Euro area banks as intermediators of US dollar liquidity via repo and FX swap markets
Published as part of the Financial Stability Review, November 2024.
US dollar funding of euro area banks may be a contingent source of vulnerability. 23% of euro area banks’ funding is denominated in foreign currency, with the US dollar providing the largest contribution (17%). The bulk of this US dollar funding is obtained via wholesale markets (96%), with unsecured funding from financials (39%) via commercial paper, for instance, and repos (35%) accounting for almost three-quarters of the total (Chart A, panel a). The short-term wholesale nature of US dollar funding can expose banks to liquidity stress, as this funding has often dried up in times of heightened market volatility. US dollar liquidity coverage is usually lower than total liquidity coverage, which suggests that maturity mismatches may contribute to liquidity risk. There is wide variation across banks, and the most internationally active financial institutions rely on dollar-denominated instruments for up to a third of their funding.
Euro area banks’ sizeable use of US dollar funding largely reflects the role played by their US affiliates as intermediaries in repo markets. Examining the activities of euro area banks in the United States allows us to better understand the prevailing business models and their role in intermediating US dollars. After a decade in which their presence in the United States declined, euro area banks have recently expanded the balance sheets of their branches and broker-dealer subsidiaries (Chart A, panel b, left graph). The business models of the US affiliates differ markedly: while bank subsidiaries engage in traditional deposit-taking and lending operations, broker-dealer subsidiaries focus more on capital market activities and are heavily involved in repo markets as intermediators. Bank branches appear to follow a hybrid business model of capital market activities alongside lending to larger clients on aggregate (Chart A, panel b, right graph). There are notable differences across jurisdictions however, with branches of French banks the most active in repo markets. By contrast, branches of German banks focus more on lending and rely to a larger extent on headquarter funding.
Chart A
Euro area banks’ US dollar funding is sizeable, especially for G-SIBs; banks source from wholesale markets, which is linked to some extent to their capital market activities through their US affiliates
a) Foreign currency funding reliance and characteristics of euro area banks’ US dollar funding | b) Total assets over time and current balance sheet structure of euro area banks’ US affiliates |
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(Q2 2024, percentages) | (left graph: 2000-23, USD trillions; right graph: 2023, percentages) |
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Sources: ECB (supervisory data), FFIEC, S&P Dow Jones Indices LLC and/or its affiliates and ECB calculations.
Notes: Panel a: the numbers refer to euro area banks on aggregate. Panel b: total assets and the balance sheet decomposition refer to US bank branches, US bank subsidiaries and the US non-bank (i.e. security broker-dealer) subsidiaries of euro area-headquartered banks. A stands for assets; L stands for liabilities. In the case of the security broker-dealer subsidiaries, repos might include also security lending activities. G-SIBs stands for global systemically important banks.
Euro area banks became more active in US dollar repo markets when interest rates started rising, with banks intermediating US dollar liquidity between their US affiliates and non-banks. Since the monetary policy tightening cycle began in 2022, total outstanding amounts of euro area banks’ US dollar repos have almost doubled, reaching €1.6 trillion in November 2024. Euro area banks’ activity in the US dollar repo market is facilitated by differences in regulatory reporting requirements.[1] The volume of repos exceeds that of reverse repos by around €250 billion, implying that euro area banks are net US dollar borrowers (Chart B, panel a). This compares with euro-denominated repos (in the euro area repo market), whose volumes have remained more or less unchanged since the beginning of 2023. US dollar repos are largely (70%) collateralised by government bonds (of which 95% are Treasuries). The bulk of this is not centrally cleared (87%), implying a higher counterparty risk than is the case for centrally cleared transactions.[2] The vast majority of repos are short-term, with 85% having a maturity of one week or less (Chart B, panel b). Euro area banks play a key role in intermediating US dollar liquidity. They do so by receiving cash largely from their US-affiliated security broker-dealers and lending the dollars to non-banks, the majority of which are offshore investment funds (Chart B, panel c). As cash borrowing exceeds cash lending, euro area banks have excess US dollars at their disposal, which they can sell in the FX swap market.
Chart B
US dollar repo market activities have expanded strongly since end-2022 and are rather short-term and largely bilateral; euro area banks intermediate US dollars to non-banks outside the euro area
a) Outstanding volumes of USD repos and reverse repos over time | b) Characteristics of euro area banks’ USD repos | c) Net USD cash borrowing and cash lending by euro area banks |
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(Jan. 2022-Nov. 2024; left-hand scale: € billions, right-hand scale: € billions) | (Jan.-Nov. 2024 average, percentages) | (Jan. 2022-Nov. 2024, € billions) |
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Sources: ECB (SFTDS) and ECB calculations.
Notes: Panel b: the maturities shown refer to transactions. ON includes overnight, tomorrow next and spot next. Panel c: other region-sector pairs include euro area banks, US banks, European non-euro area banks, US non-financial corporations and European non-euro area non-banks. EA stands for euro area.
The EUR/USD FX swap market is large, and its short maturities and high degree of market concentration pose rollover risks. With a daily trading volume of €250 billion and €3 trillion of gross outstanding amounts, the euro area FX swap market is another major source of US dollars. Global recession fears, higher interest rates and the growing profitability of carry trades increased demand for US dollars via FX swaps sharply in 2022, before it started to gradually revert towards previous levels and then picked up again in autumn (Chart C, panel a). The FX swap market is highly concentrated, with the top four euro area dealers accounting for about 60% of the market, up from 50% five years ago. Similar to repos, the bulk of FX swap trading volumes are short-term. In the second quarter of 2024, 55% of transactions had a maturity of one day. The short-term nature of this market, combined with high market concentration, implies that liquidity can dry up quickly for counterparties without direct access to sources of US dollar funding. Moreover, as the payment obligations are recorded off-balance-sheet, it is more challenging for policymakers to anticipate the scale of US dollar rollover needs.
Chart C
Demand for EUR/USD FX swaps rose amid higher risk aversion and the start of the hiking cycle; euro area banks are net US dollar lenders to non-banks, especially investment and pension funds
a) EUR/USD FX swap outstanding amount and VIX | b) Net EUR/USD FX swap positions, by counterparty sector and region | c) Net EUR/USD FX swap positions (USD buy) over time, by counterparty |
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(2 Jan. 2021-12 Nov. 2024; left-hand scale: € trillions, right-hand scale: index) | (Nov. 2024, € billions) | (2 Jan. 2018-12 Nov. 2024, € billions) |
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Sources: ECB (MMSR), Bloomberg Finance L.P. and ECB calculations.
Notes: Panel a: the outstanding amounts of FX swaps refer to EUR/USD FX swaps and are the sum of buying and selling US dollars at a point in time. VIX is the Chicago Board Options Exchange’s CBOE Volatility Index. Panel b: positive (negative) values refer to outstanding amounts of buying (selling) US dollars, net amounts are computed as the difference between selling US dollars and buying US dollars. NFC stands for non-financial corporation; RoW stands for rest of the world.
Euro area banks have substantially expanded their role as net providers of dollar liquidity to euro area non-banks in recent years. In terms of their main counterparty sectors and regions, euro area banks have been net US dollar buyers from US banks and net US dollar sellers to euro area non-banks in recent years (Chart C, panel b). Whereas net positions to most counterparty sectors have remained more or less unchanged over time, those with euro area non-banks have tripled in size over the last five years. This has been driven by growth relating to investment funds and pension funds, for which net positions have increased up to fivefold and threefold respectively since 2018, while net positions towards other financial corporations increased since summer this year (Chart C, panel c). Moreover, the mean tenor of FX swaps of euro area banks vis-à-vis their non-bank counterparties is substantially higher than the average, particularly for investment and money market funds, highlighting the maturity transformation role of banks. These elements reveal the strong interlinkages between banks and non-banks and hence the potential for shocks to propagate more easily through the financial system.
The intermediation of US dollar liquidity by euro area banks represents an important source of funding for non-banks but also poses financial stability risks. In repo markets, in which transactions are short-term and not centrally cleared, borrowers face both rollover and counterparty risks. The off-balance-sheet nature of FX swap markets makes it more difficult for central banks to assess the degree of potential US dollar liquidity shortages. Euro area banks may be vulnerable to dollar supply shocks emanating from the United States, as repo and FX swap markets would be correlated and would not serve as substitutes. Both markets are highly concentrated, implying that very few institutions have intermediation capacity, and as the US dollar liquidity provided by euro area banks to non-banks in particular includes maturity transformation this contributes to the interlinkages between the two sectors. During times of stress this increases the potential for liquidity problems to become systemic, especially where stress may be transmitted to non-banks with strong links to banks across different market segments. Such an environment might compromise the ability of financial institutions to fund their foreign currency investments, potentially leading to forced sales of dollar-denominated assets, which would serve to amplify market shocks. Central bank swap lines can mitigate these risks by providing necessary dollar liquidity during periods of financial stress.
In US dollar repo markets, euro area banks benefit from different leverage ratio reporting requirements. While US banks report daily averages on a quarterly basis, euro area banks report quarter-end figures. This creates an incentive to indulge in “window dressing” by reducing volumes at reporting dates. See the special feature entitled “Recent developments in euro area repo markets, regulatory reforms and their impact on repo market functioning”, Financial Stability Review, ECB, November 2017.
After June 2026, mandatory clearing for US Treasury-collateralised transactions may reduce repo volumes on the back of higher clearing costs and netting-induced balance sheet cuts by US competitors.