DEFINITION of Swap Network
A swap network is a worldwide network of central banks that establish a reciprocal credit line relationship to temporarily swap currencies. The purpose of the swap line is to give each bank the ability to simultaneously exchange a fixed amount of one another's currencies to both stabilize its own currency and improve liquidity conditions. While many repayment periods on swap lines are typically three months, debt holders can roll over their outstanding loans to extend the repayment terms.
A swap network may also be known as a currency swap line or temporary reciprocal currency arrangement.
BREAKING DOWN Swap Network
When a central bank swaps currencies it has the ability to then auction off those foreign currencies in overnight funds to private banks. The purpose is to maintain sufficient liquidity in foreign and domestic currencies so that commercial banks can achieve their mandated reserve requirements. The auction will then increase the supply of that foreign currency in that country and help lower the interest rate that banks charge (LIBOR) when lending to one another. This is an important benefit when liquidity is otherwise strained; the swap network can help increase banks and businesses' access to more-affordable financing often required to meet operating expenses. In the United States, The Federal Reserve operates swap lines under the authority of Section 14 of the Federal Reserve Act. All swaps must comply with authorizations, policies, and procedures established by the Federal Open Market Committee (FOMC).
Swap network arrangements were used extensively between countries worldwide during the 2008 international credit crisis to help ease liquidity restrictions in the foreign exchange market.
Examples of Swap Networks
For example, In October 2013, the European Central Bank (ECB) agreed to open a 3-year currency swap line with the Peoples Bank of China (PBoC). The ECB received immediate access to 350 yuan (CNY), and China access to €45 billion euros. While each central bank gained access, they did not necessarily take advantage of the line of credit. Instead, the swap arrangement ensures liquidity in case of an emergency, making it safer for Eurozone banks with an international presence to do business in yuan instead of insisting on U.S. dollars or euros. In some ways, the establishment of a swap network serves to signal legitimacy more than anything else.
As another example, On September 18, 2008, at the height of the financial crisis, the Federal Reserve authorized a USD $180 billion expansion of its swap network, extending lines to the central banks of Japan, England, and Canada. The Federal Reserve worked in tandem with other central banks around the world to stop the financial panic that temporarily brought down money markets, which for the first time "broke the buck".