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

During a period of acute stress, a European bank with large US dollar assets funded by short-term wholesale dollar borrowing finds that private FX swap markets are impaired. Which official-sector arrangement is most directly designed to relieve this bank's dollar funding pressure?

A Federal Reserve swap line with the home central bank is the right tool. The Fed provides dollars to that central bank, which on-lends them to its banks against local collateral, directly easing dollar funding stress when private FX swap and wholesale markets are impaired.

  1. AA standing swap line between the Federal Reserve and the bank's home central bank, which lends dollars to the bank against local collateralCorrect
  2. BA reduction in the home central bank's policy rate in local currency
  3. CAn increase in the bank's holdings of local-currency government bonds
  4. DA Federal Reserve purchase of euro-denominated corporate bonds

Explanation

Under a swap line, the Fed exchanges dollars for foreign currency with the foreign central bank, which then lends the dollars to its domestic banks against eligible collateral. This directly supplies dollars. Lower local rates or local-currency assets do not provide dollars, and Fed purchases of euro bonds are not the mechanism.

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