The Dollar Shortage, Again! in International Wholesale Money Markets

The Dollar Shortage, Again! in International Wholesale Money Markets


During the 2008-2009 global financial crisis, There were many European Banks which got into trouble due to shortage of US Dollar funding in the whole sale international interbank market.  US Federal Reserve eventually extended currency swaps to ECB and other central banks to ease the pressure.

Is it happening now?  There is no banking crisis but there seems to be Dollar Shortage.


Foreign Exposure of European Banks

Liquidity Constraints in Global Money Markets (International Interbank Market)

  • Eurodollar Market

Non US Borrowers got funding from FX Market

  • FX Swap
  • Currency Swap

and Non Bank Sources (Shadow Banking)

  • MMMF
  • ABCP


Funding and liquidity management

Funding can be defined as the sourcing of liabilities. Funding decisions are usually, but not exclusively, taken in view of actual or planned changes in a financial institution’s assets. The funding strategy sets out how a bank intends to remain fully funded at the minimum cost consistent with its risk appetite. Such a strategy must balance cost efficiency and stability. A strategy which targets a broader funding base may entail higher operating and funding costs, but through diversity provides more stable, reliable funding. One which focuses efforts on generating home currency funding may prove more reliable in adverse times but entail higher costs in normal markets. The balance of cost and benefit will reflect a range of factors (see Section 3). Accordingly, funding risk essentially refers to a bank’s (in-)ability to raise funds in the desired currencies on an ongoing basis. Liquidity management is the management of cash flows across an institution’s balance sheet (and possibly across counterparties and locations). It involves the control of maturity/currency mismatches and the management of liquid asset holdings. A bank’s liquidity management strategy sets out limits on such mismatches and the level of liquid assets to be retained to ensure that the bank remains able to meet funding obligations with immediacy across currencies and locations, while still reflecting the bank’s preferred balance of costs (eg of acquiring term liabilities or holding low-yielding liquid assets) and risks (associated with running large maturity or currency mismatches). Accordingly, liquidity risk refers to a bank’s (in-)ability to raise sufficient funds in the right currency and location to finance cash outflows at any given point in time. Funding and liquidity management are interrelated. Virtually every transaction has implications for a bank’s funding needs and, more immediately, for its liquidity management. The maturity transformation role of banks renders them intrinsically vulnerable to both institution-specific and market-related cash flow risks. The likelihood of an unexpected cash-flow shock occurring, and a bank’s ability to cope with it, will reflect not only the adequacy of its funding and liquidity management strategies, but also their coherence under stressed conditions. A bank’s funding strategy will condition liquidity management needs. Hence, the risks embedded in the chosen funding strategy will translate into risks that liquidity management will have to address. Failure to properly manage funding risk may suddenly manifest itself as a liquidity problem, should those sources withdraw funding at short notice. Conversely, inadequate liquidity risk management may place unmanageable strains on a bank’s funding strategy by requiring very large amounts of funding to be raised at short notice.


From The Global Financial Crisis and Offshore Dollar Markets

The Global Shortage of U.S. Dollars

International firms need U.S. dollars to fund their investments in U.S.-dollar-denominated assets, such as retail and corporate loans as well as securities holdings. The funding for these investments is typically obtained from a variety of sources: the unsecured cash markets, the FX swap market, and other shortterm wholesale funding markets.

During the financial crisis, a global shortage of dollars occurred, primarily reflecting the funding needs of European banks. Baba, McCauley, and Ramaswamy (2009) show that European banks had substantially increased their U.S. dollar asset positions from about $2 trillion in 1999 to more than $8 trillion by mid-2007. Until the onset of the crisis, these banks had met their funding requirements mainly by borrowing from the unsecured cash and commercial paper markets and by using FX swaps. Unfortunately, most unsecured funding sources eroded during the crisis. For example, U.S. money market funds abruptly stopped purchasing bank-issued commercial paper after they faced large redemptions associated with the bankruptcy of Lehman Brothers (Baba, McCauley, and Ramaswamy 2009). The reduced availability of dollars resulted in higher dollar funding costs.

The remainder of this article describes the increase in dollar funding costs as reflected in the FX swap market, the primary market enabling global financial institutions to manage multi- currency funding exposures without assuming the credit risk inherent in unsecured funding markets. As liquidity in major unsecured lending markets eroded, the demand for dollar funding through FX swap markets intensified sharply and pushed up the cost of raising dollars through FX swaps. Moreover, heightened demand for dollar funding in conjunction with a reduced willingness to lend dollars noticeably impaired the functioning of the FX swap market, particularly as term liquidity dried up.


Measures of Liquidity Tightening

  • LIBOR-OIS Spread
  • FX Swap implied basis spread


Two Measures

Two measures are used to show the increased cost of dollar funds in private markets during the crisis.

  • The first is the spread between the London interbank offered rate (Libor) and the overnight index swap (OIS) rate.
  • The second measure is the foreign exchange (FX) swap implied basis spread, which reflects the cost of funding dollar positions by borrowing foreign currency and converting it into dollars through an FX swap.






What are the Money Markets

Wholesale money markets

  • Unsecured cash term deposits and loans
  • Money market calculations and conventions
  • Benchmark rates and their determination
  • Libor
  • Euribor
  • Overnight indexed rates such as Eonia and Sonia
  • Treasury bills (a first look at risk-free)
  • Commercial Paper – CP credit ratings
  • Secured money market loans – sale and repurchase agreements (Repos)


Money market derivatives

  • Short term interest rate futures (STIRs): Eurodollar, Short Sterling and Euribor futures
  • Forward rate agreements
  • Interest rate swaps
  • Overnight index swaps (OIS): Sonia and Eonia swaps
  • Monetary policy and the money markets

How a central bank uses money markets to transmit its interest rate intentions.



OTC US Dollar Money Markets:  Sources of short term Funding

A.  Fed Funds Market (Domestic)

B.  Interbank Money Market

  • Cash Market
  • Market for Short Term Securities
  • Market for Derivatives

Cash Market

  • Unsecured – Eurodollar
  • Secured – REPO
  • Secured (Collateralized markets) – FX Swap Market

Short Term Securities Market

  • T-Bills
  • Commercial Paper
  • Certificate of Deposits

Derivatives Market

  • Interest Rates Swaps



Money Markets in EU

In the unsecured market, activity is concentrated on the overnight maturity segment. The reference rate in this segment is the Eonia (Euro Overnight Index Average). It is a market index computed as the weighted average of overnight unsecured lending transactions undertaken by a representative panel of banks. The same panel banks contributing to the Eonia also quote for the Euribor (Euro Interbank Offered Rate). The Euribor is the rate at which euro interbank term deposits are offered by one prime bank to another prime bank. This is the reference rate for maturities of one, two and three weeks and for twelve maturities from one to twelve months.11

The market for short term securities includes government securities (Treasury bills) and private securities (mainly commercial paper and bank certificates of deposits).

In the market for derivatives, typically interest rate swaps and futures are traded.


Is it happening again?

Policy Decisions such as

  • Rising Interest Rates
  • Stronger Dollar
  • Repatriation of Corporate profits from Europe
  • Unwillingness to extend of CB Swap Lines

can cause liquidity crisis which show up in

  • LIBOR rate
  • Eurodollar rate
  • OIS Rate
  • CIP breakdown


Breakdown of CIP – Then and Now




A brief history of the three key periods of global USD-funding shortfalls:

  • The first episode immediately after the Lehman bankruptcy coincided with a US banking crisis that quickly became a global banking crisis via cross border linkages. Financial globalization meant that Japanese banks had accumulated a large amount of dollar assets during the 1980s and 1990s. Similarly European banks accumulating a large amount of dollar assets during 2000s created structural US dollar funding needs. The Lehman crisis made both European and Japanese banks less creditworthy in dollar funding markets and they had to pay a premium to convert euro or yen funding into dollar funding as they were unable to access dollar funding markets directly.
  • The second episode of very negative dollar basis took place during the Euro debt crisis. The sovereign crisis created a banking crisis making Euro area banks less worthy from a counterparty/credit risk point of view in dollar funding markets. As dollar funding markets including fx swap markets dried up, these funding needs took the form of an acute dollar shortage. European banks and companies that had dollar assets to fund had to pay a hefty premium in fx swap markets to convert their euro funding into dollar funding. Those European banks and companies that were unable to do so, were forced to liquidate dollar assets such as dollar denominated bonds and loans to reduce their need for dollar funding
  • The third phase of very negative dollar basis started at the end of last year. Monetary policy divergence has for sure played a role during the end of 2014 and the beginning of this year. The ECB’s and BoJ’s QE has created an imbalance between supply and demand across funding markets. Funding conditions have become a lot easier outside the US with QE-driven liquidity injections raising the supply of euro and yen funding vs. dollar funding. This divergence manifested itself as one-sided order flow in cross currency swap markets causing a decline in the basis. And we did see these funding imbalances in cross border corporate issuance.


Emergent and Related Issues:

  • Global Liquidity
  • Offshore Dollar Money Markets
  • Eurodollar Market
  • International Lender of Last Resort
  • FX Swaps and Currency Swaps Market
  • Cross border funding
  • International Interbank Market
  • Shadow Banking – MMMF, ABCP,
  • Covered Interest Parity (CIP) Breakdown
  • Wholesale Funding Market
  • Global Credit
  • Credit Markets
  • Impact of Global Liquidity on Global Trade
  • Credit Networks of Global Banks
  • International Investment Positions of Banks
  • Derisking by global banks
  • Decline in Correspondent Banking
  • Shortage of Trade Finance


Why has Global Trade dropped so precipitously since 2014?

Is it because of shortage of US Dollars?





Key Sources of Research:


“This Is An Extremely Serious Problem” – Dollar Funding Shortage Hits Record In Japan




Global Dollar Shortage Intensifies To Worst Level Since 2012




Dollar Illiquidity Getting Critical: A $10 Trillion Short Which The Fed Does Not Understand




The VIX Is Dead: According To The BIS, This Is The New “Fear Indicator”




New ICC survey finds worsening global shortage of trade finance




A ‘dollar shortage’ has returned. This is why




Dollar shortage *alert* (plus global trade *alert*)




As goes correspondent banking, so goes globalisation




How do you solve a problem like de-globalisation?




On the ongoing demise of globalisation




Textbook defying global dollar shortages




The Coming Dollar Shortage



Dollar Shortage Goes Mainstream: When Will The Fed Confess?




The Global Dollar Funding Shortage Is Back With A Vengeance And “This Time It’s Different”




The US dollar has been on a tear, and that will spell bad news for the rest of the world



There is a war for capital coming, says UBS




The eurodollar as an economic no-man’s land





Eurodollars, China, TIC data + mysteries




Petrodollars are eurodollars, and eurodollar base money is shrinking




All about the eurodollars




A global reserve requirement for all those eurodollars




On the availability of dollar funding




The dollar shortage problem, evaluated




All about the eurodollars, redux




BIS says we should follow the money




Eurodollars, FX reserve managers and the offshore RRP issue




The BoE as eurodollar dealer of last resort?




FT:  The Eurodollar Market: It All Starts Here




From turmoil to crisis: dislocations in the FX swap market before and after the failure of Lehman Brothers

N Baba



Dollar Funding and Global Banks

Jeremy C. Stein




The US dollar shortage in global banking and the international policy response

by Patrick McGuire and Götz von Peter

October 2009



The US dollar shortage in global banking


Patrick McGuire Goetz von Peter





Emergent International Liquidity Agreements: Central Bank Cooperation after the Global Financial Crisis

Daniel McDowell



The Financial Crisis through the Lens of Foreign Exchange Swap Markets

Crystal Ossolinski and Andrew Zurawski




The spillover of money market turbulence to FX swap and cross-currency swap markets

N Baba




Liquidity Shocks, Dollar Funding Costs, and the Bank Lending Channel During the European Sovereign Crisis

Ricardo Correa, Horacio Sapriza, and Andrei Zlate





John L. Simpson



Systemic risk in the major Eurobanking markets: Evidence from inter-bank offered rates

J.L. Simpson, J.P. Evans




The Eurocurrency interbank market: potential for international crises?.

Saunders, Anthony.

Business Review (1988): 17-27.



The Great Liquidity Freeze: What Does It Mean for International Banking?

Dietrich Domanski and Philip Turner

June 2011



The Euro-dollar market as a source of United States bank liquidity

Steve B. Steib



The LIBOR Eclipse: Political Economy of a Benchmark

Alexis Stenfors1 and Duncan Lindo

January 2016



Basics of U.S. Money Markets




Implementing Monetary Policy – Short-term Money Markets Monitoring




The Dollar Squeeze of the Financial Crisis

Jean-Marc Bottazzia Jaime Luqueb

Mario R. Pascoac Suresh Sundaresand



Central Bank Dollar Swap Lines and Overseas Dollar Funding Costs





The Global Financial Crisis and Offshore Dollar Markets

Niall Coffey, Warren B. Hrung, Hoai-Luu Nguyen, and Asani Sarkar





When and how US dollar shortages evolved into the full crisis?: Evidence from the cross-currency swap market

Naohiko Baba* and Yuji Sakurai†






Funding patterns and liquidity management of internationally active banks



The functioning and resilience of cross-border funding markets






The Impact of the Financial Crisis on Cross-Border Funding

Yaz Terajima, Harri Vikstedt, and Jonathan Witme




Financial Crises and Risk Premiums in International Interbank Markets 

Shin-ichi Fukuda

Mariko Tanaka



Dollar Funding and the Lending Behavior of Global Banks

Victoria Ivashina

David S. Scharfstein

Jeremy C. Stein

October 2012



Financial crises and bank funding: recent experience in the euro area

by Adrian van Rixtel and Gabriele Gasperini

March 2013



The Financial Crisis and Money Markets in Emerging Asia

Robert Rigg and Lotte Schou-Zibell

No. 38 | November 2009



Money Market Integration

Leonardo Bartolini Spence Hilton Alessandro Prati



Segmentation in the U.S. Dollar Money Markets During the Financial Crisis

James J. McAndrews

May 19, 2009



Re-thinking the lender of last resort

September 2014



Towards an International Lender of Last Resort

Stephen G. Cecchetti

September 2014



Global Liquidity: Public and Private

Jean-Pierre Landau



The Global Dollar System

Stephen G Cecchetti



US dollar money market funds and non-US banks

Naohiko Baba Robert N McCauley Srichander Ramaswamy




Improving the Resilience of Core Funding Markets


Bank of Canada

Jean-Sébastien Fontaine, Jack Selody, and Carolyn Wilkins



How do Global Banks Scramble for Liquidity? Evidence from the Asset- Backed Commercial Paper Freeze of 2007*

by Viral V. Acharya Gara Afonso Anna Kovner

October 24, 2012



The Financial Crisis and Money Markets in Emerging Asia

Robert Rigg and Lotte Schou-Zibell

No. 38 | November 2009



Regulatory Reforms and the Dollar Funding of Global Banks:

Evidence from the Impact of Monetary Policy Divergence

Tomoyuki Iida

Takeshi Kimura

Nao Sudo




Monetary policy spillovers and currency networks in cross-border bank lending

by Stefan Avdjiev and Előd Takáts

March 2016




Prepared by Cho-Hoi Hui, Hans Genberg and Tsz-Kin Chung




Deviations from Covered Interest Rate Parity

Wenxin Du  Alexander Tepper  Adrien Verdelhan

January 1, 2016



Limits to Arbitrage and Deviations from Covered Interest Rate Parity



Capital Constraints, Counterparty Risk, and Deviations from Covered Interest Rate Parity

Niall Coffey Warren B. Hrung Asani Sarkar

September 2009



Covered interest parity lost: understanding the cross-currency basis

Claudio Borio Robert McCauley Patrick McGuire Vladyslav Sushko




Bye-bye covered interest parity

Claudio Borio, Robert McCauley, Patrick McGuire, Vladyslav Sushko

28 September 2016


Author: Mayank Chaturvedi

You can contact me using this email mchatur at the rate of AOL.COM. My professional profile is on

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