Global report identifies foreign currency funding vulnerabilities

The report, prepared by a CGFS working group, focuses on foreign currency funding risk and cross-border liquidity across five major currencies: the US dollar, euro, Japanese yen, British pound, and Swiss franc.

A key finding is the US dollar's dominant role in foreign currency exposures across financial systems and jurisdictions, with small open European economies using the euro as their primary foreign currency being an exception.

The study examines exposures from both a consolidated (nationality) perspective, useful for home authorities, and a host-country (residence) perspective, relevant for host authorities.

Banking groups primarily source foreign currency funding from home offices, with affiliates often relying on internal capital markets.

The report also highlights that on-balance sheet currency mismatches are frequently reduced using short-term foreign exchange derivatives, which can introduce rollover risk.

NBFIs, including asset managers and pension funds, also show significant offshore investments leading to foreign currency exposures, though internationally active insurance companies tend to have limited open positions.

The second part of the report investigates channels for alleviating foreign currency funding shortages when external private market funding is impaired.

Internal capital markets serve as a first line of defense against liquidity shortages within financial groups.

However, regulatory restrictions or internal risk-management reasons can impede intragroup transfers, especially during generalized stress.

Survey responses indicate that over 20 percent of foreign currency funding risk exposures in three of the five major currencies have faced such restrictions historically.

Central bank foreign currency liquidity facilities act as a last resort.

The report reviews their coverage, size, conditionality, and accessibility, alongside prudential measures aimed at reducing banks' foreign currency funding risks.