Dollars on Demand: The Fed’s New FIMA Repo Facility
April 1, 2020
The Federal Reserve continues to innovate as it seeks to stem the financial fallout from an unprecedented health, economic, and financial crisis. Tuesday morning, it announced the establishment of a temporary facility to provide foreign central banks with access to dollars in exchange (temporarily) for their holdings of U.S. Treasuries. According to the Fed’s press release, the new FIMA repo facility (named for its targeted users: Foreign and International Monetary Authorities), will “help support the smooth functioning of financial markets, including the U.S. Treasury market, and thus maintain the supply of credit to U.S. households and businesses.” The facility acknowledges the dollar’s role as the global reserve currency by providing dollars to central banks that would otherwise be forced to sell U.S. Treasury holdings to meet dollar demand.
Q1: How does the facility work?
A1 : The FIMA repo facility will allow foreign central banks to temporarily exchange their holdings of U.S. Treasury securities for U.S. dollars from the Fed; the foreign central bank would then be obligated to repurchase or “repo” the securities at maturity. The short maturity of the agreements—they are overnight but can be “rolled over as needed”—means the Fed can assess conditions on a daily basis. The Fed’s fact sheet also indicates the facility is priced at a premium to private markets, meaning it will be utilized “only in unusual circumstances such as those prevailing as present” and not when the Treasury market is functioning well.
The facility is available to foreign central banks and other international monetary authorities with accounts at the Federal Reserve Bank of New York, and applications to use the facility will be approved by the Federal Reserve. Importantly, dollar denomination of the transactions and full collateralization by U.S. Treasuries means there is neither foreign exchange nor credit risk to the Fed. Given that the repo operations will depend on the provision of U.S. Treasury securities, the use of the facility will de facto be limited by countries’ international reserves and the portion of reserves held in U.S. Treasuries.
Q2: Why are dollars in such short supply?
A2 : The U.S. dollar is often called the global reserve currency, given its widespread use outside the United States as a store of value, unit of account, and medium of exchange. It is also a safe haven currency, meaning that in times of market instability, like now, demand for dollars spikes. This is especially a problem for countries that need to meet dollar obligations. Accessing dollars may not be a problem in normal times, but with the global economy facing an unprecedented shock, these are not normal times. An indication of financial stress can also be seen in the “sudden stop” of capital flows to emerging markets stemming from uncertainty about the spread and economic impact of COVID-19.
Central banks with large foreign reserves—the majority of which are denominated in dollars—can draw down reserves to meet dollar demand. But this is only possible to the extent they have reserves to spend and can liquidate their dollar holdings, which often are invested in U.S. Treasuries. In fact, the Fed’s announcement states the FIMA facility will reduce “the need for central banks to sell their Treasury securities outright and into illiquid markets, which will help to avoid disruptions to the Treasury market and upward pressure on yields,” something clearly in the U.S. interest.
Q3: Will the FIMA facility be enough?
A3: The FIMA facility builds on existing efforts by the Fed to boost the supply of dollars in the international system. But as noted above, it only functions to provide dollars to the extent countries hold U.S. Treasuries. Central bank swap lines are a separate line of defense, available to a more limited number of countries. Even before the pandemic, the Fed had standing swap lines with major central banks, including the European Central Bank and the Bank of Japan, among others. The Fed also re-activated swap lines first introduced during the global financial crisis. While these swap lines are important, they do not solve the problem for the majority of emerging market and low-income countries in need of dollars or other “hard” currencies and facing a sudden stop in capital flows, to say nothing of collapsing growth and urgent spending needs to deal with the health crisis.
Fed actions—both swap lines and the new FIMA facility—are clearly an important part of the crisis response; in Tuesday’s announcement, the Fed recognized its unique responsibility to provide dollars to the international system given the dollar’s predominant role as an international currency. At the same time, Fed action alone will not be sufficient. Support from the International Monetary Fund and regional financing arrangements will be critical to addressing the sudden stop and meeting balance of payments needs; while the multilateral development institutions will be essential in helping countries meet the massive spending on health and recovery efforts to come.
Stephanie Segal is a senior fellow with the Simon Chair in Political Economy at the Center for Strategic and International Studies in Washington, D.C.
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