.
 The proliferation of foreign exchange (FX) swaps as a source of funding and as a hedgingtool has focused attention on the role of the FX swap market in the recent crisis. Theturbulence in international money markets spilled over into the FX swap market in thesecond-half of 2007 and into 2008, giving rise to concerns over the ability of banks to rollover their funding requirements and manage their liquidity risk. The turmoil also raisedquestions about banks’ ability to continue their supply of credit to the local economy, as wellas the external financing gap it could create. In this paper, we examine the channels throughwhich FX swap transactions could affect a country’s financial and economic stability, andhighlight the strategies central banks can employ to mitigate market pressures. While notoffering any judgment on the instrument itself, we show that the use of FX swaps for fundingand hedging purposes is not infallible, especially during periods of market stress.JEL Classification Numbers: E44, F31, F32, F34Keywords: Balance of payments, Basel Accords, capital adequacy, FX swaps, hedging, IFRS,international reserves, ISDA.Authors’ E-Mail Address: bbarkbu@imf.org; long@imf.org
1
The authors would like to thank Roberto Benelli, Martin
Č
ihák, Antonio Galicia-Escotto, Patrick Iman, ChengHoon Lim, Donal McGettigan, Jason Mitchell and Mark Stone for their invaluable comments. Any remainingmistakes are the responsibility of the authors.
 
2Contents PageI. Introduction ............................................................................................................................4
 
II. Stylized Facts ........................................................................................................................5
 
III. Financial Stability ................................................................................................................7
 
A. Capital Charges under the Basel Accords ...............................................................10
 
B. Liquidity Risk ..........................................................................................................11
 
C. Transparency under International Financial Reporting Standards ..........................11
 
IV. Economic Stability.............................................................................................................13
 
A. Increased Costs of FX Funding and Hedging .........................................................13
 
B. External Financing Gap ...........................................................................................16
 
C. Exchange Rate Volatility ........................................................................................17
 
V. Central Bank Measures to Mitigate Risks from and Shocks to FX Swap markets .............19
 
VI. Concluding Remarks .........................................................................................................21
 
References ................................................................................................................................43
 
TablesA.1. Credit Conversion Factors for Potential Credit Exposure ...........................................29
 
A.2. Assumptions: FX Spot and Swap Rates ......................................................................30
 
A.3. Example: Calculation of Margin Calls on FX Swaps ..................................................38
 
Figures1. Global Foreign Exchange Market Turnover, by Instrument ..........................................9
 
2. Global FX Swaps Turnover, by Maturity ......................................................................9
 
3. Global FX Swaps Turnover, by Location ......................................................................9
 
4. Cross-Border FX Swaps Turnover, by Counterparty ....................................................9
 
5. G-10 and Switzerland: Notional Amounts Outstanding of OTC Foreign ExchangeDerivatives, by Instrument .......................................................................................9
 
6. G-10 and Switzerland: Gross Market Values of OTC Foreign Exchange Derivatives, by Instrument ...........................................................................................................9
 
7. U. S. Dollar Basis Spread on the EUR, Implied from 3-Month USD/EUR FX SwapContracts ................................................................................................................15
 
8. U. S. Dollar Basis Spread on the GBP, Implied from 3-Month USD/GBP FX SwapContracts ................................................................................................................15
 
9. U. S. Dollar Basis Spread on the JPY, Implied from 3-Month USD/JPY FX SwapContracts ................................................................................................................15
 
A.1. Advanced Countries and Major Financial Centers: FX Swaps Turnover, 2007 ..........24
 
A.2. Key Emerging Market Countries: FX Swaps Turnover, 2007 ....................................24
 
A.3. FX Spot Turnover by Currency, 2007.........................................................................25
 
A.4. FX Forwards Turnover by Currency, 2007..................................................................25
 
A.5. FX Swaps Turnover by Currency, 2007 ......................................................................25
 

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