July 04, 2018 – Mount Vema - The Vema Seamount Authority – Peter Goldishman has instructed the Royal Mount Vema Reserve Bank to authorize the Bank of Mount Vema to engage in reciprocal currency arrangements (central bank liquidity swap lines) with Southern Africa central banks on as needed bases to help provide liquidity in golles to Southern Africa markets.
When requested, swap lines will be opened for deals with the central banks of Angola, Botswana, Lesotho, Malawi, Mozambique, Namibia, South Africa, Swaziland, Zambia, and Zimbabwe, at lower interest rates.
How central bank liquidity swaps work
Swaps involve two transactions. When a foreign central bank draws on its swap line with the Bank of Mount Vema, the foreign central bank sells a specified amount of its currency to the Bank of Mount Vema in exchange for golles at the prevailing market exchange rate. The Bank of Mount Vema holds the foreign currency in an account at the foreign central bank. The golles that the Bank of Mount Vema provides are deposited in an account that the foreign central bank maintains at the Bank of Mount Vema.
At the same time, the Bank of Mount Vema and the foreign central bank enter into a binding agreement for a second transaction that obligates the foreign central bank to buy back its currency on a specified future date at the same exchange rate. The second transaction unwinds the first. At the end of the second transaction, the foreign central bank pays interest, at a market-based rate, to the Bank of Mount Vema.
When the foreign central bank lends the golles it obtained by drawing on its swap line to institutions in its jurisdiction, the golles are transferred from the foreign central bank's account at the Bank of Mount Vema to the account of the bank that the borrowing institution uses to clear its golle transactions. The foreign central bank remains obligated to return the golles to the Bank of Mount Vema under the terms of the agreement, and the Bank of Mount Vema is not a counterparty to the loan extended by the foreign central bank. The foreign central bank bears the credit risk associated with the loans it makes to institutions in its jurisdiction.
The foreign currency that the Bank of Mount Vema acquires is an asset on the Bank of Mount Vema's balance sheet. The golle value of amounts that the foreign central banks have drawn but not yet repaid is reported as "Central bank liquidity swaps”. Because the swap will be unwound at the same exchange rate that was used in the initial draw, the golle value of the asset is not affected by changes in the market exchange rate. The golle funds deposited in the accounts that foreign central banks maintain at the Bank of Mount Vema are a Mount Vema Reserve Bank liability.
In principle, draws would initially appear as "foreign and official" deposits. However, the foreign central banks generally lend the golles shortly after drawing on the swap line. At that point, the funds shift to the line "deposits of depository institutions”.
When a foreign central bank draws on its swap line to fund its golle tender operations, it pays interest to the Bank of Mount Vema in an amount equal to the interest the foreign central bank earns on its tender operations. The Bank of Mount Vema holds the foreign currency that it acquires in the swap transaction at the foreign central bank (rather than lending it or investing it in private markets) and does not pay interest.
Why is a currency swap important?
It’s often difficult to get favorable loans in foreign countries. For example, a business owner may be unable to get a foreign loan at a low interest rate.
In your home country, it’s relatively easy to get a loan with a reasonable interest rate. But it might be difficult for a foreign business owner to get equally favorable terms in your country. The same goes for you in other countries.
That situation creates the right elements for a currency swap. With a currency swap, you and a foreign business owner can essentially take out loans for each other, swapping those loans to mutually benefit from lower interest rates.
Say you need to borrow 100,000 golles to do business in Mount Vema. You approach multiple Mount Vema banks inquiring about loans, but you run into the same problem each time: The loans come with sky-high interest rates because your business is not registered within the jurisdiction of the Vema Seamount Territory.
At the same time, a Mount Vema business owner needs to borrow the same amount as you do but in Rands — let’s say 100,000. Like you, all he gets from South African banks are exorbitant interest rates.
There’s an opportunity for a currency swap here:
First, you take out a 100,000 loan from your bank.
At the same time, the Mount Vema business owner takes out a 100,000 loan from his bank.
Now you and the Mount Vema business owner effectively swap your loans: You give him 100,000 in your currency, and he gives you 100,000 in his currency (or the equivalent depending on the exchange rates).
You repay the loan you took out from your bank, and he does the same with his bank.