Danmarks Nationalbank's Euro
and Dollar Auctions

BACKGROUND

The international money markets froze up to the collapse of Lehman Brothers in September 2008. The market players focused on securing their own liquidity and were reluctant to lend funds to counterparties and customers and assume counterparty risks. Consequently, Danish banks and mortgage-credit institutes found it extremely difficult to obtain the necessary foreign liquidity.

Danmarks Nationalbank supplied euro and dollars from the foreign-exchange reserve via the market for FX swaps¹ with Danish banks. Sub sequently, Danmarks Nationalbank established swap facilities with the Federal Reserve, Fed, and the European Central Bank, ECB, under which Danmarks Nationalbank offers dollar and euro loans to its monetary-policy counterparties on behalf of the Fed and the ECB.

Danmarks Nationalbank's euro and dollar lending to monetary-policy counterparties is part of a globally coordinated initiative among a large number of central banks to boost the international exchange of liquid ity. The use of the currency swap facilities is diminishing both in Den mark and abroad, which can be attributed to improvement of the condi tions on the money markets².

DANMARKS NATIONALBANK PROVIDES EURO AND DOLLAR LOANS

In the autumn of 2008, Danmarks Nationalbank established temporary currency swap facilities with the Fed and the ECB in order to improve Danish banks' and mortgage-credit institutes' access to liquidity in euro and dollars. Danmarks Nationalbank thus acts as an intermediary for euro- and dollar-denominated loans to Danmarks Nationalbank's mon etary-policy counterparties on behalf of the ECB and the Fed. Lending takes place via auctions using the same collateral base as for Danmarks Nationalbank's monetary-policy lending denominated in kroner. Dan marks Nationalbank has lent euro and dollars at maturities of up to three months.

In connection with an auction, Danmarks Nationalbank fixes the lend ing rate (marginal rate) and volume on the basis of the counterparty bids. The amount in euro or dollars allotted to the monetary-policy counterparties is received by Danmarks Nationalbank from the ECB or the Fed, respectively. In return, Danmarks Nationalbank pays a corres ponding amount in kroner to the ECB or the Fed. When the loan ma tures, Danmarks Nationalbank forwards the counterparties' repayments and interest payments to the ECB or the Fed, which returns the amount in kroner to Danmarks Nationalbank. The risk of non-payment by the counterparties is countered by requiring that counterparties pledge col lateral to Danmarks Nationalbank. The latter has no income from the swap facilities.

Danmarks Nationalbank's auctions are based on the Dutch auction principle. Participating counterparties submit a maximum of three bids stating amounts and bid rates. The bid rate must be higher than or equal to the minimum bid rate fixed by the ECB or the Fed. Bids with the highest bid rates are accepted first followed by bid rates in descending order until the full amount in euro or dollars has been allotted. All par ticipants pay the marginal rate, which is the lowest among the accepted bid rates.

Euro and dollar lending boosts Danmarks Nationalbank's balance sheet. The currency forwarded by Danmarks Nationalbank to the monet ary-policy counterparties is included on the asset side of Danmarks Na tionalbank's balance sheet under "Other lending, banks in currency". Danmarks Nationalbank's outstanding amounts at the ECB and the Fed are included on the liabilities side of the balance sheet under "Deposits related to swap facilities".

Danmarks Nationalbank's swap facility with the ECB runs for as long as deemed necessary, while the swap facility with the Fed will expire on 1 February 2010 after having been extended twice.

DEMAND IN DANMARKS NATIONALBANK'S AUCTIONS

Danmarks Nationalbank's euro and dollar lending peaked around the turn of the year, cf. Chart 1. In January, lending in foreign exchange totalled kr. 116 billion. The period since the turn of the year has seen a marked decline in demand for euro and dollars in Danmarks Natio nalbank's auctions. Total lending now amounts to kr. 16 billion. By end-August 2009, 9 euro auctions and 17 dollar auctions had taken place.

Demand for dollar liquidity in Danmarks Nationalbank's auctions was strong up to the turn of the year. Foreign counterparties closed credit lines, which caused liquidity prices to rise. In the first dollar auction on 26 September, Danmarks Nationalbank received bids for more than three times the amount supplied. Demand for euro has been less pro nounced. In all euro auctions, supply has exceeded demand.

14 banks and mortgage-credit institutes have participated in Dan marks Nationalbank's euro auctions, while 13 have participated in the dollar auctions. In the autumn of 2008, the participants were predomin antly large banks, but since the turn of the year more smaller banks have been interested, especially in the euro auctions.

The allotment of liquidity in Danmarks Nationalbank's euro and dollar auctions has been concentrated on a few counterparties, cf. Chart 2. 50 per cent of the counterparties accounted for 97 per cent of the total allotment in the euro auctions and 88 per cent in the dollar auctions. The reason for the more uneven distribution in the euro auctions is that the number of smaller banks was higher in the euro auctions than in the dollar auctions, reflecting the greater need for euro liquidity among the smaller Danish banks.

In all the auctions, Danmarks Nationalbank's euro and dollar lending has been more expensive compared with a market rate based on col lateralised lending³. On average, the marginal rate in the euro auctions has been 75 basis points higher than the market rate based on col lateralised lending, while the corresponding figure for the dollar auc tions has been 84 basis points on average. This should be viewed in the light of the increased uncertainty about the creditworthiness of the counterparties. During and after the crisis small and medium-sized counterparties in particular have faced interest rates far higher than market rates in general.

Danmarks Nationalbank's auctions seek to remedy the situation for banks that have suffered under the difficult market conditions. The auctions have helped solve the banks' problems of raising euro and dollar loans. Interest in the auctions has diminished as the international money markets have improved. Given the continued normalisation of the money markets, Danmarks Nationalbank's auctions will only be held when an actual need is observed.