Journal Issue

Uses And Risks With Fx Liquidity Assistance In Systemic Crisis—Is It A Good Idea For Russia?

International Monetary Fund. European Dept.
Published Date:
October 2013
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Uses and Risks with FX Liquidity Assistance In Systemic Crisis—Is it a Good Idea For Russia?1

Should the Central Bank of Russia (CBR) set up policy framework to ease foreign exchange (FX) conditions when it faces systemic FX liquidity shortage? The global financial crisis caused systemic FX liquidity shortages around the world, and central banks took various measures to ease FX liquidity shortages. What is the need for introducing such facilities when the CBR already has committed domestic liquidity support and ample FX was supplied in spot FX market under exchange rate peg framework? Direct lending in FX may be more effective to ease FX liquidity shortage while avoiding a balance of payment crisis. The CBR’s large scale FX intervention and ample domestic liquidity support seem to have distorted the arbitrage conditions in FX markets during the 2008 crisis, leading to additional capital outflows and nearly resulting in a balance of payment crisis. Direct lending in FX at market cost for those who prudently manages FX liquidity risks but turned into shortages due to systemic nature of the crisis, could help achieving the right balance.

A. Introduction

1. Maintaining the stability of FX funding is one of the key elements ensuring the financial stability of the system. For globally active banks with multinational operations, FX funding is an integral part of their overseas operations. In emerging market economies (EM), FX funding often reflects capital inflows (into banks, nonfinancial corporations, and sovereign), a reversal of which is a major source of systemic risk not only to the financial sector, but also to the whole economy. Moreover, risks to FX funding in EM are often associated with broader shocks to the balance of payment (BOP), including large exchange rate depreciation and declines in key commodity export prices. The global financial crisis demonstrated that shocks to FX funding give distinctive challenges to banks, different from domestic liquidity problems.

2. In response to systemic FX liquidity shortage during the global financial crisis, many central banks and governments provided FX liquidity. In advanced economies (AE), central banks introduced temporary FX emergency liquidity facilities for banks. The supply of dollar was often backed up by time-bound swap arrangement with the U.S. Federal Reserve Board (FRB). In EM, a wider range of measures were taken, including those very similar to FX market intervention, changes with capital account restrictions, and targeted support for non-financial corporates. Many countries drew down their international reserves, while some established bilateral swap arrangements with central banks issuing hard currencies and/or sought IMF programs.

3. What are the benefit and costs of introducing FX liquidity facility? There are questions about the need for introducing such facility when the CBR already has committed domestic liquidity support and ample FX was supplied in spot FX market under exchange rate peg framework. In the 2008 crisis, banks and corporates managed to obtain FX by first securing domestic liquidity and then converting them to FX in spot market

4. This chapter explores the rationale for introducing such FX facility. For one, the CBR is moving to inflation targeting framework from exchange rate peg. This will limit the scope of large scale FX intervention in the future. Moreover, the policy mix have, in effect, provided dollar funding at negative rate, making it profitable to borrow in Ruble, convert them into dollar with forward cover and then invest in dollar assets. During the global financial crisis, this appears to have worsened already high balance of payment outflow pressures, risking a BOP/currency crisis. In the end, the CBR devalued the Ruble and tightened monetary policy to avoid a full-blown crisis and regain confidence. On the contrary, directly lending in FX would give the CBR more flexibility to set the adequate levels of dollar interest rate, limiting potential misuse. Providing FX liquidity out of international reserve is also consistent with the need for tightening domestic monetary conditions, which often becomes relevant for EM under BOP crisis pressures.

5. If the CBR introduces FX liquidity facility, care should be taken to establish a framework that can minimize misuse. Proper risk management and monitoring should be in place to prevent excess buildup of FX liquidity risks to begin with. Additional reporting might become necessary to identify institutions that are truly in need of liquidity assistance. It should be emphasized that it is an exceptional measure to counteract against a systemic stress and not a facility to be used for regular operations, let alone expansions.

B. Primer: FX Funding Instruments

6. Banks can rely on a number of FX funding options.

  • Local funding abroad: If a bank has branches and subsidiaries abroad, they may tap into retail deposits in the host countries. Wholesale funding in the host country is another option, including issuing commercial paper, CDs, long-term bonds (purchased by local mutual funds and other institutional investors). If the bank has qualified assets to be pledged as collateral (such as local government bond and other securities), they could use repurchase agreement (repos) or other secured funding options, which are relatively more stable and cheap compared to unsecured funding, especially during stress time. Some banks may have status as a counterpart of local central bank’s monetary operations, which allows them to tap local liquidity facilities.
  • Cross-border and cross-currency funding: A bank can issue international bonds in foreign currency. If a bank has foreign parent, the parent bank might send FX liquidity to the subsidiary/branch. Another avenue is cross-currency funding where banks first obtain domestic currency funding and then convert them into foreign currency by exchanging them in spot FX market while hedging currency risk with FX forward (shorter-term) or currency basis swap (longer-term).2 Cross-currency funding allows banks to access FX funding even when they do not have access to direct FX funding instruments or their interest rates are too expensive.
  • FX funding in domestic market: In some dollarized economies in particular, banks may collect FX deposits in their home country.

C. FX Liquidity Shortage and Support since the Global Financial Crisis

7. The global financial crisis caused systemic FX liquidity shortages in funding and FX markets around the world.

  • In advanced economies (AE), the distress in money markets destabilized wholesale bank funding (in both domestic and foreign currencies), which had been extensively used to expand banks’ investment in securities and derivatives (Adrian and Shin, 2010, and IMF’s Global Financial Stability Report, 2010). Banks often relied on local wholesale funding, as they lacked deposit base in FX. Notably, some European banks built up large exposures to U.S. mortgage securities, financed with wholesale funding from U.S. money market mutual funds (Baba, McCauley, and Ramswamy, 2009). They came under serious liquidity distress when the money market mutual funds cut down financing due in part to their own withdrawal pressures and to increased counterparty risk3 with European banks.
  • The systemic liquidity shortages disturbed normal functioning of FX swap and cross-currency basis swap markets, making cross-currency funding extremely expensive or weakening its availability (see Box 1 for details). The market liquidity dry up limited arbitrage trading in FX derivatives markets, violating covered interest parity condition for a prolonged period since the crisis even for euro, yen and dollar (Figure 1). This gap raised the cost of cross-currency dollar funding using euro and yen above dollar Libor rate.
  • In emerging market economies (EM), FX liquidity shortage was closely related to BOP flow reversals, and therefore, its impact was felt by the broad segments of the economy beyond the financial sector. Capital flows to EM swing substantially when global investors’ risk aversion changes. Fluctuation in commodity prices can affect both current and capital account flows for a commodity producer such as Russia. All of these lead to drastic surge in exchange rate volatility. Governments may carry high levels of foreign currency debt. Banks may be exposed to FX and FX liquidity risks4, including though lending to unhedged borrowers. Non-financial corporations and household may also have large FX mismatches between their assets and liabilities (e.g., dollarized economies). These economy-wide vulnerability to FX and FX liquidity shocks can result in solvency problems (for sovereigns, banks, and corporate) and require macro-policy adjustments, in addition to financial sector policies.

Figure 1:Global Turbulences in FX Forward Markets and Cross Currency Dollar Funding Cost

Box 1.Mechanics of Basic Cross-Currency Funding Using FX Forward and Currency Basis Swaps, and their Behavior during a Systemic Crisis

For banks that need FX (dollar) funding, there are two basic options: [A] direct funding in dollar interbank market (such as Libor) and [B] cross-currency funding using FX forward or currency basis swaps (Figure 1.1). Dollar interest rate with option [A] is i_usd, which is set at the time of contract (t=0). Dollar interest rate with option [B] is i_usd_cc, which is determined by spot Ruble-dollar rate, forward Ruble-dollar rate with one month tenor, and interest rate in Ruble interbank loan market. All of these three inputs are known at the time of contract (t=0), therefore i_usd_cc is set with certainty at t=0.

Figure 1.1:Mechanics of Cross-currency Funding

Notes: S(t=0) is Ruble-USD exchange rate (1 dollar for S Ruble) as of t=0; F(t=0) is Ruble-dollar forward exchange rate with 1 month tenor; i_usd(t=0) is interest rate in dollar Libor market as of t=0; i_rub(t=0) is interest rate in Ruble interbank market as of t=0; and i_usd_cc(t=0) is cross-currency dollar interest rate using transactions [B], using Ruble-dollar spot and forward markets and Ruble interbank market.

During normal time, healthy arbitrage transactions should bring the difference between the two interest rates close to zero (net of transaction costs) especially for well-developed and liquid FX markets for advanced economies—this is the nature of covered interest parity (CIP). When direct dollar interest rate is higher than cross-currency dollar rate, an arbitrager can make money (with certainty) by borrowing in Ruble, convert it in spot market into dollar, and then cover its future dollar value by selling dollar in forward market and then invest in dollar Libor market.

At the time of systemic crisis, however, the increased recognition of counterparty risk often obstruct these arbitrage transactions, violating CIP (Figure 1). Banks become increasingly wary about their counterparty becoming distressed in the future (i.e., credit risks of the countrerpary), refraining from being engaged in arbitrage transactions despite of (FX risk free) profit-taking opportunities. Some may lose access to some or all of the four key markets required to take the arbitrage positions or face much more expensive price than what the reported price indicate. These are the transaction-level mechanics leading to market liquidity “dry up” in the FX forward and currency basis swaps markets. Such violation of CIP was widely observed for a large number of currency markets (Baba and Packer, 2009a). Indeed, the violation of CIP (and some other arbitrage-free conditions) can be used as an indicator of systemic liquidity shortage (IMF, Global Financial Stability Report, 2011a).

For euro and yen, the CIP has continued to be violated since the Lehman crisis well into 2013 (Figure 1). The acute systemic liquidity shortage that followed the Lehman collapse resulted in the large jumps of both dollar Libor rate, euro-dollar and yen-dollar cross currency rates, and their differences. The rates have come down rapidly, as major central banks expanded liquidity support in domestic currency and, in some cases, in dollar (IMF, 2010). However, possibly due to the sustained concerns over counterparty risks, the CIP hasn’t been fully recovered for several years, widening more when global markets experienced renewed pressures (e.g., end 2011 when the concerns over European debt crisis deepened).

8. There are central banks that have FX liquidity facilities, some on temporary basis in response to the crisis. The IMF surveyed central banks about their monetary policy instruments in 2008 and 2010 (Gray and Jadrijevic, 2010).5 As of 2010, 67 (32) percent of central banks conduct spot FX (FX swaps) transactions as part of open market operations. Central banks in Middle East were the most involved in spot FX transactions (85 percent). Some central banks—Bahrain, the Czech Republic, and the European Central Bank (ECB)—explicitly reported that they used FX swaps only on a temporary basis.

9. In AE, central banks introduced temporary FX liquidity facilities to banks, often using similar framework to domestic liquidity facilities and backed up by swap agreement with the FRB. Key features of these facilities are follows.

  • Temporary: In key AE6, FX facilities were introduced at end 2007, most of which expired in February 2010. The ECB, United Kingdom, Switzerland, Canada, and Japan reinstituted the facilities in May 2010 when market pressures reemerged, but these are expected to expire in 2014.7
  • Emergency: The facilities were offered against systemic crises and not standing facilities that bank can count on normal times.8
  • Counterparty: The facilities were offered to financial institutions that satisfy similar eligibility criteria to domestic liquidity support.
  • Operations: Some offered (reverse) repo (including the Bank of England, the ECB, and the Swiss National Bank), and the others offered FX swaps (the Bank of Japan, BOJ). Some central banks offered limited quantity based on competitive auctions, while some offered the facility without quantitative ceiling, using fixed rate, noncompetitive auction where all bids would be filled (full allotment, Table 1).
  • Collateral: The facilities were collateralized, using similar eligible collaterals to domestic liquidity facilities in case of repo (with haircuts) or using domestic currency cash as collateral in case of FX swaps.
  • Backup: Most AE central banks that offered FX facilities established dollar swap arrangement with the FRB.
  • Pricing: The costs of these funding were set at levels that are expensive during calmer times but competitive during stress periods (Figure 2).The rate (OIS+100 bps initially and the +50 bps since end 2011) has been above dollar Libor and cross-currency dollar rate most of the time, but the rise in market rate, especially cross-currency dollar rate at end 2011 made central bank funding more attractive.
Table 1.Details of Dollar Swap Arrangement with FRB and Corresponding Domestic Dollar Provision Modality, by Central Banks, October 2008 through 2010
CountryLot size (USD billion)As of dateRange of tenors offered since inceptionMinimum bid rateNotesAuction format in each jurisdiction 1/
ECBFull allotment10/13/08overnight, 1W, 1M, 3MUSD OIS+ 100 bpsExpired in Feb. 2010, re-established in May 2010, extended to Feb. 2014. Bid reduced to USD OIS+ 50 bps in Nov. 2011.Non-competitive, fixed rate, full allotment
SwitzerlandFull allotment10/13/08overnight, 1W, 1M, 3MUSD OIS+ 100 bpsExpired in Feb. 2010, re-established in May 2010, extended to Feb. 2014. Bid reduced to USD OIS+ 50 bps in Nov. 2011.Non-competitive, fixed rate, full allotment
EnglandFull allotment10/13/08overnight, 1W, 1M, 3MUSD OIS+ 100 bpsExpired in Feb. 2010, re-established in May 2010, extended to Feb. 2014. Bid reduced to USD OIS+ 50 bps in Nov. 2011.Non-competitive, fixed rate, full allotment
Australia309/29/081M, 3MUSD LiborExpired in February 2010.Competitive, multi-price auction
New Zealand1510/28/08Not drawnExpired in February 2010.
JapanFull allotment9/29/081M, 3MUSD OIS+ 100 bpsExpired in Feb. 2010, re-established in May 2010, extended to Feb. 2014. Bid reduced to USD OIS+ 50 bps in Nov. 2011.Non-competitive, fixed rate, full allotment
Canada309/29/08Not drawnExpired in Feb. 2010, re-established in May 2010, extended to Feb. 2014. Bid reduced to USD OIS+ 50 bps in Nov. 2011.
Denmark159/29/081M, 3MLibor + 50 bpsExpired in February 2010.Competitive, single price auction
Sweden309/29/083MUSD OIS+ 50 bpsExpired in February 2010.Competitive, single price auction
Norway159/29/081M, 3MExpired in February 2010.Competitive, multi-price auction
Korea3010/29/083MUSD OIS+ 50 bpsExpired in February 2010.Competitive, multi-price auction
Brazil3010/29/08Not drawnExpired in February 2010.
Mexico3010/29/083MUSD OIS+ 50 bpsExpired in February 2010.Competitive, multi-price auction
Singapore3010/29/08Not drawnExpired in February 2010.
Sources: Goldberg, Kennedy, and Miu (2010) and FRB (2013)

Collateral eligibility follows those for domestic open market operations.

Sources: Goldberg, Kennedy, and Miu (2010) and FRB (2013)

Collateral eligibility follows those for domestic open market operations.

Figure 2.Cost of AE Central Bank Dollar Facility

Sources: Bloomberg and Staff calculations.

1/ Cross-currency funding rate is synthetic USD funding costs by borrowing in yen/euro at ye Libor/euribor rate and converting into U.S. dollar in spot market with FX forward cover.

2/ USD lending facility by BoJ and ECB charged OIS+ 100 bps up to mid December 2011 and then cut to + 50 bps.

10. EM, on the other hand, used a wider range of tools to ease dollar funding conditions. As summarized in Table 2, the measures included those very similar to spot FX market intervention9; changes with capital account restrictions; changes in FX reserve requirements; open market operations including FX swaps and other types of lending in FX to banks; regulatory forbearance and amendment; and targeted support for non-financial corporates10. Many countries drew down their international reserves; some established bilateral swap arrangements with the FRB or other central banks; and some asked for IMF-supported programs. Some of these measures were directly or indirectly meant to provide FX liquidity for corporates in addition to banks, as FX and FX liquidity risks were often widespread among non-financial corporations reflecting the openness of the economy.

Table 2.Emergency FX Liquidity Support by Types of Instruments in Emerging Markets-September 2008-June 2009
Trading FX in the spot market (excluding peg countries)
  • Turkey, CB starts intermediating interbank FX operations. (2008)
  • Turkey, CB halts its daily purchase of dollars and shifts to daily dollar sales. (2008)
  • Chile, CB suspends reserve accumulation program. (2008)
  • Chile, CB initiates daily FX sale auction program. (2009)
  • Columbia, CB provides FX based on a rule (giving market participants the option to buy FX from CB when the volatility goes above a threshold). (2008)
    • Mexico, CB offers rule-based daily FX auction with a minimum price floor. (2009)
Changes in reserve requirement
  • Indonesia, CB reduces FX reserve requirement. (2008)
  • Romania, CB reduces FX reserve requirement. (2009)
  • Serbia, CB reduces FX reserve requirement and further changes currency structure of required reserves. (2008)
  • Turkey, CB reduces FX reserve requirement. (2008)
  • Ukraine, CB relaxes FX reserve requirement. (2009)
  • Argentina, CB relaxes FX reserve requirement. (2008)
  • Chile, CB relaxes FX reserve requirement to be met in any FX not just USD. (2008)
  • Mexico, CB begins to pay monthly interest on dollar bank deposits. (2008)
  • Peru, CB eliminates reserve requirements on long-term international bank loans. (2008)
  • Peru, CB reduces marginal reserve requirement on FX deposits. (2008)
Lending using FX swaps
  • Hong Kong SAR, CB offers FX swaps to banks. (2008)
  • India, CB offers temporary FX swaps to overseas branches of Indian banks (2008)
  • India, CB offers temporary FX swaps to Indian banks with overseas offices. Allow banks to get domestic liquidity from the central bank to be used for swaps. (2008)
  • Indonesia, CB extends FX swap tenors. (2008)
  • Korea, government provides liquidity in FX swaps market. (2008)
  • Korea, CB introduces competitive auction FX swap facility. (2008)
  • Hungary, CB offers FX swaps daily. (2008)
  • Hungary, CB offers fixed price euro/Swiss franc swap. (2008)
  • Hungary, CB offers 6-month euro/froint swaps 3-month floating-price euro/froint swaps (2009)
  • Poland, CB introduces FX swaps. (2008
  • Serbia, CB offers local currency liquidity and FX swaps for foreign banks’ subsidiaries committed to maintain their exposures to the country.
  • Chile, CB offers FX swap program, and extends its maturity later. (2008)
Lending in FX to banks
  • Korea, government grants temporary 3-year guarantee on banks’ FX borrowings. (2008)
  • Philippines, CB starts to offer USD repo. (2008)
  • Vietnam, CB expands eligible collaterals for its FX lending operations to include recently issued USD sovereign debt of the country. (2009)
  • Russia, government provides its FX reserve to state-owned development bank (VEB) to on-lend banks and corporate (2008).
  • Turkey, CB increases the limit on its GX lending window and cuts the rates. (2008)
  • Turkey, CB extends the maturity for FX repo between banks and vis-à-vis CB. (2009)
  • Argentina, CB offers to auction options for banks to borrow dollars to help trade finance. (2009)
  • Brazil, CB sells 1-month dollar liquidity lines. (2008)
  • Brazil, government allows Brazilian banks to borrow reserves (collateralized) for on-lending to exporters. (2008)
  • Brazil, CB auctions FX loans taking Brazilian sovereign global bonds as collateral. (2008) The eligible collaterals are expanded later. (2009)
  • Brazil, CB offers dollar repo targeted at exporters. (2008)
Support for non-banks
  • India, CB offers collateralized FX lending to oil refinery companies. (2009)
  • Indonesia, government creates a new export financing agency to provide FX liquidity via guarantees, insurance, or lending.
  • Korea, government and CB provide funding to exporters. (2008).
  • Korea, CB expands collateral for FX loans given to banks, including export bills from all enterprises to facilitate export financing from banks. (2008)
  • Hungary, government provides FX to state-owned development bank to boost lending to companies. (2009)
  • Russia, government provides its FX reserve to state-owned development bank (VEB) to on-lend banks and corporate (2008).
  • Brazil, CB offers 1-year dollar loans to companies. (2008)
Changes in capital account restrictions
  • India, CB allows banks to borrow FX from overseas branches. (2008) India, CB raises refinancing limit on bank export credit. (2008)
  • India, CB raises interest rate ceilings on FX export credit. (2009)
  • Indonesia, state-owned firms are required to repatriate export proceeds. (2008)
  • Korea, CB eliminates limits on bank purchases of USD in offshore non-deliverable forward markets. (2008)
  • Philippines, CB relaxes some FX documentation rules to allow easier access to dollars. (2009)
  • Ukraine, CB relaxes limits on foreign borrowings by banks. (2008)
  • Argentina, impose 3-day waiting period for investors buying local securities for sale abroad for dollars. (2008)
Regulatory forbearance/amendment
  • Nigeria, CB lowers limits on net open FX position. (2008, 09, 10)
  • Philippines, CB lowers limit on FX liquidity holdings in excess of FX liability. (2008)
  • Philippines, CB relaxes marked-to-market requirement for foreign currency deposit units to reduce their dollar demands. (2008)
Swap/lending arrangement with other central banks
  • China, with Japan and Korea. (2008)
  • Hong Kong SAR with Netherland. (2009)
  • Estonia with Sweden. (2009)
  • Hungary with ECB. (2008)
  • Iceland with Denmark, Norway, Sweden and Finland. (2008)
  • Latvia with Sweden and Denmark. (2008)
  • Poland with Switzerland and ECB. (2008)
  • Brazil, Korea, Mexico with the U.S. (2008-Feb. 2010) Among AEs, Australia, Canada, ECB, Japan, Singapore, Norway, New Zealand, Denmark, Sweden, Switzerland and the U.K. also had swap arrangement with the U.S. Most of these expired in February 2010, except for Canada, Japan, ECB, Switzerland and the U.K. where the arrangement has been extended to 2014.
  • Brazil, the government eliminates certain tax on FX transactions. (2008)
  • Chile, government shifts FX deposit from foreign banks to domestic banks and coordinates with CB in auctioning USD CDs to local banks. (2008)
Sources: Author’s extract from background database for Ishi, Stone, and Yehoue (2009), based on central bank websites, Factiva and IMF country reports; Moreno (2010); and Druck, Hofman and Lu (2013).Note: CB stands for central bank.
Sources: Author’s extract from background database for Ishi, Stone, and Yehoue (2009), based on central bank websites, Factiva and IMF country reports; Moreno (2010); and Druck, Hofman and Lu (2013).Note: CB stands for central bank.

11. As in AE, EM central banks also offered domestic monetary easing and liquidity support, although they were initiated at a later stage in the global financial crisis. The global financial crisis started in AE, and many EM faced the downturn only in late 2008. In earlier part of the year, EM economic growth was generally strong with persistent inflationary pressures, which warranted tight monetary policy stance. They turned to monetary accommodation only when the global financial stress intensified upon the Lehman’s failure. As capital flow reversed and economic outlook deteriorated, central banks took measures to mitigate the broad liquidity shortage and balance sheet effects.

12. However, not every EM could aggressively ease domestic liquidity conditions. For those with their own vulnerability, the external shock evolved into a full-blown BOP crisis, and they needed to raise domestic policy rate in order to regain confidence and limit capital outflows. In general, EM could face more serious trade-offs between giving support for balance sheet misalignment of the private sector and maintaining the overall confidence in the economy. Unlike AE which issue international reserve currencies, monetary loosening and unconventional monetary policy in EM at the time of financial distress could fuel capital outflows and sales pressures on their currency, increasing the chances of currency crisis (Jacome, Sedik, and Townsend, 2011). However, even in such cases, a central bank might still be able to offer limited FX facilities, to the extent its international reserves allow, as they are consistent with monetary tightening (i.e., the reduction of net foreign assets and reserve money). Indeed, Hungary offered FX swaps to mitigate FX liquidity needs (Table 2, and IMF, 2009).

D. Russia’s “FX Liquidity Support” during the Crisis: Benefits and Consequences

13. Turning to Russia, the CBR provided FX liquidity in spot market through 2008-09, but this was within its exchange rate peg framework rather than directly providing FX loans (Figure 3).11 Russian financial system experienced serious generalized liquidity shortage, as oil prices declined and external borrowing by banks and corporates reversed. The CBR provided ample domestic liquidity to banks and corporates (channeled through banks) including with uncollateralized lending to banks.12 The CBR did not offer FX loans per se. However, it supplied substantial FX out of international reserves in spot exchange rate market in order to maintain Ruble at its target range.13 Banks and corporates obtained FX by first securing domestic liquidity and then convert them to FX in spot market.

Figure 3.External and Monetary Conditions in Russia during the 2008–09 Crisis

14. However, Russia risked a BOP/currency crisis.14 The accommodative monetary policy providing large domestic liquidity at low interest rate immediately after the Lehman shock fueled further capital outflows. At macroeconomic levels, the sudden change in exchange rate expectations trigged by the collapse in oil prices led banks and corporates to seek to hedge their foreign currency exposures, exacerbating pressure on the Ruble. The CBR’s FX intervention reduced international reserves from a peak of $598 billion in August 2008 to a trough of $375 billion in March 2009 (Figure 3). Confronted with surging reserve losses, the Ruble was devalued sharply, and monetary policy tightened with higher interest rate and withdrawal of domestic liquidity support to banks (Figure 4).

Figure 4.Russia’s Interest Rate Policy: 2008–10

Sources: CBR

15. Pricing appears to have been a key problem with the policy mix in 2008-09. The best practices for liquidity support during a systemic crisis (Box 2) suggest that it is critical to provide liquidity at rates that do not give substantial arbitrage profits to banks. The pricing problem with the CBR framework comes out clearly when the costs are compared with those for AE facilities.

  • In advanced economies: The charges on the FX facilities provided by key AE central banks were broadly consistent with market conditions: the dollar interest rates charged by the ECB and BOJ (OIS +100 bps initially and then +50 bps since end 2011) were more expensive than dollar Libor and cross-currency funding rate most of the time but were less expensive during stress period (e.g., end 2011, Figure 2, Box 1).
  • Arbitrage opportunity in Russia: In contrast, interest rate structures for Russian banks in late 2008 were such that banks could earn substantial risk-free arbitrage gains by borrowing in Ruble and investing in dollar. The implied dollar funding rate using dollar-Ruble forward fell to negative upon the Lehman event (Figure 5)15. Banks who maintained access to these rates16 could earn FX risk-free profit by borrowing in Ruble (at interbank MosPrime or CBR repo rates) and lending in dollar (Libor or other) markets. The interest earning from dollar was near zero after the FRB cut its policy rate, and MosPrime (1 month), by comparison, was high at over 20 percent levels. Nonetheless, the main source of profit was the Ruble depreciation implied in dollar-Ruble forward market, amounting to annualized 30-50 percent in late 2008.

Figure 5.Cross-Currency Arbitrage Opportunities in Russia and Capital Flows: 2008–09

16. The pricing problem appears to have further fueled already severe capital outflow pressures. The capital flows turned to large net outflows in 2008Q4. Especially, the acquisition of foreign assets—consistent with the arbitrage trading—contributed to this turnaround more than the reduction in liabilities (Figure 5). Indeed, Ishi, Stone, and Yehoue (2009) reference news reports discussing that some Russian banks used the cheap Ruble liquidity to invest in abroad and profit from depreciation.

17. Directly providing FX loans/swaps instead can, in principle, mitigate some of the above issues. A central bank can set the right FX borrowing costs that do not create arbitrage opportunities, instead of indirectly relying on (out-of-parity) market FX forward rates. If fixed amount of FX is auctioned off at competitive prices, it would help delivering the scarce FX liquidity to those who need them the most. If FX loan is provided out of international reserves (instead of providing domestic currency liquidity and then ask banks to convert them into FX), net foreign assets decline and domestic monetary conditions are tightened. But such tightening might be desirable when the central bank needs to raise domestic interest rate in order to regain confidence and limit the possibility of a currency crisis.

18. Lastly, having the capacity to provide FX liquidity can become more important when Russia fully moves to inflation targeting framework. The CBR is aiming at moving to inflationtarget framework in 2014, under which intervention in FX market becomes harder to justify. Using auction and intervening based on rules could give different wrap from FX intervention to maintain exchange rate, in reality. However, it is hard to draw a clear line between FX provision and intervention in reality as seen in the case of Mexico. Furthermore, Ishi, Stone and Yehoue (2009) showed that countries with inflation targeting framework were more likely to introduce FX liquidity facilities during the last crisis.

Box 2.Best Practice for Liquidity Support by Central Banks in a Systemic Crisis 1/

This box lists some of the key issues in designing and assessing FX liquidity provision framework upon systemic financial crisis. Most items also apply to domestic currency liquidity provision framework.

  • Proper liquidity risk management by banks: Crisis management tools should be accompanied by solid crisis prevention/monitoring framework. Banks should have sound liquidity risk management framework, and supervisors need to monitor risks posed by banks, and when relevant, the corporate sector. FX liquidity stress test could be a useful tool. FX risks are usually well monitored and regulated in EM using open FX positions. However, it is not sufficient to monitor FX liquidity risk because it does not capture maturity mismatch in FX assets and liabilities. IMF survey on stress testing (Schumacher and Oura, 2012 and Oura, 2012) points out a half of the country authorities in the sample conduct FX liquidity tests.
  • Establish (cross/within) organizational coordination: On the national level, Memoranda of Understanding (MoU) are needed among the central bank, the ministry of finance, the supervisor(s), and the deposit insurance institution to establish the principles for assigning the responsibility to approve liquidity provisions, sharing information, dividing other responsibilities, and securing government guarantees for support resources. MoU between home-host supervisors/central banks are desired to cover cross-border issues. In particular, preparing for obtaining liquidity back-up from other central banks or from private sources is an important set-up for FX liquidity support.
  • Instrument choice: Three basic instruments are typically used: (i) repo against a list of eligible securities; (ii) collateralized lending against a list of eligible assets (including non-security assets that cannot be used for repos) or FX swaps; and (iii) lending against whatever collateral the bank has. It is also important that banks have ample flexibility to use their reserves at the central bank and liquid assets for short-term liquidity management. The central bank should consider relaxing reserve requirements and liquid asset requirements, if they exist.
  • Terms and quantity: Reserve (or other FX resource) adequacy should guide the term and quantity. Large and longer term FX lending operations are risky to undertake with relatively low levels of reserves. In such a case, short-term tenors (overnight to one-week) and limited amounts are appropriate. Spot intervention permanently reduces international reserves, while repos and FX swaps reduce the usable portion of reserves until they mature. When a central bank is rolling-over very short-term FX loans repeatedly, it is critical to signal that these measures are discretionary and emergency, and borrower should not develop false sense of security.
  • Collateral: For both domestic and FX liquidity facilities, securing collaterals is essential for mitigating risks to central bank balance sheet. With FX swaps, the collateral is simply domestic cash. For repos and collateralized lending, it is critical to maintain solid collateral eligibility criteria. Many AE central banks use the same eligibility criteria as domestic open market operations (OMO), possibly with additional haircut on local currency assets to reflect FX risk (e.g., ECB puts additional 15 percent haircut).
  • Pricing: Pricing should be consistent with market conditions for off-shore FX funding costs and should not result in subsidizing banks. This is critical for preventing banks with easy access to the FX funding market from arbitraging against central bank facilities. FX funding costs calculated from FX forward and domestic interest rate (i.e., synthetic FX funding rate with domestic currency funding and FX forward (or swaps) where synthetic FX rate = domestic interest rate – domestic currency depreciation implied by spot and forward rate) should guide adequate charges. A discriminative or “market-related” pricing would also prevent misuse of this facility and an unnecessary drawdown of FX reserves.
  • Counterparties: Expand the pool of counterparties in a crisis if necessary beyond standard OMO counterparties. In large market, in particular, central banks do not deal directly with all commercial banks (and other systemically important financial firms). When distress limits the distribution function of the interbank market, the central bank may need to use different operational instruments and allowing a wider group of financial institutions to have direct access to the central banks’ OMO. Affiliates of foreign-owned banks are generally expected to be treated the same way as domestic banks. But there have been examples where the central bank referred foreign-owned banks to their headquarters for (FX) liquidity support in order to ration FX reserves.
  • Transparency: Central banks should publish about their international reserves positions, including repos, swaps, and other operations that affect usable amount of the reserves. During the Asian crisis, the lack of transparency (intervening using swaps and forwards without properly reflecting these position to international reserves data) ultimately led to trigger a loss of confidence that resulted in currency crisis.

1/ Based on the IMF note “Emergency Liquidity Support by Central Banks in Systemic Crisis” by Zsofia Arvai, Luis Jacome, and Alexandre Chailloux and “Central Bank FX Reverse Transactions” by Alexandre Chailloux, Simon Gray, and Mark Stone. All notes are available on IMF Fundwide Collaboration Workspace for Crisis Group

E. Key Considerations for Establishing Effective FX Liquidity Safeguard in Russia

19. An effective FX facility should follow principles similar to liquidity support in general (Box 2). Without adequate safeguards, central bank facilities could cause moral hazard and eventually cost losses to the central bank. Moreover, the adequacy and effectiveness of liquidity provision framework needs to be judged in the context of overall crisis prevention and management framework, which includes framework for supervisory early intervention of problem banks (crisis prevention), micro- and macro-prudential supervision and tools, and crisis management tools (official liquidity and capital support, orderly and effective resolution, and deposit guarantee schemes). Recommendations in 2011 FSAP should guide the issues for further improvement in this broad area.17 Nonetheless, there are a few specific areas that should be strengthened when considering FX liquidity facilities in Russia.

20. First and foremost, it is important to monitor and limit the buildup of vulnerability. The financial crisis in Russia in 2008-09 was partly triggered by global development but its root causes were domestic. Domestic bank credit to the corporate and household sectors rose at an unsustainable level of approximately 400 percent over the four years prior to the crisis. Fueled by rising property and commodity prices and the authorities’ earlier focus on exchange-rate stability, Russian bank lending was increasingly financed by external borrowing (Figure 3, 6). Thus, banks and corporates were in vulnerable to sudden changes in exchange rate expectations.

Figure 6.Russia Banks, Foreign Financing and Credit Growth

21. In particular, terms and uses of external debt for both banks and corporates need to be monitored carefully. Non-bank private corporations rely more on external debt than banks, and borrowing has been picking up strongly once again recently (Figure 7). Bank external debt is rising again as well, but their net foreign assets have turned to positive since 2009, which is a distinctive improvement compared to the time just before the global financial crisis. When assessing FX maturity mismatch/liquidity risks, it is necessary to look beyond contractual maturity. External borrowings often include covenants that give creditors options to request repayment before maturity when certain market conditions are met18 Many of the external borrowing by Russia contracted before the global financial crisis indeed had such covenants, which suddenly shortened residual maturity and increased liquidity need exactly when the market conditions deteriorated.

Figure 7.Russia’s External Debt: 2005–13

22. For fuller assessment of cross-border risks that often contribute to FX liquidity risks, home host collaboration, and regular data collection are particularly relevant.

  • As pointed out by 2011 FSAP, the CBR monitors a rather limited set of banks’ cross-border activities. Cross-border exposure data by country are limited to inter-bank claims. While balance of payment data provide some information about cross-border financial flows for banks, they do not cover funding and investment activities of Russian banks that do not cross the Russian border.19 If, for example, Russian banks build similar positions to European banks’ exposures in the United States (obtain funding from money market funds in the United States to purchase U.S. securities in U.S. markets), it will be hard to gauge the exact extent of such exposures with existing data.
  • More broadly, reporting and monitoring of cross-border exposures, liquidity, and FX liquidity is weak in most countries, including AE, even though data on overall liquidity are being enhanced, as countries prepare for introducing Basel III liquidity regulations.20 Still, the regulatory requirements to cover FX liquidity risks are scant. When needed, some national supervisors require systemically important institutions to report additional details in line with the risks and vulnerability the financial systems face.

23. Stress test, especially bottom-up stress tests could be effectively used to monitor FX and FX liquidity risks even when there is limited regulatory reporting. Bottom up stress tests are organized by supervisor and implemented by banks. The supervisor usually sets up specific common scenarios and shock assumptions to be applied to all the participating banks, and banks calculate the impact using their own internal data. Due to limited liquidity data, many supervisors rely more on banks’ data and methodology for liquidity stress tests than solvency tests (Schumacher and Oura, 2012). The IMF survey on stress testing by supervisors/central banks (Oura, 2012) indicates that about a half of the regulators conducts separate FX liquidity stress tests. For the Japan 2012 FSAP21, the IMF and the BOJ focused on U.S. dollar liquidity risks in their liquidity stress test, including the roll-over risks with FX swaps (one of the key dollar funding tools for Japanese banks), which materialized after the Lehman failure.

24. It will be extremely important to make it clear that a possible FX facility is an exceptional measure against a systemic crisis and not standing facility. Such exceptional liquidity facilities (both in domestic or foreign currencies) should not be misused to finance banks’ regular operation or let alone credit expansion. Setting expiration date explicitly and charge costs in line with market conditions are essential for avoiding moral hazard and misuse, which can not only cause some direct loss to the central bank but also risk large capital outflows and currency crisis.

25. Any liquidity facility should be consistent with broad policy packages for regaining confidence. For EM, unconventional monetary policy and other financial sector support upon crisis, can do more harm than good when a country has its own domestic vulnerability. The central bank and government might need to make difficult choices under substantial uncertainty. At the height of a crisis, one needs to focus on measures that can help regaining confidence. For instance, Stone, Walker and Yasui (2009) discussed various FX liquidity support taken by Brazil in 2008–09, and point out that the announcement of the swap arrangement with the U.S. FRB contributed the most among other FX support measures (including spot and futures market intervention, FX swaps auctions, dollar lending to exporters and corporations with external debt) in stabilizing the FX markets.


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Prepared by Hiroko Oura (MCM).


FX swaps are usually short-term (3–6 months) and consist of two transactions, the exchanges of principals at spot rate in the beginning of the contract and the exchange at maturity at forward rate. Currency basis swaps are usually longer-term (1–5 years) and consist of three types of transactions: the exchanges of principals at the spot rate when starting the contract, the exchanges of interest rate payments during the contract period, and the exchanges of principals at maturity using the same spot rate as the start of the contract. See for details.


It is the risk of losing money when one’s counterparty (usually financial institutions) defaults on interbank deposit and loans, CDs, commercial papers, derivatives, etc.


FX risk reflects exchange rate fluctuation and reflects FX asset and liability mismatch. FX liquidity risk is caused by maturity mismatch between FX assets and liabilities.


The 2011 sample contains 121 respondents (including 3 monetary unions), representing 151 countries. 22, 60, 18 percent of responses are from high, middle, and low income countries respectively.


Including euro area, Switzerland, United Kingdom, Australia, New Zealand, Japan, Canada, Denmark, Sweden, Norway, South Korea, and Singapore.


However, central banks may agree to extend the program if they consider it necessary, as they have done in the past five years.


FX liquidity stress test for Japan FSAP (IMF, 2012) excluded access to BOJ’s FX facility from FX liquidity buffer based on the understanding that the facility should not be counted on regular basis.


Some countries attempted to set the operational framework by adopting rule-based auctions to distribute FX (Moreno, 2010) so that such measures are not interpreted as a policy defending a certain level of exchange rate. For example, Colombia offered market participants the option to buy FX from the central bank when exchange rate volatility jumped beyond a certain threshold. Mexico adopted a rule to set the daily amount to be auctioned with a minimum price floor.


See Druck, Hofman, and Lu (2013) and Stone, Walker and Yasui (2009) for pros and cons with each tool.


Nonetheless, the government separately provided $50 billion (10 percent of the reserve at that time) to support banks and eventually corporates. The funds were placed with VEB and could be lent to banks and corporate to repay liabilities to foreigners (contracted before announcement date) at terms that reflect market conditions (Ishi, Stone, Yehoue, 2009, Table 2).


A wide range of measures were adopted including temporary lowering required liquidity reserve ratios, widening access to the CBR’s refinancing facilities (including extending eligible collateral to accept corporate bonds), auctioning government deposits, extending unsecured loans from the CBR to banks with a minimum credit rating, and guarantees by the CBR of interbank loans. See IMF (2011) for details.


Druck, Hofman, and Lu (2013) count this as a form of FX liquidity support, while Ishi, Stone, and Yehoue (2009) exclude it from their FX liquidity provision database.


See IMF (Russia country report) for details discussing BOP conditions and monetary and exchange rate policy in Russia during the crisis time.


The figure is calculated using mid-prices for simplicity. Cross-currency dollar interest rate remains negative when incorporating bid-ask spreads explicitly as well (see Bloomber’s FXFA function for instance).


It is possible that not all banks had access to these markets at the quoted rates.


See Russian Federation: Technical Note on Crisis Management and Crisis Preparedness Framework (IMF Country Report No.11/335).


For instance, some covenants are linked to global interest rates (e.g., U.S. dollar Libor) and trigger early repayment when the rates jump beyond a certain threshold.


For instance, when Russian banks’ affiliates in Cyprus take deposit in the country and lend to local entities or to any entity from countries other than Russia, these activities will not be captured by BoP.


Quantitative Impact Study (QIS) organized by Basel Committee on Banking Supervision (BCBS) to prepare for Basel III regulations ensures banks and national regulators are setting up adequate reporting and monitoring framework for introducing the regulations. One Russian bank participated in the most recent exercise released in March 2013 (

21 More recently, the BoJ follows up with similar exercises in their Financial Systems Report

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