Three Ideas to Improve the International Role of the ECB - DGAP Policy Brief
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German Council on Foreign Relations
No. 04
February 2021
COMMENTARY
Three Ideas
to Improve the
International Role
of the ECB
The ECB has been forced – in part by cess to euro swap and repo facilities to
the COVID-19 crisis – to review its bi- non-euro area central banks – thereby
lateral arrangements with foreign cen- helping the ECB to stabilize prices and
tral banks. But the recent changes made mitigate financial stability risks do-
by the ECB fall short of the Europe- mestically and abroad.
an Commission’s ambitions to boost
Shahin Vallée
Head, Geo-Economics the international role of the euro. We During the 2008 global financial cri-
Program, DGAP suggest the ECB should put in place sis and its aftermath, the ECB had to
an alternative three-pillar frame- make hard choices about its FX swap
work to improve the international role policy and adopted a very conservative
of the ECB and cement its pivotal role line, precisely when it was enjoying the
in the international financial system. generous support of the Federal Re-
serve’s own US dollar liquidity lines.
In a new paper released on January 19, Indeed, between 2009 and 2011, the
the European Commission (EC) reit- ECB refused to extend swap lines to
erated its commitment to strengthen Hungary and Poland when they were
the international role of the euro. This in a financial crisis and in need of euro
Daniela Gabor is part of a long-standing plan that has liquidity, or to Latvia when the Swiss
Professor of Economics
and Macro-Finance, been followed by little action so far. Al- National Bank and the Swedish Riks-
UWE Bristol though the report is broad, it does not bank respectively rose to the challenge
mention actions to be taken by the of effectively offering support when
ECB – despite the fact that its role as the ECB should have also been there to
a global lender of last resort is becom- help.
ing ever more important to the inter-
national financial system. The new changes introduced by the
ECB due to the COVID-19 pandem-
Since the economic shock of the ic do not go far enough in creating the
COVID-19 pandemic, the ECB has framework to provide euro liquidity to
overhauled its euro liquidity provision those who may need it. The ECB’s bi-
to foreign non-euro central banks. The lateral lending framework – via swaps
overhaul has involved reviewing exist- and repos – continues to create double
ing arrangements and extending a c - standards between EU member statesNo. 04 | February 2021 2
COMMENTARY Three Ideas to Improve the International Role of the ECB
THE EUROPEAN CENTRAL BANK’S FRAMEWORK
OF SWAP AND REPO LINES
collateral National
EUR Bank of
Serbia
Danish
Bank of Bank of National
Canada Japan Bank National
Bank of
Bulgarian Albania
National
Federal S TA N D I N G Bank Repo lines
Reserve G LO B A L
F X S WA P L I N E
ECB
Swedish
ECB granted under
EUREP
Riksbank
Hungarian
Swiss Croatian National
Bank of National National Bank
England Bank Bank
……… National
Bank of
Romania
S WA P L I N E S REPO LINES
ECB provides euro against currencies accepted ECB provides euro against adequate euro-
by the ECB for swap line operations dominated collateral accepted by the ECB
Source: ECB | own illustration
and lacks accountability and trans- 3. A discretionary emergency assis- a corresponding Bulgarian lev loan to
parency. The ECB falls short of being tance facility to provide financial assis- the ECB. These FX swaps ensure the
a lender of last resort for financial sys- tance to foreign countries undergoing flow of hard currency/euro liquidity
tems that are dependent on euro li- a balance of payment crisis. where and when it is needed and pre-
quidity. As a result, the ECB is failing to vent financial instability from tempo-
reduce financial stability risks and to rary liquidity shortages from setting in.
promote the international role of the DOUBLE STANDARDS
euro as much as it should. FOR EU MEMBER STATES In contrast, repos are more onerous
for the borrowing central banks for a
In this paper, we first review in de- In the hierarchy of instruments avail- variety of reasons. Sticking with our
tail the shortcomings of the ECB’s new able to global lenders of last resort, example, the Bulgarian central bank
framework, which was announced on FX swaps rank higher than repos. FX needs to have euro-denominated se-
August 19, 2020. We then outline a swaps create stability by protecting curities – rather than its own domes-
more rigorous and systematic global against volatility. In an FX swap, two tic currency – to post as collateral to
Lender of Last Resort (LoLR) function countries’ central banks “lend” each the ECB to receive euro liquidity in re-
based on three pillars: other some of their own currency. turn. Because securities are consid-
ered more risky than cash, the repo
1. A global and European network of Let’s take a swap between Bulgaria loan may also be subject to “haircuts”
FX swap lines to ensure appropriate and the ECB as an example. The Bul- on collateral. To account for variation
distribution of euros and other hard garian central bank has a euro depos- in the market value of these securities,
currencies across the EU and the in- it and that account gets credited with haircuts may be complemented by a
ternational financial system; the agreed sum in euros, at an agreed daily variation margin. Repo collater-
exchange rate and for an agreed peri- al is more difficult to service because,
2. A structural repo facility for foreign od. Bulgaria pays interest on this loan when the price of collateral falls, the
central banks to ensure the global li- of currency back to the ECB. But in re- Bulgarian central bank needs to send
quidity of euro area collateral; and turn for euro liquidity it also createsNo. 04 | February 2021 3
COMMENTARY Three Ideas to Improve the International Role of the ECB
the ECB additional collateral to make between central banks. Repos are still 1. An emergency facility to deliver euro
up the value of the swap again. the preferred method by which the liquidity in times of distress and help
Central Bank offers liquidity to com- liquify the foreign exchange reserves
The ECB resorts to double standards mercial banks, adjusting the eligible of central banks at Europe’s periphery.
in its treatment of EU member states collateral and the haircut proportional-
by offering liquidity on different terms ly to the perceived counter-party risk, 2. A structural facility to improve the
to some nations. These double stan- the quality of the collateral, and the flow of euro collateral and offer both
dards can be difficult to understand. daily variation in the price of collateral. repo and reverse repo windows to for-
For example, why would the National eign central banks outside of Europe
Bank of Hungary enjoy a repo line and FX swaps are less onerous for count- to encourage the use of euro assets in
not the National Bank of Poland? Why er-party central banks because there is their reserves as a liquid store of value.
would the Danish National Bank enjoy an established exchange rate between
a full swap line rather than a mere re- currencies. That means collater- The ECB should instead consider a
po line when Denmark is not part of al doesn’t need a haircut to match the simpler framework with three distinct
ERM2 – the managed exchange rate value of the liquidity received. Swaps facilities, detailed below:
mechanism used in the transition pe- are, in principle, reserved for central
riod before a country joins the single banks whose currency is more trust- 1. A Global and European FX Swap
currency – and does not intend to join ed or stable. However, this judgement Line Network
the currency union? Meanwhile, Ro- of trust establishes a political distinc- This would put in place a permanent
mania – part of ERM2 and a country tion between trusted official peers and and unlimited swap line facility with
that is openly committed to entering less trusted ones. This process of mak- the G10 and all the EU’s central banks,
the eurozone – only enjoys a repo ar- ing distinctions is questionable within without discrimination. The heart of
rangement. There are numerous such the EU and for countries on the EU ac- this agreement would essentially be
examples of double standards. But cession track. the current permanent core swap line
there seems to be a political ratio- network (Federal Reserve, ECB, Bank of
nale beyond financial stability consid- The creation of the Eurosystem repo England (BoE), Bank of Canada (BoC),
erations for these distinctions. This facility for central banks (EUREP), fol- Bank of Japan (BoJ)).
could explain why Croatia (an EU lows a similar move that was made by
member state) would enjoy a swap line the US Federal Reserve, and includes In practice, this would see the ECB
while Serbia and Albania only have a two important functions that should play a nodal role in distributing US
repo line. But then why leave out Mon- be disentangled: dollars and euros to all European cen-
tenegro, which is on the EU accession tral banks, ensuring a stable flow of
track and has unilaterally adopted the
euro as its currency?
A NEW PERMANENT SWAP NETWORK
Does the ECB introduce a political
judgement on the various countries’
accession prospects? Or is it that the
ECB does not want to sanction unilat- Danish
Bank of Bank of National
eral adoption of its currency? Wheth- Canada Japan Bank
er it is one or the other, it should be
spelled out with more clarity to justi- • Bank of Bulgarian
National PERMANENT
Mexico
fy the policy. • Bank
Federal S TA N D I N G
ECB Bank S WA P L I N E S
Reserve G LO B A L TO A L L
of Korea F X S WA P L I N E EU COUNTRIES
•… Swedish
Riksbank
THE IMPORTANCE OF Swiss Croatian
REPO LINES FOR FOR- Bank of National National
EIGN CENTRAL BANKS England Bank Bank
………
Because swaps rank higher than re- T E M P O R A R Y S WA P
pos in the hierarchy of financial in- PBoC
LINE FOR TRADE
AND INVESTMENT
struments, it is usually the instrument SETTLEMENT
of choice for liquidity transactions Source: ECB | own illustrationNo. 04 | February 2021 4
COMMENTARY Three Ideas to Improve the International Role of the ECB
USD and EUR across the European fi- A DISCRETIONARY SWAP WINDOW FOR
nancial system.
BALANCE OF PAYMENT ASSISTANCE
The ECB would continue to have a bi-
lateral swap line with the People’s Bank
of China (PBoC) designed to facilitate
trade and investment flows rather than
financial stability. This would both fa- IMF program
cilitate the internationalization of the
RMB, which serves the purpose of a EU’s Macrofinancial
Assistance
more multipolar, international mon-
etary system and expand the use of
the euro in China while promoting a
more multipolar international mone-
tary system.
Banque
2. A Structural Repo and Reverse ECB du Liban
Repo Facility for Foreign Central
Banks
The ECB should offer temporary and Source: ECB |
limited repo lines to selected count- own illustration
er-parties for the purpose of facilitat-
ing trade and investment settlement.
This would be particularly useful, for and the EU Macro Financial Assistance quidity risks in euros across the world
instance, for countries that trade with Programme. While it may sound like – and to expand the role of the euro
Europe but in which the banking sys- this facility would duplicate the IMF’s among foreign central banks.
tem does not facilitate international work, in the 1980s and 1990s it was
commerce (think of African coun- rather common for IMF programs to The ECB has an opportunity to ex-
tries with weak correspondent bank- be complemented by Federal Reserve pand its pivotal place in the interna-
ing links); or for countries with highly swap arrangements. When these be- tional monetary and financial system
euro-ized banking systems that are came harder to come by, G10 cen- as one of the few central banks that is
not in the EU, such as Serbia, Turkey, tral banks were called on to step in via connected to both the People’s Bank
or Lebanon. the Bank for International Settlements of China (PBoC) and to the US Fed-
(BIS). This happened in 1995 during eral Reserve, but, in order to do so, it
Opening a standing repo and reverse Mexico’s peso crisis, which led to a $50 must accept further operational and
repo line to all foreign central banks billion bailout package. An emergency counter-party risks. These are inev-
(with varying haircuts) would offer assistance facility could be very use- itable if the euro is to rise as a lead-
advanced custody and payment ser- ful today, for example to address Leba- ing international reserve currency and
vices in euros to all central banks. But non’s financial cum banking crisis. help reshape the international mone-
it would also ensure the highest pos- tary order.
sible level of international euro collat-
eral fluidity, which is important for the CONCLUSION
conduct of the ECB’s domestic policy
and the control of its short-term se- The European Union wants to pro-
cured funding rates. mote the international role of the euro
in order to reap the benefits of issu-
3. A Discretionary Emergency Assis- ing a true international reserve cur-
tance Facility rency and provide a more stable and
The ECB should also consider creat- multipolar international monetary or-
ing a standing FX swap and/or repo der, but the ECB’s framework for swap
facility that can be accessed in cases and repo lines is not up to the task. It
of distinct country-level distress – in should be revised profoundly to pro-
particular alongside existing financial vide a simpler and more systematic
assistance programs such as the IMF set of instruments to limit potential li-No. 04 | February 2021 5
COMMENTARY Three Ideas to Improve the International Role of the ECB
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Deutsche Gesellschaft für
Auswärtige Politik e.V.
ISSN 1864-347
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