A Central Bank Currency Swap (CBCS) is a reciprocal loan between central banks from two different countries (or currency regions, such as the Eurozone), allowing one of the participants to make the currency of the other available within its own constituency. After a specified period of time, the currencies are swapped back. At least one of the two currencies is an international currency.
Although both parties loan their currency to each other, in effect the recipient of the more widely accepted currency may be considered the "borrower," while the "lender" typically just holds the currency received in a special account until it is swapped back. The swap enables the "borrower" to lend international currency to commercial banks and financial institutions within its jurisdiction, providing them with liquidity in times of market stress. The advantage of the CBCS is that both loans function as collateral for each other, and there is no exchange risk.
CBCS as a financial instrument can be traced back to the 1960s, when they were used to control exchange rates. The way they are known today, central bank currency swaps are a product of the 2008 financial crisis, and are used to target liquidity shortages in certain countries and areas. Due to extreme dollar shortages, the Fed set up CBCS, primarily with European central banks, in late 2007 and 2008. At the height of the financial crisis, when Lehman Brothers collapsed, covered interest rate parity was broken in markets worldwide, and CBCS were expanded and also extended to a number of emerging market economies. One consequence of the crisis was the establishment of permanent CBCS arrangements between central banks from all over the world.