FRM Exam Part II · The US Dollar Shortage in Global Banking and the International Policy Response

Federal Reserve Central Bank Swap Lines Explained

Updated 11 October 2026 · Fact-checked

A central bank swap line lets a foreign central bank get US dollars from the Federal Reserve in exchange for its own currency, at an agreed exchange rate. The foreign bank then lends the dollars to its local banks. This eases dollar funding stress and makes the Fed an international lender of last resort.

Understand Central Bank Swap Lines and Policy Response

Global banks hold large dollar assets but often lack a matching base of dollar deposits. They fund the gap in wholesale markets, such as short-term dollar borrowing and FX swaps. In a crisis, these markets freeze. Foreign banks cannot get dollars, and the local central bank cannot print them.

A central bank liquidity swap line solves this. The Fed gives dollars to a foreign central bank (for example the ECB). The foreign central bank gives the Fed an equal value of its own currency at the spot exchange rate. At maturity, the trade reverses at the same exchange rate, and the foreign central bank pays interest to the Fed.

The foreign central bank then lends the dollars to banks in its own jurisdiction, usually against eligible collateral. This is the key point: the Fed lends to the foreign central bank, not to foreign banks directly. The foreign central bank carries the credit risk of its banks. The Fed bears no exchange rate risk on the principal, because the reverse trade uses the original rate. It still bears credit risk to the foreign central bank, and holding the foreign currency mitigates that risk.

This is why swap lines act as a global lender of last resort in dollars. They cap how high dollar funding costs can go, because banks can borrow from their central bank at a known rate. During 2007-2009 the Fed set up swap lines with many central banks, and these were later made standing arrangements with a core group of central banks. Swap lines lowered pressure on FX swap and cross-currency basis markets and reduced fire sales of dollar assets.

Swap lines differ from the FIMA repo facility. FIMA lets foreign official institutions with accounts at the New York Fed repo their US Treasury securities for dollars, without selling them. Swap lines give central banks dollars against their own currency. FIMA is a backstop that depends on holding Treasuries. Swap lines are available only to the central banks with which the Fed has arrangements. Other policy responses include coordinated rate cuts and national dollar facilities.

Key formulas to remember

Swap line, initial leg: Dollars delivered by the Fed = Foreign currency received × spot rate (USD per unit); The Fed receives foreign currency at the spot rate on the start date.
Swap line, reversal: Foreign currency returned = same amount, at the same initial rate; The reverse trade uses the original rate, so the Fed has no exchange rate risk on the principal. It still bears credit risk to the foreign central bank, which is mitigated by holding the foreign currency.
Cost to the borrower: Interest = USD amount × swap rate × days ÷ 360; Interest is paid in dollars at a rate fixed relative to a policy benchmark. Use the day count given in the question.
Who bears the credit risk: Fed exposure = foreign central bank; central bank exposure = its commercial banks; The Fed does not lend to foreign commercial banks directly.

How to solve Central Bank Swap Lines and Policy Response questions

Use this sequence for any question on swap lines or the policy response to a dollar shortage.

1Identify the stress: dollar funding gap, frozen FX swap market, or widening cross-currency basis.
2Name the facility: swap line (central bank to central bank) or FIMA repo (foreign official holders of Treasuries).
3Trace the cash flows: who gives dollars, who gives local currency, and at what exchange rate on both legs.
4Identify who bears credit risk: the foreign central bank bears the risk of its own banks; the Fed holds the foreign currency as protection.
5Check the pricing and conditions: rate over a benchmark, term, and eligible collateral at the foreign central bank.
6State the effect: lower dollar funding costs, narrower basis, fewer fire sales, a cap on the cost of dollar funding.
7Note the limits: access restricted to selected central banks, stigma, moral hazard, and the fact that the Fed is not a global central bank by mandate.

Quickest way: Four-question check for MCQs

When to use it: Use when an option list mixes swap lines, FIMA repo, and general QE or rate cuts.

Who is the borrower? Central bank means swap line. Foreign official holder of Treasuries means FIMA.
What does the borrower give? Own currency means swap line. Treasuries means FIMA repo.
Does the exchange rate move on reversal? No, it is fixed at the initial rate.
Who lends to the commercial bank? The local central bank, not the Fed.

Common mistakes in Central Bank Swap Lines and Policy Response

Saying the Fed lends dollars directly to foreign commercial banks.
The phrase lender of last resort suggests direct lending to banks.
Fix: Remember the chain: Fed to foreign central bank to local banks. The foreign central bank takes the bank credit risk.
Thinking the Fed bears exchange rate risk on the swap.
Students see two currencies and assume currency exposure.
Fix: The reversal rate equals the initial rate, so exchange rate risk on the principal is removed. The Fed still bears credit risk to the foreign central bank, which is mitigated by holding the foreign currency.
Confusing swap lines with the FIMA repo facility.
Both supply dollars to foreign official entities.
Fix: Swap line: central bank posts its own currency. FIMA: official holder repos US Treasuries. Different counterparty and collateral.
Saying swap lines remove the dollar shortage permanently.
Overstating the effect of a crisis tool.
Fix: They cap funding stress and ease the basis in a crisis. Structural currency mismatches in bank balance sheets remain.
Treating swap lines as monetary easing in the US.
Dollars are created and lent, so it looks like QE.
Fix: Swap line dollars are lent for liquidity and reversed at maturity. The purpose is financial stability abroad, not US policy stance.

Worked examples

Example 1

The Fed provides USD 10 billion to a foreign central bank under a swap line when the spot rate is 1.25 USD per unit of foreign currency. The line runs for 7 days at an interest rate of 0.90% on an actual/360 basis. How much foreign currency does the Fed receive, what is the interest paid, and what is returned at maturity if the spot rate has moved to 1.40?

Show the solution

Foreign currency received = 10,000,000,000 ÷ 1.25 = 8,000,000,000 units.
Interest = 10,000,000,000 × 0.0090 × 7 ÷ 360 = 1,750,000 USD.
At maturity the reverse trade uses the original rate of 1.25, not 1.40.
The Fed returns 8,000,000,000 units of foreign currency and receives USD 10 billion plus interest.

Answer: The Fed receives 8 billion units of foreign currency, is paid USD 1.75 million interest, and the reversal is at 1.25, so the later move to 1.40 does not affect the principal exchange.

Example 2

In a dollar funding crisis, a European bank cannot roll its short-term dollar borrowing. The ECB has a standing swap line with the Fed. Which statement is most accurate? A) The Fed lends dollars directly to the European bank. B) The ECB obtains dollars from the Fed against euros and lends them to the bank, bearing the bank's credit risk. C) The bank repos its US Treasuries with the Fed under FIMA. D) The Fed bears exchange rate risk on the principal of the euros it receives.

Show the solution

A is wrong: the Fed's counterparty is the central bank, not the commercial bank.
C is wrong: FIMA is for foreign official institutions holding Treasuries, not a commercial bank.
D is wrong: the reversal at the initial rate means the Fed bears no exchange rate risk on the principal.
B matches the mechanism: dollars to the ECB against euros, then on to the bank, with the ECB bearing the bank credit risk.

Answer: B

Exam tips

Always trace the chain of counterparties; most wrong options misplace who lends to whom.
If a question gives a later exchange rate, ignore it for the reversal: the original rate applies.
For FIMA versus swap line, look at the collateral: Treasuries means FIMA, own currency means swap line.
Link the effect to markets: narrower cross-currency basis and lower dollar funding costs, not a permanent fix.
Expect case-style items on 2007-2009 and later episodes where swap lines acted as a backstop.

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

Central Bank Swap Lines and Policy Response: frequently asked questions

How do Fed swap lines work?

The Fed gives dollars to a foreign central bank and receives that bank's currency at the spot rate. At maturity the trade reverses at the same rate, and the foreign central bank pays interest. The foreign central bank lends the dollars to its own banks.

Why is the Fed called an international lender of last resort?

Through swap lines it supplies dollars to foreign central banks when private dollar markets freeze. This is lender of last resort support in a currency the local central bank cannot create. The access is limited to selected central banks.

What is the difference between swap lines and the FIMA repo facility?

Swap lines are between the Fed and foreign central banks, which post their own currency. The FIMA repo facility lets foreign official account holders at the New York Fed repo their US Treasuries for dollars. FIMA avoids forced Treasury sales.

Were swap lines effective in 2008?

They are generally seen as having eased dollar funding stress and narrowed pressure in FX swap markets. They did not remove the underlying currency mismatch in bank funding.