All bank failures can be quickly papered over, except those that involve foreign currency. The authorities are well equipped to deal with domestic currency bank failures, where even the failure of a GSIB can be resolved and forgotten in a week. But the authorities cannot print foreign currency, and there are several trillion in uninsured dollar deposits abroad. A loss of confidence in regional U.S. banks raised the awareness of bank credit risk, and led to a shift out of smaller banks and into safer investments. This is a scenario that could also play out when dollar depositors in foreign banks realize that only U.S. banks enjoy the full support of the dollar printer. This post reviews the recent flight to safety, sketches out the global dollar banking system and suggests it is a point of vulnerability.
Flight to Safety
The failure of a few regional banks appears to have shaken the confidence of some depositors in small banks. Although the authorities protected all deposits in the failed banks, the data shows sizable outflows out of small banks and inflows into large banks and money market funds. Note that First Republic and Silicon Valley Bank are categorized as large banks. This suggests that some depositors did not feel secure with their small bank despite strong actions by the authorities. These depositors may have felt safer in a money market fund or a GSIB. This is not a crisis, but it illustrates how fragile confidence in banks can be.
Dollar deposits in U.S. banks are now de facto fully protected by the U.S. government, but that protection does not extend to the trillions of dollar deposits in foreign banks. The dollar is unique in that there is an extensive network of foreign banks that offer dollar banking services throughout the world. These banks take dollar deposits and make dollar loans, but are outside the purview and protection of U.S. regulators. They are supervised by their home country regulators, who usually do not and cannot offer insurance on dollar deposits. Note that even the U.S. branches of foreign banks tend to be uninsured by the FDIC.
Foreign banks can meet withdraws of dollar deposits with their liquid dollar assets or by drawing on official sector support. Collectively, foreign banks hold $1.3t in cash at the Fed. If that is not enough, they can also borrow from their own central bank or the Fed. Some foreign countries hold tremendous amounts of dollar reserves to support the dollar needs of their banks. Other countries rely on emergency borrowings from the Fed, who has become the global dollar lender of last resort through its FX swap lines and FIMA Repo Facility.
Fed facilities are a powerful life line, but that they are not without limit. The FIMA Repo Facility has a trivial limit of $60b. Fed FX swap lines are “unlimited” for the closest allies of the U.S., and limited to $30b or $60b for a few others. The swap facilities have been drawn on significantly the in the past, and successful in calming dollar squeezes. But they are ultimately subject to political concerns and not actually without limit.
There is little indication of a dollar run, but that is a possibility in a world where awareness of bank credit risk is rising. A confidential draw on the FIMA Repo Facility suggests some need for dollars by a central bank. The failure of Credit Suisse appears to be shaking confidence in European banks, especially Deutsche Bank. Most European countries hold small amounts of foreign reserves and are completely reliant on the Fed.
Although granular deposit data is not publicly available, aggregate data indicates European banks have $3t in dollar liabilities booked in Europe and about the same amount outside of Europe. Off-shore dollar depositors tend to be institutional and corporate accounts that can exhibit high degrees of risk aversion. The failure of a regional U.S. bank showed some depositors that small banks may not be safe. Concerns over large foreign banks could easily spark a realization that dollars can only be safe within the U.S. That would be a crisis that could not be easily papered over.