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Box Story 2

A Central Bank’s Role in an International Financial Centre

Walter Bagehot — a 19th century English businessman, essayist, and journalist — summarised the central bank’s role with the dictum “lend freely at a high rate, on good collateral.” This maxim has served central banks well for many years. However, with the globalisation of capital flows through global financial institutions, there has been a philosophical shift in how central banks think about their roles as liquidity providers.

As capital flows become more globalised, central banks, especially those in international financial centres like Singapore, have recognised the need to be able to provide liquidity not just in the local currency but in global currencies. At the same time, as more global financial institutions participate in local financial systems, central banks have also responded by recognising a broader set of good collateral from global capital markets in their liquidity facilities.

This has led to two main developments among central banks in the crisis. First, foreign exchange swap lines allow central banks to provide liquidity to local markets in global currencies, such as the US dollar and Euro. This has helped to prevent stresses in global funding markets from cascading down into local markets. To that end, MAS entered into a US$30 billion swap arrangement with the US Federal Reserve in October 2008 to help improve liquidity conditions in global financial markets.

Second, cross-border collateral arrangements allow central banks to provide local currency liquidity to foreign financial institutions, which may hold the bulk of their quality collateral in the global markets of their parent or head office. Accordingly, MAS concluded a Memorandum of Understanding with De Nederlandsche Bank N.V., the Dutch central bank, as part of establishing a network of cross-border collateral arrangements to accept well-rated foreign currencies and government debt securities as collateral in the Standing Facility.

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