Swap Agreements Are Generally Conducted By The

The use of foreign exchange swaps to generate reserves is difficult to distinguish from central bank swaps used to stimulate financial markets or subsidize certain activities. For example, central banks that act as market makers in futures markets, provide futures and exchange rate guarantees, subsidize domestic financial institutions and attract foreign investment. Some of these activities are quasi-tax transactions with subsidies; they are very common in developing countries. Whatever the purpose, these transactions are similar to those discussed above: they result in the central bank occupying an open position and thus assuming a foreign exchange risk that often results in heavy losses. These activities are generally not recommended. Central banks can do more to stimulate financial markets through a credible exchange rate policy. Subsidies should be included in the state budget and the financial sector will not win in the long run if its central bank incur large losses, which most often need to be monetized. Argentina experienced a balance-of-payments crisis from 1982 and announced a series of far-reaching measures to deal with this crisis. These included foreign exchange swaps with national banks and residents holding foreign exchange deposits (e.g. B importers). National banks and external debt companies that had to be repaid were also encouraged to renegotiate the debt by requesting the suspension of payment and new loans.

If they were able to renegotiate, they could pay the domestic monetary equivalent of their debt service to the Central Bank (BCRA), which would assume responsibility for the U.S. dollar. This procedure provided a foreign exchange guarantee for the residual duration of the debt. If the counterparty is the banking system, banks` reserves are credited with the internal monetary equivalent of buying foreign currency, and the banks` foreign assets are shrinking. As a result, reserve money increases, which normally leads to an increase in the money supply. (If the Federal Reserve had made a reverse swap – that is, foreign exchange deposits had been sold and purchased forward to domestic banks – the reserve money would have fallen and rationalized the money market.) Switzerland is the only country where foreign exchange swaps are the main instrument for managing bank reserves, mainly due to the absence of short-term government bonds (the federal government generally does not have a budget deficit). As Table 3 shows, SNB foreign exchange swaps became a permanent source of bank reserves in the early 1980s; Contracts were renewed regularly and the total amount gradually increased to a peak of about 50% of the monetary base in 1993. Swiss foreign exchange swaps are almost exclusively traded in the United States.