FX Basis, Cross-Currency Funding, and Bank Balance-Sheet Costs
Summary
The exchange explains the FX basis by comparing two ways to obtain one currency while providing another: borrowing and lending directly, or exchanging currencies at spot and reversing the exchange with a forward trade. A difference in the effective funding rates across those transactions is the basis. In the example, a bank seeking Australian dollars could use US-dollar funding and FX swaps to convert the proceeds, so the swap-implied Australian-dollar rate may differ from the onshore rate.
The response suggests that balance-sheet treatment can help explain why a bank may prefer FX swaps despite a rate premium. It also points to a year-end increase in the basis as consistent with banks placing greater value on limiting balance-sheet impact around reporting dates. This is an informal explanation, not a full account of basis pricing: it does not quantify regulatory, liquidity, credit, or collateral effects, and it challenges the source article’s explanation without providing supporting data or a formal model.
Key ideas
- The FX basis measures a difference between funding costs implied by swaps and direct borrowing and lending.
- A spot currency exchange combined with a forward reversal can replicate a cross-currency funding transaction.
- Balance-sheet treatment may make FX swaps attractive even when their implied funding rate is higher.
- The response associates year-end basis increases with banks’ balance-sheet reporting incentives.
- The explanation is qualitative and does not isolate or quantify the drivers of the basis.
Tags
Full text
# Australian banks funding # Australian banks funding "Typically, Australian banks pay a small premium to swap foreign currency into Australian dollars. This premium is also referred to as the basis, which is the difference between the implied cost of obtaining Australian dollars in the FX swap market and the cost of obtaining Australian dollars onshore." https://www.bis.org/review/r210219a.pdf I understand, Australian banks issue USD bonds to finance their AUD assets. They then use FX swaps to convert USD into AUD. The author mentions they pay a premium which is the FX swap implied rate less OIS AUD rate. Given this premium is usually positive it means FX swap implied rate > AUD OIS rate. So what is the reason why banks pay a higher rate in the FX swap market instead of using cheaper onshore funding (AUD OIS)? ## Answer by JoshK (score 1) https://quant.stackexchange.com/a/61419 I don't think that article is correct in the explanation. The FX basis means the difference between the rate you would get from trading a spot vs forward fx trade versus just outright borrowing money. For example, as bank I could: Scenario 1: - Borrow currency X (which I don't have but want) - Lend currency Y (which I have enough of) Or, I could trade in the FX market and: Scenario 2: - Exchange currency Y for X right now combined with trading a forward in X for Y. So the transactions are the same, right? I give you currency Y now and you give me currency X. Then at some time in the future we pay each-other back. When there is a "basis", that just means that the rates for these two transactions is different. Now, why are they different? The article gets into some of that. But one of the big reasons is the FX spot vs forward doesn't hit the balance sheet. That's just accounting rules, hate the game - not the player. So for banks who want to minimize the impact of this funding trade on their balance sheets they will preffer to do it in the FX market. That can make the rates drift a little bit from each-other. If you look at the chart in the document that you shared you can see it spike at the end of the year. That is typical as the balance sheet impact is most highly valued by banks when you get into EOY reporting.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.