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
- EURIBOR
- TIBOR
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,
- LIBOR EURIBOR TIBOR
- Covered Interest Parity (CIP) Breakdown
- OIS LIBOR
- 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
2016
Global Dollar Shortage Intensifies To Worst Level Since 2012
2015
http://www.zerohedge.com/news/2015-10-03/global-dollar-funding-shortage-intesifies-worst-level-2012
Dollar Illiquidity Getting Critical: A $10 Trillion Short Which The Fed Does Not Understand
2016
The VIX Is Dead: According To The BIS, This Is The New “Fear Indicator”
2016
http://www.zerohedge.com/news/2016-11-15/vix-dead-according-bis-new-fear-indicator
New ICC survey finds worsening global shortage of trade finance
http://www.fx-mm.com/52872/news/trading-news/icc-survey-trade-finance/
From Exorbitant Privilege to Existential Trilemma
A ‘dollar shortage’ has returned. This is why
2016
https://www.weforum.org/agenda/2016/10/a-dollar-shortage-has-returned-this-is-why
Dollar shortage *alert* (plus global trade *alert*)
2016
https://ftalphaville.ft.com/2016/11/15/2179675/dollar-shortage-alert-plus-global-trade-alert/
As goes correspondent banking, so goes globalisation
2016
https://ftalphaville.ft.com/2016/07/26/2170875/as-goes-correspondent-banking-so-goes-globalisation/
How do you solve a problem like de-globalisation?
2015
https://ftalphaville.ft.com/2015/09/24/2140786/how-do-you-solve-a-problem-like-de-globalisation/
On the ongoing demise of globalisation
2016
https://ftalphaville.ft.com/2016/10/11/2177071/on-the-ongoing-demise-of-globalisation/
Textbook defying global dollar shortages
2016
https://ftalphaville.ft.com/2016/06/09/2165690/textbook-defying-global-dollar-shortages/
The Coming Dollar Shortage
https://dailyreckoning.com/coming-dollar-shortage/
Dollar Shortage Goes Mainstream: When Will The Fed Confess?
2016
http://www.zerohedge.com/news/2016-11-24/dollar-shortage-goes-mainstream-when-will-fed-confess
The Global Dollar Funding Shortage Is Back With A Vengeance And “This Time It’s Different”
2015
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
2016
https://ftalphaville.ft.com/2016/02/25/2154339/there-is-a-war-for-capital-coming-says-ubs/
The eurodollar as an economic no-man’s land
2016
https://ftalphaville.ft.com/2016/04/08/2158883/the-eurodollar-as-an-economic-no-mans-land/
Eurodollars, China, TIC data + mysteries
2016
https://ftalphaville.ft.com/2016/03/31/2157947/eurodollars-china-tic-data-mysteries/
Petrodollars are eurodollars, and eurodollar base money is shrinking
2016
All about the eurodollars
2014
https://ftalphaville.ft.com/2014/09/05/1957231/all-about-the-eurodollars/
A global reserve requirement for all those eurodollars
2016
On the availability of dollar funding
2015
https://ftalphaville.ft.com/2015/04/01/2125661/on-the-availability-of-dollar-funding/
The dollar shortage problem, evaluated
2009
https://ftalphaville.ft.com/2009/08/05/65406/the-dollar-shortage-problem-evaluated/
All about the eurodollars, redux
2015
https://ftalphaville.ft.com/2015/09/24/2140580/all-about-the-eurodollars-redux/
BIS says we should follow the money
2014
https://ftalphaville.ft.com/2014/09/04/1955881/bis-says-we-should-follow-the-money/
Eurodollars, FX reserve managers and the offshore RRP issue
2015
The BoE as eurodollar dealer of last resort?
2015
https://ftalphaville.ft.com/2015/02/20/2119663/the-boe-as-eurodollar-dealer-of-last-resort/
FT: The Eurodollar Market: It All Starts Here
2016
http://www.zerohedge.com/news/2016-12-04/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
http://www.bis.org/publ/work285.htm
Dollar Funding and Global Banks
Jeremy C. Stein
2012
Click to access stein20121217a.pdf
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
Emergent International Liquidity Agreements: Central Bank Cooperation after the Global Financial Crisis
Daniel McDowell
Click to access mcdowell_eln.pdf
The Financial Crisis through the Lens of Foreign Exchange Swap Markets
Crystal Ossolinski and Andrew Zurawski
2010
The spillover of money market turbulence to FX swap and cross-currency swap markets
N Baba
2008
Liquidity Shocks, Dollar Funding Costs, and the Bank Lending Channel During the European Sovereign Crisis
Ricardo Correa, Horacio Sapriza, and Andrei Zlate
2012
GLOBAL INTEGRATION OF BANKING MARKETS: AT WHAT COST?
John L. Simpson
Click to access 00463515e5285b6a85000000.pdf
Systemic risk in the major Eurobanking markets: Evidence from inter-bank offered rates
J.L. Simpson, J.P. Evans
2005
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
Click to access adbi-wp291.pdf
The Euro-dollar market as a source of United States bank liquidity
Steve B. Steib
http://lib.dr.iastate.edu/cgi/viewcontent.cgi?article=6277&context=rtd
The LIBOR Eclipse: Political Economy of a Benchmark
Alexis Stenfors1 and Duncan Lindo
January 2016
Click to access RMF-47_Stenfors-Lindo.pdf
Basics of U.S. Money Markets
2016
Click to access 05.10.2016-moneymarkets-9.15am.pdf
Implementing Monetary Policy – Short-term Money Markets Monitoring
2015
Click to access 09.29.2015-mmarketsv2-1.30pm.pdf
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
Linda S. Goldberg, Craig Kennedy, and Jason Miu
http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.422.11&rep=rep1&type=pdf
The Global Financial Crisis and Offshore Dollar Markets
Niall Coffey, Warren B. Hrung, Hoai-Luu Nguyen, and Asani Sarkar
2009
https://papers.ssrn.com/sol3/papers2.cfm?abstract_id=1496407
When and how US dollar shortages evolved into the full crisis?: Evidence from the cross-currency swap market
Naohiko Baba* and Yuji Sakurai†
10/27/2009
Funding patterns and liquidity management of internationally active banks
http://www.bankingreview.nl/download/23711
The functioning and resilience of cross-border funding markets
2010
CGFS 37
The Impact of the Financial Crisis on Cross-Border Funding
Yaz Terajima, Harri Vikstedt, and Jonathan Witme
2011
Click to access fsr-0610-terajima.pdf
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
Click to access dollar_funding_october_2012_final.pdf
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
Click to access wp38-financial-crisis-money-markets.pdf
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
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2504732
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
2009
Improving the Resilience of Core Funding Markets
2009
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
2016
Monetary policy spillovers and currency networks in cross-border bank lending
by Stefan Avdjiev and Előd Takáts
March 2016
FUNDING LIQUIDITY RISK AND DEVIATIONS FROM INTEREST-RATE PARITY DURING THE FINANCIAL CRISIS OF 2007-2009
Prepared by Cho-Hoi Hui, Hans Genberg and Tsz-Kin Chung
2009
Click to access HKMAWP09_13_full.pdf
Deviations from Covered Interest Rate Parity
Wenxin Du Alexander Tepper Adrien Verdelhan
January 1, 2016
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2768207
Limits to Arbitrage and Deviations from Covered Interest Rate Parity
James Pinnington1 and Maral Shamloo
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
Bye-bye covered interest parity
Claudio Borio, Robert McCauley, Patrick McGuire, Vladyslav Sushko
28 September 2016
Viewpoints which Matter 