Cherry-Picking in Central Bank Currency Swaps: Empirical Insights into the Determinants and Income Bias in Swap Access during Crises

Since the 2007-09 global financial crisis, central bank currency swaps have become a crucial element of the Global Financial Safety Net (GFSN)—the set of institutions and arrangements that backstop countries in financial distress. These swaps, where credit lines between central banks aim to provide liquidity to stabilizing markets during turmoil, have two key advantages: immediate and voluminous disbursement, and absence of conditionality. However, access to swaps is unevenly distributed among countries.

In a new working paper, Thomas Goda, Laurissa Mühlich, Marina Zucker-Marques and Barbara Fritz investigate the determinants of access to swaps by analyzing a comprehensive, novel swap dataset covering 194 countries from 2007-2022. The authors find that a country’s income level is a more significant factor in securing access to swaps than crisis status or external debt levels. In short, advanced economies are more likely to receive swaps during crises than middle-income countries, and low-income countries are completely excluded from swaps.

Key findings:

• In line with previous studies on US Federal Reserve (Fed) and the People’s Bank of China (PBOC) swaps, a country is more likely to receive a currency swap the higher its level of economic development, economic size and credit rating, and when it has a trade agreement and is geographically close to the country of the swap-providing central bank.
• Both the Fed and the PBOC have a much higher likelihood of providing currency swaps to countries in financial crisis and with high external debt levels than other central banks. This indicates that these two major swap providers differ less in their behavior as a lender of last resort (LOLR) than previously thought.
• The LOLR function, however, does not extend to all countries. Developing countries, which are most in need of currency swaps as additional unconditional crisis finance instruments in the case of systemic shocks, are systematically excluded from this swap “safety net.”
• A country’s access to unconditional IMF lending lowers the probability of receiving a central bank swap, which points to the interaction between different layers of the GFSN. However, for countries that are members of a regional financial arrangement (RFA), there is no statistically significant evidence that this membership influences currency swap agreements.

The authors derive two policy recommendations from these findings.

Policy recommendations:

• Coordination must be intensified between lending across different elements of the GFSN. This should include closer coordination between RFAs and the International Monetary Fund (IMF). Major swap-providing central banks should be involved in this exchange of information and coordination of lending activities.
• The IMF’s unconditional lending should be expanded, especially for developing economies that are hit by external shocks and excluded from swaps and sufficient RFA finance. Such change would level out differences in the ‘safety net’ coverage of currency swap provision, creating a more level playing field that enhances crisis resilience for all countries.

The authors conclude by noting that addressing these flaws in the GFSN is crucial for sustainable global economic growth and achieving the United Nations 2030 Sustainable Development Goals.