Swap Network

What Is a Swap Network?

A swap network is a reciprocal credit line laid out between at least two central banks. The purpose of a swap network is to permit central banks to exchange currencies with one another to keep a liquid and stable currency market.

Swap networks are otherwise called "currency swap lines," or as "impermanent reciprocal currency arrangements."

Understanding Swap Networks

The purpose of a swap network is to keep up with liquidity in foreign and domestic currencies so that commercial banks can keep up with their commanded reserve requirements. By lending currency among themselves and selling the borrowed funds to private banks, central banks can influence the supply of currencies and in this way assist with bringing down the interest rate that banks charge while lending to one another. This interest rate is known as the interbank rate.

Swap networks can play a critical job in keeping up with financial-market stability when liquidity is generally stressed, for example, amidst a credit crunch. The swap network can assist with expanding banks' access to affordable financing, which thus can be given to businesses all through the economy as bank loans. Thus, central banks are once in a while alluded to as "the lender of last resort."

In the United States, the Federal Reserve operates swap networks under the authority conceded to it by Section 14 of the Federal Reserve Act. In doing as such, the Federal Reserve must likewise conform to the approvals, policies, and procedures laid out by the Federal Open Market Committee (FOMC).

During the 2007-2008 financial crisis, swap network arrangements were utilized widely by central banks all through the world. Around then, central banks worldwide were desperate to further develop liquidity conditions in the foreign exchange market and among domestic banks.

Real World Example of a Swap Network

In Sept. 2008, at the level of the financial crisis, the Federal Reserve authorized a $180 billion increase to its swap network, consequently expanding its lines of credit with the central banks of Canada, England, and Japan. Central banks the world over worked closely with one another to assist with preventing the crisis from spiraling crazy.

All the more as of late, the European Central Bank (ECB) agreed in Oct. 2013 to lay out a swap network with the [People's Bank of China (PBOC)](/people groups bank-china-pboc). Under this agreement, the ECB extended euros worth about $50 billion to the PBOC, while the PBOC extended similar amount to the ECB in its own currency, the yuan.

While swap networks empower central banks to exchange currencies with each other on demand, this doesn't mean that they will fundamentally do as such. All things being equal, the swap network gives a source of liquidity in the event of an emergency, lessening uneasiness among banks and other market participants. On account of the ECB-PBOC swap network, the arrangement diminishes the risk for eurozone banks with an international presence to carry on with work in yuan; and vice versa for Chinese banks carrying on with work in the eurozone. Thusly, the foundation of a swap network is in part a manner to impart investor confidence.

Features

• These swaps lines are an important device for decreasing and overseeing financial risks since they permit central banks to increase liquidity in both international and domestic banking sectors.
• Swap networks are credit and foreign exchange liquidity facilities laid out between central banks.
• During the 2007-2008 financial crisis, the U.S. Federal Reserve laid out large swap network facilities with other central banks all through the world.