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

Before 2007, many European banks built large US dollar-denominated asset portfolios (e.g., US structured credit) while having few dollar retail deposits. Which funding pattern best describes how these banks financed the dollar assets, creating the vulnerability exposed in 2007-2009?

Non-US banks funded long-dated dollar assets mainly with short-term wholesale dollar borrowing and FX swaps. This created a currency and maturity mismatch, so when wholesale markets froze they faced rollover risk and a dollar shortage, because they lacked stable dollar deposits.

  1. AStable US retail deposits gathered through branch networks in the United States
  2. BShort-term wholesale dollar funding, including money market borrowing and FX swaps converting domestic currency into dollarsCorrect
  3. CLong-term dollar bonds with maturities matching the asset portfolio
  4. DDirect and unlimited access to the Federal Reserve discount window by head offices

Explanation

Non-US banks relied heavily on short-term wholesale dollar funding and on FX swaps to convert euros or other currencies into dollars. The assets were long-dated and illiquid, so a freeze in these markets created a maturity and currency mismatch. Retail deposits and matched long-term bonds were not the main funding source.

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