NEW YORK (Reuters) - The Federal Reserve's currency swap line with overseas central banks may not stem a further widening of the spread on dollar three-month London interbank offered rate and overnight indexed swap rate, a Citi Research analyst said on Tuesday.
The premium of three-month LIBOR over three-month OIS, which is seen as a gauge of stress in the money markets, grew to 48.45 basis points earlier Tuesday, the widest gap since January 2012.
"Although 3-month LIBOR/OIS is approaching 50 basis points, we don’t believe central banks’ liquidity swap lines will prove to be a hard ceiling on LIBOR/OIS given the tenor mismatch, stigma costs, and collateral requirements," Citi rates strategist Ruslan Bikbov wrote in a research note.
Currently the Fed has arrangements with the Bank of Canada, Bank of England, European Central Bank, Swiss National Bank and Bank of Japan. They enable the five central banks to sell their local currencies to the Fed in exchange for dollars at the market exchange rate and to pay an interest to the Fed when a swap ends.
Foreign central banks have used this arrangement to help their local financial institutions during episodes of strains in money markets when investors are reluctant to lend their dollars.
Since December 2011, the Fed charges a central bank a 50 basis point premium on the three-month OIS to tap the currency swap facility.
Bikbov said the seven-day term of the Fed's swap line may not match the dollar needs of foreign central banks.
Moroever, the use of the swap line may raise market concerns about a country's banking system, he said.
"We hear anecdotal reports of foreign central banks dissuading their banks to use the facility as it may signal systemic risks," Bikbov wrote.
Foreign private banks face stiff costs to obtain dollars through the swap line, he said.
For example, the Bank of Japan charges a 13 percent "haircut" for yen-denominated collateral. This means a private Japan bank obtains only 87 percent on the value of a yen-denominated loan or security if BOJ uses it as collateral for the swap line to borrow greenbacks from the Fed.