The Federal Reserve Bank of New York today released The Global Financial Crisis and Offshore Dollar Markets, the latest article in its series Current Issues in Economics and Finance.
Highlighting the international dimensions of the financial crisis that began in the fall of 2007, authors Niall Coffey, Warren B. Hrung, Hoai-Luu Nguyen and Asani Sarkar examine the difficulties international firms encountered obtaining U.S. dollars and the ensuing effects on the foreign exchange (FX) swap market. Analysis shows that as firms increasingly turned to the FX swap market to obtain funding, the dollar “basis”—the premium paid for dollar funding—became persistently large and positive, primarily as a result of higher funding costs paid by smaller firms and non-U.S. banks.
Differential access to dollar funding by U.S. and non-U.S. banks had visible effects on the borrowing rates for all institutions. The authors note that two factors—the perceived riskiness of non-U.S. institutions relative to U.S. banks and the excess demand for dollars by international firms lacking a natural base of dollar deposits to support their dollar-denominated assets—could account for an increase in the dollar basis.
Additionally, as the crisis evolved, the credit risk of the largest banks generally increased less than that of other institutions, leading to a favorable differential in their funding costs relative to those of other institutions. These differential funding costs, in turn, were associated with an increase in the dollar basis.
Niall Coffey and Warren B. Hrung are specialists in the market operations monitoring and analysis function of the Federal Reserve Bank of New York’s Markets Group; Hoai-Luu Nguyen is an economist in the capital markets function and Asani Sarkar a research ofﬁcer in the money and payments studies function of the Bank’s Research and Statistics Group.