Foreign currency funding risk and cross-border liquidity

Report prepared by a CGFS Working Group co-chaired by Stephanie Curcuru (Federal Reserve Board) and Antoine Martin (Swiss National Bank)

Liquidity shortages are a key driver of financial stress, especially when they involve a foreign currency. They come to the fore when funding markets are impaired and worsen when there is a mismatch between financial intermediaries' liquid claims and flighty funding.

This report considers the US dollar, euro, Swiss franc, pound sterling and Japanese yen as foreign currencies. First, it examines what available data reveal about financial intermediaries' exposures to foreign currency funding shortages. Second, it investigates the resilience of intragroup cross-border transfers ("internal capital markets") when access to external private funding markets is impaired. In this part, the report also discusses last resort liquidity assistance from central banks and prudential measures for reducing foreign currency funding risks.

The key findings are as follows. Given the US dollar's central role in the global financial system, banks actively manage risks associated with dollar funding. More broadly, derivatives-based hedging is often used to minimise currency mismatches, which may mitigate foreign currency funding risks but may introduce rollover risks. Additionally, banks primarily obtain foreign currency funding through their headquarters and subsequently allocate it via intragroup transfers. Thus, disruptions to the efficient functioning of internal capital markets could have adverse financial stability implications. Since such disruptions may occur under severe stress, central bank foreign currency liquidity facilities play a crucial role as a last resort measure. The findings in the report underscore the value in authorities' ongoing efforts to reduce foreign currency funding risks. Global maps of exposures to such risks would benefit from further efforts to close existing data gaps.