FRM Part II · FRM Exam Part II · The US Dollar Shortage in Global Banking and the International Policy Response
A European bank holds a large portfolio of US dollar-denominated long-term assets, such as US mortgage-backed securities, funded largely by short-term US dollar wholesale borrowing from money market funds and by FX swaps. Which feature of this arrangement most directly created the bank's vulnerability when dollar funding markets froze in 2007-2008?
The main vulnerability was a maturity mismatch in dollars: long-term dollar assets were funded by short-term wholesale dollar borrowing and FX swaps, with no stable dollar deposit base. When markets froze and rollover failed, the bank could not refinance its dollar positions.
- AA maturity mismatch between long-term dollar assets and short-term dollar liabilities, with no stable dollar deposit base to roll overCorrect
- BA currency mismatch in which the bank's assets were in euros and liabilities in dollars
- CAn excess of dollar retail deposits that could be withdrawn at will
- DA shortage of euro capital relative to euro risk-weighted assets
Explanation
The bank's dollar assets were long term while dollar funding was short term and sourced from wholesale markets and swaps. When counterparties refused to roll over, the bank could not refinance. The currency mismatch option is wrong because the assets were also in dollars; the issue was maturity and funding source.
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