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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 uses FX swaps to turn euro funding into dollars. After the crisis, the cross-currency basis for euro/dollar has stayed persistently negative at times. Which explanation is most consistent with the remaining vulnerability, as discussed in the reading?

Balance sheet constraints on dealer banks explain the persistent negative basis. Post-crisis leverage and capital rules make arbitrage costly, so covered interest parity deviations are not fully closed while demand for synthetic dollar funding through FX swaps remains strong.

  1. AConstraints on dealer bank balance sheets and quarter-end leverage ratio reporting limit arbitrage, so covered interest parity deviations persistCorrect
  2. BRegulation has eliminated all demand for dollar hedging
  3. CCentral banks have abolished swap lines, widening the basis
  4. DInterest rate differentials are always exactly offset by spot moves, so deviations are measurement errors

Explanation

Post-crisis regulation raised the cost of balance sheet use for arbitrageurs, so they do not fully exploit deviations, while demand for dollar funding via swaps persists. The other options are factually wrong: swap lines remain and hedging demand has not vanished.

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