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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 Eurozone bank notes that the bank holds USD 50 billion of long-term dollar assets funded with USD 10 billion of dollar deposits and the rest by swapping euros into dollars via 3-month FX swaps. What is the bank's key vulnerability if dollar swap markets freeze?

The bank must repeatedly roll over USD 40 billion of short-term swap funding against long-term dollar assets. If swap markets freeze, it cannot obtain dollars, creating rollover and currency-specific liquidity risk even if it is solvent, because euro liquidity cannot be readily converted into dollars.

  1. AIt must roll over USD 40 billion of swap funding repeatedly, facing rollover and liquidity risk in dollars even though it may be solventCorrect
  2. BIt faces no risk because euro assets can offset the dollar liability
  3. CIt faces only exchange rate risk since swaps are hedged, so there is no funding risk
  4. DIt faces credit risk only on the USD 10 billion of deposits

Explanation

Dollar funding via swaps = 50 - 10 = USD 40 billion, which matures every three months against long-term assets. A freeze forces the bank to find dollars at any price. Euro liquidity cannot be converted without the swap market, so currency-specific liquidity risk remains.

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