Cross-Currency Basis
The cross-currency basis is the extra cost, or saving, of borrowing one currency through the FX swap market compared with borrowing it directly. A negative dollar basis means dollars are scarcer and dearer offshore than interest rates alone imply.
Also called: cross-currency basis swap spread · currency basis · dollar basis · the basis
In theory, borrowing dollars directly should cost the same as borrowing euros and swapping them into dollars, because any difference could be arbitraged away. This is covered interest parity. In practice a gap persists, and that gap is the basis, quoted in basis points.
The basis has been persistently negative for most major currencies against the dollar since 2008. Bank balance-sheet rules make the arbitrage costly, and demand for dollar funding from non-US institutions regularly exceeds what dealers are willing to supply. In March 2020 the basis widened sharply within days as borrowers scrambled for dollars, and narrowed again once central bank swap lines were expanded.
The basis is useful as a gauge. A widening basis signals stress in offshore dollar funding before it reaches headlines. For a treasury that funds payouts by swapping currencies, it is also a direct cost that sits on top of the visible FX spread, and it tends to jump at quarter-end and year-end.
Commonly confused with
| Term | How it differs |
|---|---|
| FX spread | The FX spread is the difference between buy and sell rates for a conversion. The basis is a funding premium embedded in the forward leg of a swap. |
See also
- FX SwapAn FX swap is a contract in which two parties exchange two currencies today and agree to reverse the exchange on a set future date at a rate fixed now. In economic terms it is a loan of one currency secured by another.
- Central Bank Swap LineA central bank swap line is a standing agreement under which one central bank lends its currency to another in exchange for the borrower's currency, so the borrower can supply foreign-currency funding to banks in its own jurisdiction.
- EurodollarA Eurodollar is a US dollar deposit held at a bank outside the United States, or at an offshore unit of a US bank. Eurodollars are created by bank lending abroad and sit largely beyond US banking regulation; they have nothing to do with the euro.
- Basis PointA basis point is one hundredth of one percentage point — 0.01%. FX and payments pricing is quoted in basis points because small percentages are easy to misread: 25 basis points is 0.25%, and 100 basis points is 1.00%.
- Forward ContractA forward contract is an agreement to exchange one currency for another on a future date at a rate fixed today. It creates a binding obligation on both sides — which is what makes it useful for certainty and dangerous if the underlying payment never happens.