G7 panel: Central banks need to use range of forex

By Mark Felsenthal

WASHINGTON (Reuters) - A high-level international crisis response body recommended on Friday that central banks of the world's richest economies handle assets in a range of one another's currencies so they can quickly extinguish any financial conflagrations in the future.

The Financial Stability Forum, which includes central bankers and global regulators who have worked on the issues since autumn, recommended steps central banks could take to respond quickly to any crises, such as the current credit crunch that began in the United States and rippled around the world.

The group recommended central banks accept collateral in foreign currencies and across borders to mobilize liquidity around the world.

"When international liquidity distribution is inadequate, coordination between central banks may be useful to provide funds in a foreign currency to banks with international operations where they are unable otherwise to obtain adequate access," the group said.

The recommendations come after the U.S. Federal Reserve cut interest rates repeatedly and opened a series of emergency liquidity facilities to stabilize U.S. financial markets.

Coordinating central bank policies across borders makes sense in an era of increasingly integrated world financial markets, said Ethan Harris, chief U.S. economist for Lehman Brothers in New York. While central banks might disagree on where interest rates should be, they share an interest in smoothly working markets, Harris said.

"They all kind of sink or swim together based on whether the capital markets are working and whether the money market is working," he added.

The forum also suggested that central banks, which have established emergency foreign currency swap facilities with one another to make sure U.S. dollar-denominated assets remain liquid, maintain standing currency swap lines.

Central banks should also consider establishing a common list of high-quality collateral denominated in a range of currencies, the group said. Monetary institutions then could conduct open market operations against that collateral.

Fewer variations on the types of collateral central banks are willing to accept could make it easier for multilateral banks to find funding at different central banks, the forum said.

The group said coordinated actions between central banks in late 2007 and early 2008 to establish foreign currency swap lines had been seen positively in markets as signs of central banks' determination to maintain control of money markets.

At the same time, the forum warned that private sector banks and financial institutions should not view closer coordination among central banks as substitutes for setting up their own mechanisms.

The Fed has ratcheted up measures aimed at restoring liquidity to troubled financial markets since the summer, reaching for newer and more effective instruments as the credit crunch has failed to ease.

Initially the central bank narrowed the gap between the interest rate at the discount window -- where banks borrow directly from the fed -- and the fed funds rate, which banks charge one another for loans. The Fed was seeking to eliminate the stigma attached to borrowing from the discount window, which markets have viewed as an act of desperation for a bank

on the ropes.