When South Korea is faced with a severe dollar shortage in the local swap market, currency swap deals with other central banks have a far stronger effect than using its own foreign reserves, a BIS report found on Monday.
Since late 2008, the country's central bank provided billions of dollars to local banks out of its foreign reserves while supplying another billions of dollars using a currency swap line formed with the U.S. Federal Reserve.
But the effect from supplying dollars using the credit line with the U.S. Fed was more powerful because it enhanced market confidence more effectively because they were adding to Korea's foreign reserves, the report said.
The report by the Bank for International Settlements (BIS) came as South Korea, the host of the G20 summit in November 2010, has proposed global safety nets such as an institutionalized web of currency swap lines between central banks.
Even though building up a large amount of foreign reserves has certain merits as self-insurance, once a country faces a foreign liquidity run, swap lines with other central banks can have a powerful effect of complementing the use of foreign reserves and thus stopping the run, it added.
The report also came hours after South Korea announced long-anticipated currency controls, saying it aimed to curb rapid shifts in capital flows that were linked to short-term foreign debt and posed a risk to the world's ninth-biggest exporter.
South Korea is exposed more to market gyrations because of its heavy foreign short-term debt, which amounts to some 60 percent of its foreign reserves -- nearly twice the ratio in Indonesia or Malaysia.
(Reporting by Yoo Choonsik; Editing by Louise Heavens)