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In the financial crisis that started in 2007, European banks, like other banks worldwide, faced severe liquidity strains in US dollars. As those strains worsened, central banks took action to try to stop them spilling over to other financial markets, banks‟liquidity positions and ultimately the real economy. A number of central banks established temporary swap facilities with the US Federal Reserve to improve liquidity in US dollars. Banks took action to reduce their reliance on short-term US dollar funding and regulators increased their monitoring of banks' funding positions. When the crisis then moved to a number of euro area sovereign debt markets, and there was a re-emergence of strains in short-term US dollar funding markets in Europe, the swap facilities were extended several times. When they were last renewed, these agreements were extended until February 2014.1 In parallel, policy-makers considered initiatives to avoid similar strains in the future.
This Commentary outlines developments in European banks' use of US dollar funding prior to and during the crisis, the systemic risks associated with that use, and the measures taken to reduce those systemic risks. Those measures include the recommendations made by the ESRB in 2011, which focused on monitoring the use of US dollar funding and assessing the effectiveness of banks' contingency funding plans in the event of a shock to their US dollar funding, both for individual banks and for the sector as a whole.
One of the reasons why the liquidity problems that arose during the crisis did not have a greater systemic impact was the coordinated provision of US dollar liquidity by central banks via swap facilities.
Some countries in Europe are currently looking at how they would handle future problems in US dollar funding markets in the event that those swap facilities were not available. There is a risk that banks‟assumptions that central banks will step in, either using foreign currency reserves or establishing swap facilities, could mean that they delay moving to a more robust funding structure in US dollars.
Banks and policy-makers have therefore initiated action aimed at avoiding the kinds of strains in European banks' US dollar liquidity that were seen during the financial crisis. That includes two recommendations made to national supervisory authorities by the ESRB on the basis of its view that European banks' US dollar liquidity structures could be a source of systemic risk for the European Union.