Central Bank Liquidity Swaps: A Primer
“The swap facilities have allowed these central banks to acquire dollars from the Federal Reserve to lend to banks in their jurisdictions, which has served to ease conditions in dollar funding markets globally.” Then-Federal Reserve Board Chair Ben S. Bernanke, “The Crisis and the Policy Response,” Stamp Lecture, London School of Economics, 13 January 2009.
“We're still prepared to use [the swap line] in situations where it's within our legal authorities.” Federal Reserve Board Chair Jerome Powell, Policy Panel, ECB Forum on Central Banking, 30 June 2025.
The Trump Administration’s willingness to abrogate treaties (including those negotiated under the previous Trump Administration) makes U.S. allies doubt a whole host of commitments on which they currently rely. Their concerns could extend to a long list of financial arrangements, including access to U.S. financial markets, tax treaties, and the like.
In this post, we focus on the Federal Reserve’s central bank liquidity swaps, which provide a key backstop for global markets in dollar assets. At least twice in the past two decades, this esoteric tool played a major role in sustaining the dollar-based financial system outside the United States, thereby insulating the U.S. financial system from the default, market, and liquidity risk of foreign intermediaries. Like many pieces of financial plumbing, the disappearance of these Fed swaps could amplify a crisis or even trigger one.
Given the crisis-management role that the dollar swap lines play, we can think of no reason why the Fed itself would wish to end them. Instead, the Fed has effectively expanded their function through the introduction of a special repo facility for foreign central banks. However, if the Administration or the Congress were to perceive the Fed swap and repo facilities as supporting only foreign institutions, or if they view these facilities as a device to influence foreign behavior, it is easy to imagine pressure on the Fed to drop these crisis prevention and crisis-management tools or to make them conditional.
In this post, we explain what the swap lines are, how they operate, and how an end to the swap lines could lead to financial instability within the United States as well as undermine the use of the dollar and dollar-denominated assets in the global financial system. We then consider how foreign central banks might insulate their banking systems against the risk that they could no longer rely on the swap lines and repo facility.
It is easiest to define a central bank liquidity swap by way of an example. Suppose that the European Central Bank (ECB) would like to have U.S. dollars. The Federal Reserve can offer to swap (exchange) dollars in the United States for euros in the euro area. Specifically, the U.S. central bank will credit the ECB’s account at the Federal Reserve Bank of New York (FRBNY) with dollars in return for the ECB crediting the Federal Reserve’s account in euros. These euros effectively serve as collateral to shield the Fed against any losses. (Central banks offer accounts both to domestic commercial banks and to foreign central banks.)
The Fed introduced a version of swap lines (“reciprocal currency arrangements”) in 1962 as a complement to the Bretton Woods fixed-exchange rate system (see Bordo et al and McCauley and Schenk). The current incarnation dates to December 2007, the early days of the Great Financial Crisis. (For a detailed discussion of the mechanics, see Aldasoro et al.)
Importantly, swap lines affect the size and composition of the Federal Reserve System’s balance sheet. Consequently, they are controlled by the Federal Open Market Committee (FOMC), which effectively owns the balance sheet. As a matter of standard procedure, the FOMC sets its rules and procedures annually. These routine and usually uncontroversial decisions include the approval of broad directives that reaffirm the FRBNY’s authority to engage in domestic open market operations and foreign currency operations. While this process is often viewed as a technicality, it renders the swap lines vulnerable to the evolving views of FOMC’s voting members, a majority of whom can be appointed by the President.
At this writing the Federal Reserve maintains standing swap arrangements with five central banks: The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank.
This leads us to the central question: Why do we need swap lines?
The answer is that it allows for a dollar lender of last resort in the massive “Eurodollar” market, where financial intermediaries outside of the United States issue enormous quantities of short-term liabilities in US dollars to finance their activities. Absent a lender of last resort, a run or panic would compel these non-US intermediaries to liquidate their dollar assets in a fire sale that would almost certainly spill over to the domestic U.S. financial system.
The swap lines allow foreign central banks to act as dollar lenders of last resort to their financial institutions, thereby stabilizing the global financial system, including the U.S. financial system (see the opening quote from then-Chair Bernanke). Importantly, authorized foreign central banks activated their swap lines with the Fed both during the Great Financial Crisis of 2007-09 and the pandemic of 2020 to counter runs on the dollar liabilities of foreign intermediaries that threatened to feed back to U.S. markets and intermediaries.
This division of central bank labor is efficient because the Fed can create dollars instantly just by entering into dollar swaps, while foreign central banks would have to sell dollar assets to obtain the funds should they need them. At the same time, as they already know and supervise commercial banks in their jurisdictions, foreign central banks can better judge their solvency. Furthermore, central banks routinely receive collateral to back any loans (in whatever currency) they might make to these banks. Because the Fed’s counterparty is the foreign central bank, it is shielded from foreign commercial bank default risk. In effect, the foreign central banks act abroad as the Fed’s dollar asset stabilization agents.
We now turn to a discussion of some of the details that lie behind the swap lines and then consider what foreign central banks might do should they disappear.
To start, just how large is the dollar financial system outside the United States? The following chart shows that the dollar liabilities issued by banks with headquarters outside the United States reached nearly $18 trillion in 2024, equivalent to more than 60 percent of U.S. GDP (see McGuire, von Peter and Zhu; and McCauley). U.S. branches and subsidiaries of foreign banks have another $5.6 trillion in liabilities issued inside the United States. Looking at the foreign headquartered banks’ breakdown by nationality, we see that Canadian, Japanese, Swiss and Euro area banks are responsible for nearly two-thirds of the dollar liabilities issued outside the United States.
Balance-sheet dollar liabilities of banks headquartered outside the United States (Trillions of Dollars, quarterly), 1999-2024
Source: An updated version of Graph 8B in McGuire, von Peter and Zhu, courtesy of Patrick McGuire, Goetz von Peter and Swapan-Kumar Pradhan.
Yet, on-balance sheet bank liabilities are far from the entire story. Including off-balance sheet obligations, mainly FX swaps, almost triples the scale of dollar funding by non-U.S. banks. Indeed, in 2022, Borio, McGuire and McCauley reported that non-U.S. banks owed more than $35 trillion in forward dollar payment obligations (and that nonbanks outside the United States owed as much as $25 trillion). Much of this off-balance sheet debt is very short-term, making it sensitive to funding disruptions.
The ability of intermediaries outside the United States to finance themselves with short-term dollar liabilities is a major pillar of the global financial system. As we discuss in an earlier post, roughly 40 percent of all trade is invoiced in dollars. Since the United States accounts for about 10 percent of world trade, this means that roughly 30 percent of world trade involves non-American entities pricing their products in dollars (see here). The dollar’s role as the primary invoicing currency leads firms—both financial and nonfinancial—to maintain a significant quantity of U.S. dollar assets and liabilities on their balance sheets. Together with the enormous dollar hedging activities of portfolio managers, invoicing preferences are a leading reason that nearly 90 percent of foreign exchange transactions are with the U.S. dollar (see here). Conversely, the fact that there is an enormous dollar financing market outside the United States reinforces firms’ motivation to invoice in dollars and to use the dollar as the “in-between” currency even for transactions in two other currencies.
Like all traditional banking systems, the extraterritorial dollar banking system is vulnerable to runs. This leads to the obvious question: What does a U.S. dollar run that begins at a bank outside of the United States look like? The answer is that it almost inevitably involves the domestic U.S. financial system. To see this, consider a customer who seeks to transfer a U.S. dollar deposit from a bank abroad. The bank’s client will do one of two things: either deposit the proceeds in another foreign bank or shift it to a U.S. bank. In the first case, the transfer typically will go through a U.S. subsidiary or correspondent bank. In the second, it directly enters and stays inside the U.S. financial system. In both cases, when the transaction passes through a bank in the United States, settlement will occur through reserves held at the Fed. Again, the point is that the U.S. banking system is not shielded from the behavior of dollar-deposit holders abroad.
Before continuing, note that in a classic flight to safety a customer might prefer to purchase a Treasury security, rather than hold any bank deposit. However, Treasury securities are all registered inside the United States: that is, they are not bearer bonds that can be passed around in physical form. Consequently, someone outside the United States wishing to purchase a Treasury bill, note or bond must (through their agent) first transfer funds to the United States, then purchase the security, and finally “hold” it electronically through a U.S. custodian.
Returning to the main question, what does a foreign bank facing a run on its U.S. dollar liabilities do? Since the bank’s own central bank cannot instantly create dollars that the bank can access, it will try to sell U.S. dollar assets quickly. This fire-sale response is the principal rationale for the lender of last resort: a central bank that lends to solvent but illiquid institutions to prevent runs on individual banks from turning into broader financial panics.
Naturally, the United States has a compelling interest in stemming the fire sale of U.S. dollar assets that would spill over to U.S. financial markets. Given the scale of the dollar funding market outside the United States, the potential impact on the domestic market from developments abroad is enormous. This is where the swap lines come in. The Fed swaps dollars with the foreign central bank, which then lends them to the commercial bank facing the U.S. dollar run. (For a detailed discussion see Box 5.2 in the Federal Reserve’s May 2023 Financial Stability Report.)
As noted earlier, we saw these swap lines in action twice: first at the height of the financial crisis in 2008 and 2009, and again during the pandemic in 2020. During these episodes, commercial banks outside of the United States faced sudden U.S. dollar withdrawals, prompting their central banks to draw on the swap lines with the Fed. For example, at the end of 2008, outstanding dollar swaps stood at $554 billion – of which the two largest counterparties were the European Central Bank with $291 billion and the Bank of Japan with $123 billion (see here). During the pandemic, use of the swap lines peaked at nearly $450 billion, with the Bank of Japan accounting for $223 billion and the ECB $144 billion (see here).
Returning to where we started, we are confident that the Federal Reserve views these swap lines as necessary and effective tools to prevent or mitigate systemic risks in the U.S. financial system (see the opening quote from Chair Powell). But how does the current Administration view them? As we write, market observers are speculating that the Trump Administration might realize that they can use the swap lines as yet another tool in their arsenal to influence the behavior of foreign financial policymakers (see here).
What would happen if a U.S. Administration were to use its appointment authority to populate the FOMC with people who would vote to withdraw the swap lines? This concern – however remote – is almost surely encouraging foreign central bankers today to think through the risks that a possible future end to U.S. swap lines would pose (see, for example, here and here). How could they insulate themselves from this possibility?
The most obvious is for central banks and financial regulators to make it less attractive for banks outside the United States to issue dollar liabilities. If foreign banks do not issue dollar liabilities, this problem disappears (albeit at the expense of those U.S. dollar borrowers who have relied on foreign bank lenders for low-cost funding).
So, why are foreign central banks providing a backstop, albeit based on their relationship with the Fed, rather than simply restricting the activity that poses a systemic risk? At least today, the answer must be that they view it as a key source of profitability for the banks. However, their risk-return perceptions could shift rapidly if doubts grow about the future availability of the Fed’s repo and swap facilities.
Beyond that, we see three ways that foreign central banks could partly insure themselves against the possibility that the Fed eliminates the swap lines: 1) they could use their U.S. Treasury holdings as collateral for borrowing either from the Federal Reserve or from commercial banks, 2) they could access their existing deposits at the Federal Reserve Bank of New York, and 3) they could band together and create an off-shore US dollar clearing system. In practice, these approaches are all more costly (or less reliable) than existing central bank swap and repo facilities.
Starting with the first, foreign official sector holdings of U.S. Treasury securities are currently in the range of $4 trillion, of which $3 trillion is in custody at the Fed – these are the black and brown lines in the following chart. If the Federal Reserve’s Foreign International Monetary Authority (FIMA) repurchase facility were to remain in place, things might go smoothly because foreign central banks’ Treasury holdings far exceed the peak use of the swap lines (in red). However, that still depends on whether the central banks needing dollar funding are the same ones that hold the Treasurys. More importantly, if the U.S. government were to pressure the FOMC to halt the swap lines (or make them conditional), the repo facility (which functions as a close substitute for a swap line) likely would suffer the same fate.
U.S. dollar liquidity swaps and foreign holdings of U.S. dollar cash and Treasuries (Billions of U.S. dollars, monthly) July 2007-May 2025
Would the private market for repurchase agreements have the capacity to meet demands of foreign central banks needing dollars in times of stress? While this market is very large – with over $3 trillion outstanding on any given day – we question whether commercial banks in an episode of financial stress would have the willingness or the capacity to meet sudden demands for loans worth hundreds of billions of dollars. A combination of prudent risk management and regulatory limits would almost surely prevent it.
Turning to central banks’ cash holdings, these are both at the Fed and in commercial banks. By combining data from the U.S. Treasury and the BIS, we can get some idea of the total. This is the blue line labelled “Foreign Official Deposits” in the chart. The total currently exceeds $1 trillion. Since these are foreign exchange reserves, they may not all be managed by the central bank. But even so, they are quite large. We suspect that the distribution of these cash holdings differs from that of the swap line drawings, but foreign central banks wishing to access dollars in a crisis could opt in good times to hold more cash (or very short-term Treasury securities) in an account at the Fed and in large commercial banks in the United States. Since the alternative would be to hold domestic assets, that would pose some cost to the foreign central bank, even if it receives interest on its dollar assets.
A third possibility is that central banks band together to create their own U.S. dollar clearing system. An offshore network – arranged as a self-contained system completely outside the United States – would allow for netting of transactions where the ultimate recipient of the funds is not in the United States. For example, if a customer of a French bank wishes to make a dollar payment to the customer of a German or Japanese bank, this facility could handle the transaction without touching the U.S. financial system.
Only shifts that move funds into banks in the United States would still require settlement through reserves at the Fed. And, for those transactions there could be an agreement to lend cash balances at the Fed to one another – a type of swap arrangement among foreign central banks. Such a risk-sharing arrangement would reduce any individual central bank’s precautionary need for U.S. dollars, but the required holdings could still be substantial (and costly).
To summarize, we see the Fed’s dollar swaps as a valuable tool for ensuring financial stability both abroad and at home. That said, doubts about the attitude of the current Administration are prompting other countries to review the many ways in which they have become dependent on the United States. Regarding the global dollar market, reducing dependence would mean some combination of safeguarding the availability of dollars in a crisis and adjusting regulations to discourage issuance of short-term dollar liabilities. The more that foreign central banks opt for the latter, the smaller the incentives to continue using the dollar as an invoicing currency and as a medium of exchange.
Acknowledgements: We thank Robert McCauley, Patrick McGuire, Goetz von Peter and Swapan-Kumar Pradhan for their extensive comments, as well as their generosity with the data.