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

A risk analyst at a European bank reviews 2008 events. Dollar money market funds, a key source of short-term funding, cut exposure to European banks sharply after the Lehman failure. Which consequence for the bank's funding strategy is most consistent with the reading?

Banks turned to FX swaps to obtain dollars when money market funds pulled back. The surge in demand for dollars through swaps widened the negative cross-currency basis, raising the cost of dollar funding and increasing dependence on swap market conditions.

  1. AThe bank shifted toward FX swap markets to obtain dollars, increasing its exposure to swap market conditions and widening cross-currency basisCorrect
  2. BThe bank's dollar funding costs fell because investors moved into bank paper
  3. CThe bank no longer needed dollars because its dollar assets matured immediately
  4. DThe bank's liquidity coverage improved automatically because its funding became more diversified

Explanation

When direct dollar funding retreated, banks turned to FX swaps to convert domestic currency to dollars. Heavy demand pushed the cross-currency basis more negative, making dollars costlier. Funding costs did not fall, and dollar assets did not vanish.

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