Discussion Paper Series 2019-E-9

Central Bank Swap Lines: Evidence on the Effects of the Lender of Last Resort

Saleem Bahaj, Ricardo Reis

Theory claims that central-bank lending programs put ceilings on private lending rates, reduce ex post funding risk, and encourage ex ante investment. Testing for these effects is challenging. Most programs either have long precedents or were introduced in response to large shocks with multiple effects. Swap lines between advanced-economy central banks are a significant new policy through which a source central bank provides source-currency credit to recipient-country banks using the recipient central bank as the monitor and as the bearer of the credit risk. This paper shows that, in theory, the swap lines should put a ceiling on deviations from covered interest parity, lower average market funding costs, and increase inflows from recipient-country banks into assets denominated in the source-country's currency. Empirically, these are tested using difference-in-difference strategies that exploit variation in the terms of the swap line over time, variation in the central banks that have access to the swap line, variation in the exposure of different securities to foreign funding, and variation in banks' exposure to dollar funding risk. The evidence suggests that the lender of last resort is very effective.

Keywords: liquidity facilities; currency basis; bond portfolio flows

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

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