In the years leading up to 2007, banks across the globe dramatically increased their balance-sheet exposure to foreign currencies. The result was a corresponding increase in demand for cross-border liquidity (see for example Behr et al. 2008, Puhr et al. 2009 and Brown et al. 2009). With the successive drying up of interbank markets during the global financial crisis, the private sector no longer provided this liquidity, thus requiring a coordinated action by the world’s major central banks.
The provision of dollar liquidity to non-US banks by the Federal Reserve has received ample attention in the global financial press (see, for example, Aizenman and Pasricha 2009 and Goldberg et al. forthcoming). Much less noticed, however, was the case of the Swiss National Bank’s (SNB) large-scale provision of Swiss franc (CHF) liquidity to the banking system across and beyond the EU.
In this column, we document the extent of the liquidity provision by the Swiss National Bank. What makes the Swiss case special is the SNB’s open-access policy, i.e. that banks domiciled outside Switzerland may establish access to the SNB (“domiciled outside Switzerland” refers to an entity which does not directly have a bank license in Switzerland). At times, banks domiciled abroad made up 80% of CHF liquidity provided by the SNB.
The Swiss case is exceptional since between March 2009 and June 2010, faced with deflation risks and zero interest rates, the SNB intervened in the foreign-exchange market as part of its unconventional measures. The international banking system was flooded with CHF liquidity, an effect so big that the need for liquidity funding in the SNB’s liquidity providing open market operations virtually ceased to exist. Thus, although not an objective of the foreign-exchange interventions in itself, these may have contributed to stabilising the European banking system.
The Swiss National Bank’s open-access policy
The Swiss National Bank is by law empowered to hand out liquidity also to banks domiciled outside Switzerland. The original intention of allowing foreign banks to access the Swiss REPO system was to reduce the dependence on the few large Swiss financial institutions, to improve the general liquidity, and to thereby facilitate the steering of the Swiss policy rate.
The black solid line in Figure 1 plots the evolution of the number of banks in the REPO System that are domiciled outside Switzerland (right axis). As of mid-November 2010, 59 such banks had established access to the Eurex Repo electronic trading platform, a necessary condition to participate in the SNB’s repo auctions. Of these 59 banks, 23 where domiciled in Austria, 16 in Germany, and 6 in the UK.1
Figure 1 also documents the volume of CHF liquidity that these foreign-domiciled banks obtained directly from the SNB. The latter volume (blue solid line) temporarily exceeded CHF 50 billion. To make clear just how sizeable the foreign demand for liquidity is, Figure 1 also documents the volume of CHF liquidity that was obtained from the SNB via the REPO system by Swiss banks. During nearly all months in 2009 and also in early 2010, well over 70% of all liquidity demand actually came from outside Switzerland.
Figure 1. Use of SNB REPO by banks domiciled in and outside Switzerland
Despite the SNB’s open-access policy severe spikes in interest rates arose on the CHF money market (see Auer and Kraenzlin 2009 on this site). These tensions arose from the inability of banks outside Switzerland to roll over maturing CHF positions when the interbank money market progressively dried up after the collapse of Lehman Brothers in September 2008 (see Guggenheim et al. 2011). The SNB entered into swap agreements, among others, with the ECB to overcome these market tensions. In effect the private sector instantly gained access to the primary source of CHF, the SNB. Auer and Kraenzlin (2009) outline the effectiveness of these swap agreements.
Adding to repo volume the money obtained indirectly via the SNB-ECB swap implies that at times, nearly 90% of short term CHF liquidity was held by non-Swiss Banks. Figure 2 shows total provision of CHF liquidity to banks domiciled outside Switzerland and underpins the importance of direct access to the SNB’s REPO system for banks domiciled outside Switzerland (see also Kraenzlin and von Scarpatetti 2011).
Figure 2. Total liquidity provision to Banks domiciled outside Switzerland
Interventions in the foreign exchange market
Figures 1 and 2 document the extent of the CHF shortage during 2008 and 2009, but also that this demand decreased substantially starting in mid 2009; it even vanished completely in mid 2010. Although we might be tempted to attribute this to a resurgence of activity in the interbank money market, this is not fully the case.
Rather, starting in March 2009, the SNB intervened in the foreign-exchange market, eventually building up a foreign reserve position worth over CHF 200 billion, compared to a pre-2009 level of less than CHF 50 billion.
While the exchange-rate interventions were part of the SNB’s unconventional measures to avert deflation risks in Switzerland, an unintended side effect of the interventions was the resolution of the international CHF liquidity shortage. The 150 billion of additional CHF supply is now available to the banking system and consequently, the majority of banks are awash with CHF liquidity (see Figure 3). Demand for liquidity via REPO and SWAP transactions ceased to exist altogether. In fact, currently the SNB absorbs liquidity to implement monetary policy through weekly issuance of the SNB’s own money market bills (SNB Bills) and daily one-week REPO auctions.
Figure 3. Total supply of CHF liquidity
The exchange-rate interventions thus turned out to be helpful from a financial stability perspective as they reduced the international CHF liquidity shortage and hence refinancing pressure of banks domiciled outside Switzerland.
When liquidity demand spikes, small frictions in the private sectors' way to distribute liquidity internationally can have large effects on the interest rate paid.
The rapid, coordinated, and large policy response by central banks across Europe may have avoided an disorderly winding down of the carry trade positions that European households and firms have built up in the years leading up to the crisis.
International liquidity mismatches involving Swiss francs are currently of little concern, which may be an unintended side effect of the liquidity injection via the SNB’s interventions in the foreign exchange market. The establishment of access to the Swiss REPO system by banks domiciled outside Switzerland also contributed to such a situation. At the current juncture, the private sector has thus won time to reduce its CHF exposure in an orderly way.
The views expressed in this article are those of the authors and do not necessarily reflect those of the Swiss National Bank.
Aizenman, Joshua and GK Pasricha (2009), “Selective Swap Arrangements and the Global Financial Crisis: Analysis and Interpretation”, NBER Working Paper 14821.
Auer, Raphael and Sébastien Kraenzlin (2009), “The effectiveness of central bank swap agreements as a crisis-fighting tool”, VoxEU.org, 14 October.
Beer, Christian, Steven Ongena, and Marcel Peter (2008), “Borrowing in Foreign Currency: Austrian Households as Carry Traders”, Swiss National Bank Working Paper 2008-19.
Brown, Martin, Marcel Peter, and Simon Wehrmüller (2009), “CHF Lending in Europe”, Policy Paper, Swiss National Bank.
Guggenheim, Basil, Sébastien Kraenzlin, and Silvio Schumacher (2011), “Exploring an uncharted market: Evidence on the unsecured Swiss franc money market”, forthcoming as Swiss National Bank Working Paper.
Linda S Goldberg, Craig Kennedy, and Jason Miu (forthcoming), “Central Bank Dollar Swap Lines and Overseas Dollar Funding Costs”, Federal Reserve Bank of New York Economic Policy Review.
Kraenzlin, Sébastien and Benedikt von Scarpatetti (2011), “Liaisons and Scheming: The Network of the Swiss Franc Repo Market”, forthcoming as Swiss National Bank Working Paper.
Puhr, Claus, Markus S Schwaiger, and Michael Sigmund (2009), “Direct Cross-Border Lending by Austrian Banks to Eastern Europe, in Financial Stability Report 17”, Austrian National Bank, June.
1 The SNB also accepts securities denominated in foreign currency. High credit standards as well as a highly efficient risk management procedure eventually imply that the SNB does not apply haircuts. Banks domiciled outside Switzerland thus have the possibility to repo out non-CHF denominated securities with the SNB. It is unclear to what extent this possibility has contributed to the high use of the SNB REPO facility by this group of banks observed during 2009 and early 2010.