How do U.S. Treasury swap lines work and who bears the risk?
Executive summary
The Federal Reserve’s U.S. dollar swap lines are short-term reciprocal currency arrangements that let the Fed exchange dollars for foreign central banks’ currencies so those central banks can lend dollars in their jurisdictions, stabilizing global dollar funding without the Fed lending directly to foreign banks [1] [2]. By construction the receiving foreign central bank—not the Fed—assumes the credit risk of downstream loans to domestic institutions, and the Fed structures swaps so it is insulated from FX and market risk at inception and maturity [1] [3].
1. What the swap line mechanically does: a temporary, matched currency exchange
In a swap line the Fed and a foreign central bank agree to exchange specified amounts of currencies now and to swap them back at a fixed forward exchange rate on a specified date, meaning dollars flow to the foreign central bank and the foreign currency to the Fed, and the transaction is reversed at maturity using the same rate, which eliminates exchange‑rate and market‑value risk between the two central banks under normal terms [1] [3].
2. How dollars reach private actors: intermediated by foreign central banks
The critical operational point is that the Fed gives dollars to the foreign central bank, which then decides who in its jurisdiction receives those dollars, on what collateral and at what price; the Fed is not the counterparty to those downstream loans, so distribution and allocation choices rest with the foreign authority [1] [4] [5].
3. Who bears what risk: credit, FX, and market exposure
Official Fed guidance and academic work emphasize that the Fed does not bear the credit risk of loans the foreign central bank makes to domestic banks; that credit exposure is carried by the foreign central bank, while the Fed’s contractual counterpart is that central bank [2] [1]. The Fed also structures the swap so that the spot and forward legs cancel out FX exposure between the two central banks, meaning there is no exchange‑rate risk on the Fed’s books for the principal swap itself [1] [3]. Academic analysis adds nuance: while the bilateral swap contract minimizes Fed exposure, political and operational choices—such as how long lines remain open, which countries receive them, and what collateral the foreign central bank accepts—can create indirect balance‑sheet or reputational issues for U.S. policy [6] [7].
4. Why the Fed uses swap lines: stabilizing dollar funding and protecting U.S. markets
The Fed’s rationale is pragmatic: dollar funding markets are global, and dysfunction abroad can feed back into U.S. markets (e.g., forced sales of Treasuries or spikes in cross‑currency basis), so supplying dollar liquidity abroad via trusted central bank counterparties reduces the chance of disruptive asset fire‑sales and domestic market stress [8] [9] [7]. Researchers and policymakers have found swap lines effective in past crises, notably 2008 and 2020, in lowering dollar borrowing costs and stemming Treasury selloffs without the Fed needing to buy foreign assets directly [8] [10].
5. Political economy and residual risks: who ultimately “picks up the tab”?
Although the Fed’s contractual design limits direct losses, scholarly work and historical practice show layered responsibilities: in some past arrangements the U.S. Treasury has backstopped or taken on longer‑term obligations—especially for emerging‑market support—or the Exchange Stabilization Fund plays a complementary role, meaning ultimate fiscal risk or political accountability can shift beyond the Fed [10] [11]. Moreover, selection of counterparties and the decision to expand lines are political choices that reflect geopolitical priorities and can privilege allies or large financial centers, a point stressed by Harvard and other analyses arguing swap allocation is as much about power as economics [7] [12].
6. Limits and transparency: what reporting leaves unanswered
Public documentation and Fed FAQs make clear the Fed avoids direct private‑bank credit risk and FX exposure in the swaps [1] [3], but reporting and academic work note limits: the Fed does not control how foreign central banks re‑lend dollars or the credit standards they apply, and the extent to which Treasury or ESF contingent backstops might be invoked in extreme circumstances varies by past practice rather than a formal rule—an area where publicly available sources are descriptive rather than prescriptive [4] [11].