FRM Part II · FRM Exam Part II

The US Dollar Shortage in Global Banking and Policy Response

The US dollar shortage is the stress that arises when non-US banks hold dollar assets funded by short-term dollar liabilities, often rolled through FX swaps, and cannot refinance them. To solve questions, find the currency mismatch, trace the funding channel, then link the central bank swap line or regulation that addresses it.

What this chapter covers

This chapter explains why banks outside the United States need large amounts of US dollars, how they fund them, and what happens when that funding stops. Many global banks hold dollar assets such as loans and securities. Their dollar deposit base is often too small to fund them. They fill the gap with short-term wholesale dollar funding and with FX swaps, which are off-balance-sheet and easy to overlook.

The chapter then follows the 2007-2009 crisis. Money markets froze, counterparty fears rose, and banks could not roll over dollar funding. Cross-currency basis spreads widened. Central banks responded with swap lines, where the Federal Reserve supplied dollars to other central banks, which lent them on to local banks. The chapter ends with post-crisis rules and the vulnerabilities that remain.

This connects directly to the rest of Part II. It is a liquidity risk topic, so it links to Liquidity and Treasury Risk Measurement and Management, including funding liquidity, LCR and NSFR. It also touches market risk through FX and basis spreads, and credit risk through counterparty fears. It fits Current Issues thinking too, because the same dollar dependence shows up in modern stress episodes.

Part II has 80 equally weighted questions, so every chapter counts the same per question, and this one rewards clear reasoning more than memory. Questions are usually applied: you get a bank balance sheet or a market scenario and must identify the mismatch, the transmission channel or the right policy tool. Once you understand the logic of rollover risk and swap lines, you can answer these quickly, and the same logic helps in the wider liquidity topic.

The US Dollar Shortage in Global Banking and the International Policy Response: topics in the order to study them

1Origins of the Global US Dollar Funding ShortageStart here to learn why non-US banks hold dollar assets and why the dollar's global role creates structural demand.
2Currency Mismatch and FX Swap Market FundingNext, learn the mechanics of how dollars are raised through swaps, since every later topic depends on this.
3The 2007-2009 Crisis Dollar Shortage DynamicsWith the mechanics clear, you can see how a freeze in rollover funding and wider basis spreads produced the shortage.
4Central Bank Swap Lines and Policy ResponseThe policy response only makes sense once you know what broke, so study it after the crisis.
5Post-Crisis Regulation and Remaining VulnerabilitiesFinish with regulation and open risks, which builds on everything before and ties to LCR and NSFR.

How to prepare The US Dollar Shortage in Global Banking and the International Policy Response

Treat this chapter as one story: need, funding, failure, rescue, reform. Learn the cause and effect, not isolated facts.

Read the origins first and write one sentence on why a non-US bank needs dollars and cannot fund them all from dollar deposits.
Draw a simple FX swap on paper: borrow dollars against another currency now, reverse at maturity. Mark the cash flows at both dates and note that the bank stays exposed to rollover risk.
Learn what the cross-currency basis signals: a more negative basis means dollars are costlier to obtain through swaps. Practise stating the direction of change in a stress.
Build a timeline of the crisis funding freeze and tie each stage to a cause, such as counterparty fear, money market stress or loss of rollover.
Map each swap line step: Fed to foreign central bank, then foreign central bank to local banks. Note who bears the credit risk toward the banks.
Link reforms to the problem they address, such as LCR and NSFR for funding liquidity, and list what gaps remain.
Do timed practice questions and review every wrong answer by naming the channel you missed.

Common mistakes in The US Dollar Shortage in Global Banking and the International Policy Response

Treating the shortage as a shortage of dollars in the world rather than a funding access problem.
Fix: Frame it as banks being unable to roll over or obtain dollar funding at acceptable cost, not a lack of dollars globally.
Getting the direction of the cross-currency basis wrong.
Fix: Remember that a more negative basis signals costlier dollar funding via swaps, and expect it to widen in stress.
Saying the Fed lends directly to commercial banks abroad under swap lines.
Fix: Write the chain: Fed to foreign central bank, then foreign central bank to local banks.
Ignoring off-balance-sheet FX swaps when judging a bank's dollar mismatch.
Fix: Always ask how the bank funds dollar assets, and include swap obligations that must be rolled over.
Assuming post-crisis rules removed the vulnerability.
Fix: State what rules like LCR and NSFR improve and note that dollar funding reliance and rollover risk can persist.
Memorising dates and events without the cause-and-effect link.
Fix: For each event, write the cause and the funding effect, since exam questions test reasoning in scenarios.

Last-day revision: The US Dollar Shortage in Global Banking and the International Policy Response

Dollar shortage = non-US banks cannot roll over short-term dollar funding against dollar assets.
The core problem is a currency and maturity mismatch: long dollar assets, short dollar liabilities.
FX swaps let banks raise dollars against other currencies, but the swap must be rolled over.
FX swaps are off-balance-sheet, so the mismatch can be hidden from simple balance sheet views.
A more negative cross-currency basis means dollars are more expensive to obtain via swaps.
In the crisis, counterparty fears and frozen money markets cut off dollar rollover funding.
Swap lines: the Fed provides dollars to a foreign central bank, which lends them to its local banks.
The foreign central bank, not the Fed, carries the credit risk of its local bank borrowers.
Swap lines work by supplying dollars directly, which eases pressure on the basis.
LCR and NSFR address funding liquidity, but dollar-specific mismatches can remain.
Remaining vulnerabilities include continued reliance on short-term dollar funding and swap market stress.
Always name the channel: mismatch, rollover, basis, or policy tool.

The US Dollar Shortage in Global Banking and the International Policy Response practice questions

The US Dollar Shortage in Global Banking and the International Policy Response in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

The US Dollar Shortage in Global Banking and the International Policy Response: frequently asked questions

Is the US dollar shortage chapter hard for FRM Part II?

It is conceptual rather than calculation heavy. If you understand the mismatch, the FX swap mechanics and the swap line chain, most questions become straightforward. The risk is mixing up directions and who bears the risk.

Do I need to calculate anything in this chapter?

Mostly you need to interpret, such as what a wider cross-currency basis means or how a swap rolls over. Expect scenario questions that test the logic. Practise explaining each step in words and with a simple cash flow sketch.

How does this chapter link to other Part II topics?

It links mainly to Liquidity and Treasury Risk Measurement and Management through funding liquidity, LCR and NSFR. It also touches market risk through FX and basis spreads, and credit risk through counterparty fears.

What is the best order to study the topics?

Study origins, then currency mismatch and FX swap funding, then the 2007-2009 dynamics, then swap lines, and finish with post-crisis regulation. Each topic builds on the one before it.