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

A non-US bank holds long-term US dollar assets but funds a large share of them with short-term FX swaps, borrowing dollars against its home currency. Which risk is this bank most directly exposed to?

The bank faces rollover risk. Its long-dollar assets outlast the short-term swaps funding them, so it must renew the swaps repeatedly. If dollar funding becomes scarce or expensive, the bank may be unable to refinance without large losses or forced asset sales.

  1. ARollover risk, because the swaps must be renewed at maturity and dollar funding may be costly or unavailableCorrect
  2. BCredit risk on the swap's principal, because principal is never exchanged
  3. CInterest rate risk that disappears because the swap is a hedge
  4. DEquity price risk arising from the collateral posted in the swap

Explanation

Funding long-term dollar assets with short-term FX swaps creates a maturity mismatch in dollars. When the swaps mature the bank must roll them, and in a dollar shortage the cost can spike or the funding may disappear. The principal is exchanged in an FX swap, so option B is wrong.

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