Swap contracts

What is a currency swap agreement? It’s basically the decision of two or more countries to use their own local currencies for trade and international business payments so they don’t have to spend internationally recognized reserve currencies like the dollar and euro.

For example, in the case of Turkey-UAE swap agreement, Abu Dhabi opened a lira account at the Central Bank of Turkey and Ankara opened a dirham account at the UAE Central Bank. The nominal equivalent of 18 billion dirhams in the UAE and 64 billion liras in Turkey were placed there for storage for a period of three years.

Which countries made swap agreements with the Fed?

Currency swap agreements between developed and emerging economies… The Fed expanded its swap lines to Brazil, Mexico, South Korea and Singapore. ECB expanded swap lines to Croatia and Hungary and signed four additional repo agreements

In 2020, both the Fed and the ECB re-expanded swap lines for emerging country central banks during the COVID-19 crisis. The Fed approved emergency lines for Brazil, Mexico, South Korea and Singapore on March 19 – the same developing countries that received swap lines in 2008. As with the developed world emergency swap lines, the Fed renewed the lines for six months and then the following March. On April 15, the ECB approved a temporary line to Croatia and eight days later granted a line to Hungary. In the early months of the pandemic, the ECB also entered into buyback agreements with Albania, North Macedonia, San Marino and Serbia.

Features of swap contracts According to Mbastudymaterial, there are 7 important features that define a swap contract:

1. Basically a forward: A swap is nothing but a combination of forwards. (Has all the features of forward contracts)

2. Double overlap of wishes: Swap requires two parties with equal and opposite needs to contact each other, ie the interest rate differs from market to market and within the market itself.

3. Comparative loan advantages: Borrowers who benefit from the comparative credit advantage in variable rate debts will enter into a swap agreement for floating rate currency swap with borrowers who have comparative advantage in fixed rate debts such as bonds.

4. Flexibility: In the short-term market, lenders have the flexibility to adjust the variable interest rate (short-term rate) according to the prevailing market conditions and the current financial situation of the borrower.

5. Necessity of an intermediary: A swap requires the existence of two counterparties whose needs are opposite but matched.

6. Exchange: Although a certain principal amount is specified in the swap contract, there is no principal exchange. On the other hand, a fixed-rate interest flow is replaced by a variable interest rate and therefore there are cash flows rather than a single payment.

7. Long-term deal: Usually, futures are only issued for a short period of time. Long-term interest contracts may not be preferred because they involve more risk (default risk, interest rate fluctuation risk, etc.).

Swap lines with the CBRT and other CBs The Central Bank of the Republic of Turkey (CBRT) announced on 19 January 2022 that the nominal size of the central banks of Turkey and the United Arab Emirates (UAE) is 18 billion UAE dirhams and 64 billion TRY (4.7 billion $) announced that it has signed a swap agreement amounting to

The agreement, designed to promote bilateral trade with the aim of further strengthening financial cooperation between the two countries, will be valid for a period of three years with the possibility of extension by mutual agreement.

The central bank has swap agreements worth $23 billion with China, Qatar and South Korea. These agreements will encourage trade in local currencies, while also increasing the central bank’s gross reserves.

The validity period with South Korea is 3 years from today and can be extended by mutual agreement between the two parties. This agreement is designed to promote bilateral trade through a swap-financed trade agreement and financial cooperation for the economic development of the two countries. The two sides hope that this will further strengthen the cooperation between the two institutions.

As for China, the deal was signed on May 30, 2019 and extended in mid-June 2021. While the maturity date is not specified, we can expect the deal to last for at least 3 more years after the increase in June 2021.

Finally, the most important agreement Turkey has is Qatar. Originally signed for $5 billion in 2018, increased to $15 billion in May 2021 and extended for at least another 3 years.

Turkey’s currency swap agreements increase its gross reserves

The effect of swap agreements on the CBRT’s FX reserves The main objective of the CBRT’s TRY currency swap market is to increase the flexibility and diversity of instruments in banks’ TRY and FX liquidity management. The market became operational in November 2018. Transactions in this market only temporarily increase the CBRT reserves without creating a long-term effect.

Since transactions are carried out within predetermined limits, they should not be considered as a substitute for the offshore swap market. However, the benefits of shifting existing OTC transactions to an organized exchange are clear in terms of increased transparency, operational risk, cost reduction, central clearing, monitoring, reporting and systemic risk reduction.

Turkey’s currency swap market is important for the banking sector. Swaps are mainly used by banks to convert their foreign currency assets into TRY without taking any foreign exchange risk. Recently, the Banking Regulation and Supervision Agency has limited the total nominal principal amount of Turkish banks’ foreign currency swaps and swap-like transactions with foreign counterparties to a maximum of 25% of the relevant bank’s legal capital so that domestic banks can pay TRY and receive foreign currency. This threshold also limited foreign counterparties’ access to TRY liquidity. The main objective was to support financial stability and reduce exchange rate volatility. With the enactment of the regulation, volatility in the foreign exchange markets actually decreased and the depreciation of TRY lost momentum.

Conclusion? Policy normalization in major advanced economies affects emerging market economies (EMs) through multiple channels, posing major challenges for central banks. EMs have adopted a policy toolkit that includes monetary, fiscal, exchange rate and macroprudential policies. Since the 2007 financial crisis, central banks around the world have signed numerous bilateral currency swap agreements with each other. These agreements allow a country’s central bank to exchange its currency, usually its national currency, for a specified amount of foreign currency.

Since 2018, when the lira suddenly began to fluctuate against the US dollar, the Turkish government sought currency swap deals with other countries in an effort to ease the pressure on the G-20 country’s currency. The central bank has swap agreements worth $23 billion with China, Qatar and South Korea. With the bilateral currency swap agreement of $5 billion signed between Turkey and the United Arab Emirates (UAE) central banks, the total swap agreements of the Central Bank of the Republic of Turkey (CBRT) reached $28 billion. These steps are; In general, it affects the gross reserves positively. We, on the other hand, look at the event mostly in terms of net reserves and net reserves excluding swaps.

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