Using FX Swaps for Local-Currency Liquidity and Cash Carry
Summary
The post explains two treasury uses of FX swaps: obtaining needed local-currency cash and putting idle balances to work through carry. In an emerging-market banking example, depositors and businesses shifted toward US dollars amid fears of devaluation, while banks still needed local currency for operations and lending. Banks exchanged dollar liquidity for local currency through short-dated FX swaps and repeatedly rolled the contracts. The account describes sharply higher swap rates during the period and subsequent currency devaluations, illustrating that liquidity stress and counterparty demand can raise rollover costs.
A second response describes a carry use: buy a currency spot and sell it forward, with the forward proceeds and interest earned or paid on deposits determining the net return. Negative deposit rates can reduce or reverse that return. These are illustrative explanations rather than a general recommendation; the post gives no formal valuation framework, and repeated short-term rolls expose users to changing rates, liquidity conditions, and currency regime risk.
Key ideas
- Banks can use FX swaps to exchange foreign-currency cash for local currency needed in daily operations.
- Rolling short-dated swaps can provide liquidity but exposes users to changing rollover costs.
- Liquidity scarcity and devaluation fears can coincide with sharply higher swap rates.
- Treasuries can use spot and forward currency transactions to seek carry on idle cash.
- Net carry depends on forward pricing and the cost or return on currency deposits.
Tags
Full text
# Why do big financial groups use fx swaps to manage cash? # Why do big financial groups use fx swaps to manage cash? Can someone help me with the logic that big companies' treasury department uses fx swap to manage their cash? An example would be much appreciated! ## Answer by AK88 (score 3, accepted) https://quant.stackexchange.com/a/49506 I can give you one example from EM banking sector where FX swap played a critical role in day to day operations. This EM country's Central Bank used follow fixed rate currency regime and used to keep the USD FX rate within certain bands. In the first half of the 2010's, major political events and drastic changes in commodities prices, specifically in oil prices, affected people's and bankers' perception that the country's CB will not be able to withstand this economic disaster. Subsequently, businesses started experiencing defaults in both local and USD currency denominated loans. Whatever banks could collect (e.g. from performing loans) used to get converted to USD cash; depositors started to convert local currency savings to USD deposits -- people were expecting currency devaluation. This lasted for about 6-8 months. Given the situation, banks still had to maintain daily operations (plus some new loan underwriting) in local currency. To facilitate this, they used FX Swaps extensively -- they lent out USD and got back whatever amount they needed in local currency using one day FX Swaps (obviously, they kept rolling these one day FX Swap contract every day). As almost all market participants got rid off the local currency, only the Central Bank and some banks who had local currency liquidity acted as counterparty to those who needed the local currency. Not surprisingly, the rate on one day FX Swap rate jumped from regular 4-5% to 25-30% average during the next 6-8 months. The maximum was about 80% or 90% or something. Eventually, said CB capitulated and devalued the currency multiple times. Apparently, now they switched from fixed rate currency regime to inflation targeting. ## Answer by AlRacoon (score 1) https://quant.stackexchange.com/a/49514 A Treasury department could use the FX Swap to put cash balances to work to earn a return on idle cash. The FX Swap is utilized to implement the FX Carry trade. Investors will Buy a currency at the Spot rate and Sell the same currency forward. The difference in their cost to buy the currency and the proceeds they will receive from the forward transaction will be the FX carry amount they will earn. In addition, they will incur costs/benefits from depositing the currency they bought. The reason I say costs is that there are currencies now that have negative interest rates and therefore it will cost the owner of said currencies. The net proceeds of the FX carry and the deposit rates is what the investor will earn.
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